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 Warren E. Buffett letters

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AuteurMessage
mihou
Rang: Administrateur
mihou


Nombre de messages : 8092
Localisation : Washington D.C.
Date d'inscription : 28/05/2005

Warren E. Buffett letters Empty
05072006
MessageWarren E. Buffett letters

BERKSHIRE HATHAWAY INC.

Chairman's Letter


To the Shareholders of Berkshire Hathaway Inc.:

Our gain in net worth during 1996 was $6.2 billion, or 36.1%. Per-
share book value, however, grew by less, 31.8%, because the number of
Berkshire shares increased: We issued stock in acquiring FlightSafety
International and also sold new Class B shares.* Over the last 32 years
(that is, since present management took over) per-share book value has
grown from $19 to $19,011, or at a rate of 23.8% compounded annually.

* Each Class B share has an economic interest equal to 1/30th of
that possessed by a Class A share, which is the new designation for
the only stock that Berkshire had outstanding before May 1996.
Throughout this report, we state all per-share figures in terms of
"Class A equivalents," which are the sum of the Class A shares
outstanding and 1/30th of the Class B shares outstanding.

For technical reasons, we have restated our 1995 financial
statements, a matter that requires me to present one of my less-than-
thrilling explanations of accounting arcana. I'll make it brief.

The restatement was required because GEICO became a wholly-owned
subsidiary of Berkshire on January 2, 1996, whereas it was previously
classified as an investment. From an economic viewpoint - taking into
account major tax efficiencies and other benefits we gained - the value
of the 51% of GEICO we owned at year-end 1995 increased significantly
when we acquired the remaining 49% of the company two days later.
Accounting rules applicable to this type of "step acquisition," however,
required us to write down the value of our 51% at the time we moved to
100%. That writedown - which also, of course, reduced book value -
amounted to $478.4 million. As a result, we now carry our original 51%
of GEICO at a value that is both lower than its market value at the time
we purchased the remaining 49% of the company and lower than the value at
which we carry that 49% itself.

There is an offset, however, to the reduction in book value I have
just described: Twice during 1996 we issued Berkshire shares at a
premium to book value, first in May when we sold the B shares for cash
and again in December when we used both A and B shares as part-payment
for FlightSafety. In total, the three non-operational items affecting
book value contributed less than one percentage point to our 31.8% per-
share gain last year.

I dwell on this rise in per-share book value because it roughly
indicates our economic progress during the year. But, as Charlie Munger,
Berkshire's Vice Chairman, and I have repeatedly told you, what counts at
Berkshire is intrinsic value, not book value. The last time you got that
message from us was in the Owner's Manual, sent to you in June after we
issued the Class B shares. In that manual, we not only defined certain
key terms - such as intrinsic value - but also set forth our economic
principles.

For many years, we have listed these principles in the front of our
annual report, but in this report, on pages 58 to 67, we reproduce the
entire Owner's Manual. In this letter, we will occasionally refer to the
manual so that we can avoid repeating certain definitions and
explanations. For example, if you wish to brush up on "intrinsic value,"
see pages 64 and 65.

Last year, for the first time, we supplied you with a table that
Charlie and I believe will help anyone trying to estimate Berkshire's
intrinsic value. In the updated version of that table, which follows, we
trace two key indices of value. The first column lists our per-share
ownership of investments (including cash and equivalents) and the second
column shows our per-share earnings from Berkshire's operating businesses
before taxes and purchase-accounting adjustments but after all interest
and corporate overhead expenses. The operating-earnings column excludes
all dividends, interest and capital gains that we realized from the
investments presented in the first column. In effect, the two columns
show what Berkshire would have reported had it been broken into two parts.


Pre-tax Earnings Per Share
Investments Excluding All Income from
Year Per Share Investments
---- ----------- -------------------------
1965................................$ 4 $ 4.08
1975................................ 159 (6.48)
1985................................ 2,443 18.86
1995................................ 22,088 258.20
1996................................ 28,500 421.39

Annual Growth Rate, 1965-95......... 33.4% 14.7%
One-Year Growth Rate, 1995-96 ...... 29.0% 63.2%


As the table tells you, our investments per share increased in 1996
by 29.0% and our non-investment earnings grew by 63.2%. Our goal is to
keep the numbers in both columns moving ahead at a reasonable (or, better
yet, unreasonable) pace.

Our expectations, however, are tempered by two realities. First,
our past rates of growth cannot be matched nor even approached:
Berkshire's equity capital is now large - in fact, fewer than ten
businesses in America have capital larger - and an abundance of funds
tends to dampen returns. Second, whatever our rate of progress, it will
not be smooth: Year-to-year moves in the first column of the table above
will be influenced in a major way by fluctuations in securities markets;
the figures in the second column will be affected by wide swings in the
profitability of our catastrophe-reinsurance business.

In the table, the donations made pursuant to our shareholder-
designated contributions program are charged against the second column,
though we view them as a shareholder benefit rather than as an expense.
All other corporate expenses are also charged against the second column.
These costs may be lower than those of any other large American
corporation: Our after-tax headquarters expense amounts to less than two
basis points (1/50th of 1%) measured against net worth. Even so, Charlie
used to think this expense percentage outrageously high, blaming it on my
use of Berkshire's corporate jet, The Indefensible. But Charlie has
recently experienced a "counter-revelation": With our purchase of
FlightSafety, whose major activity is the training of corporate pilots,
he now rhapsodizes at the mere mention of jets.

Seriously, costs matter. For example, equity mutual funds incur
corporate expenses - largely payments to the funds' managers - that
average about 100 basis points, a levy likely to cut the returns their
investors earn by 10% or more over time. Charlie and I make no promises
about Berkshire's results. We do promise you, however, that virtually
all of the gains Berkshire makes will end up with shareholders. We are
here to make money with you, not off you.


The Relationship of Intrinsic Value to Market Price

In last year's letter, with Berkshire shares selling at $36,000, I
told you: (1) Berkshire's gain in market value in recent years had
outstripped its gain in intrinsic value, even though the latter gain had
been highly satisfactory; (2) that kind of overperformance could not
continue indefinitely; (3) Charlie and I did not at that moment consider
Berkshire to be undervalued.

Since I set down those cautions, Berkshire's intrinsic value has
increased very significantly - aided in a major way by a stunning
performance at GEICO that I will tell you more about later - while the
market price of our shares has changed little. This, of course, means
that in 1996 Berkshire's stock underperformed the business.
Consequently, today's price/value relationship is both much different
from what it was a year ago and, as Charlie and I see it, more
appropriate.

Over time, the aggregate gains made by Berkshire shareholders must
of necessity match the business gains of the company. When the stock
temporarily overperforms or underperforms the business, a limited number
of shareholders - either sellers or buyers - receive outsized benefits at
the expense of those they trade with. Generally, the sophisticated have
an edge over the innocents in this game.

Though our primary goal is to maximize the amount that our
shareholders, in total, reap from their ownership of Berkshire, we wish
also to minimize the benefits going to some shareholders at the expense
of others. These are goals we would have were we managing a family
partnership, and we believe they make equal sense for the manager of a
public company. In a partnership, fairness requires that partnership
interests be valued equitably when partners enter or exit; in a public
company, fairness prevails when market price and intrinsic value are in
sync. Obviously, they won't always meet that ideal, but a manager - by
his policies and communications - can do much to foster equity.

Of course, the longer a shareholder holds his shares, the more
bearing Berkshire's business results will have on his financial
experience - and the less it will matter what premium or discount to
intrinsic value prevails when he buys and sells his stock. That's one
reason we hope to attract owners with long-term horizons. Overall, I
think we have succeeded in that pursuit. Berkshire probably ranks number
one among large American corporations in the percentage of its shares
held by owners with a long-term view.


Acquisitions of 1996

We made two acquisitions in 1996, both possessing exactly the
qualities we seek - excellent business economics and an outstanding
manager.

The first acquisition was Kansas Bankers Surety (KBS), an insurance
company whose name describes its specialty. The company, which does
business in 22 states, has an extraordinary underwriting record, achieved
through the efforts of Don Towle, an extraordinary manager. Don has
developed first-hand relationships with hundreds of bankers and knows
every detail of his operation. He thinks of himself as running a company
that is "his," an attitude we treasure at Berkshire. Because of its
relatively small size, we placed KBS with Wesco, our 80%-owned
subsidiary, which has wanted to expand its insurance operations.

You might be interested in the carefully-crafted and sophisticated
acquisition strategy that allowed Berkshire to nab this deal. Early in
1996 I was invited to the 40th birthday party of my nephew's wife, Jane
Rogers. My taste for social events being low, I immediately, and in my
standard, gracious way, began to invent reasons for skipping the event.
The party planners then countered brilliantly by offering me a seat next
to a man I always enjoy, Jane's dad, Roy Dinsdale - so I went.

The party took place on January 26. Though the music was loud - Why
must bands play as if they will be paid by the decibel? - I just managed
to hear Roy say he'd come from a directors meeting at Kansas Bankers
Surety, a company I'd always admired. I shouted back that he should let
me know if it ever became available for purchase.

On February 12, I got the following letter from Roy: "Dear Warren:
Enclosed is the annual financial information on Kansas Bankers Surety.
This is the company that we talked about at Janie's party. If I can be
of any further help, please let me know." On February 13, I told Roy we
would pay $75 million for the company - and before long we had a deal.
I'm now scheming to get invited to Jane's next party.

Our other acquisition in 1996 - FlightSafety International, the
world's leader in the training of pilots - was far larger, at about $1.5
billion, but had an equally serendipitous origin. The heroes of this
story are first, Richard Sercer, a Tucson aviation consultant, and
second, his wife, Alma Murphy, an ophthalmology graduate of Harvard
Medical School, who in 1990 wore down her husband's reluctance and got
him to buy Berkshire stock. Since then, the two have attended all our
Annual Meetings, but I didn't get to know them personally.

Fortunately, Richard had also been a long-time shareholder of
FlightSafety, and it occurred to him last year that the two companies
would make a good fit. He knew our acquisition criteria, and he thought
that Al Ueltschi, FlightSafety's 79-year-old CEO, might want to make a
deal that would both give him a home for his company and a security in
payment that he would feel comfortable owning throughout his lifetime.
So in July, Richard wrote Bob Denham, CEO of Salomon Inc, suggesting that
he explore the possibility of a merger.

Bob took it from there, and on September 18, Al and I met in New
York. I had long been familiar with FlightSafety's business, and in
about 60 seconds I knew that Al was exactly our kind of manager. A month
later, we had a contract. Because Charlie and I wished to minimize the
issuance of Berkshire shares, the transaction we structured gave
FlightSafety shareholders a choice of cash or stock but carried terms
that encouraged those who were tax-indifferent to take cash. This nudge
led to about 51% of FlightSafety's shares being exchanged for cash, 41%
for Berkshire A and 8% for Berkshire B.

Al has had a lifelong love affair with aviation and actually piloted
Charles Lindbergh. After a barnstorming career in the 1930s, he began
working for Juan Trippe, Pan Am's legendary chief. In 1951, while still
at Pan Am, Al founded FlightSafety, subsequently building it into a
simulator manufacturer and a worldwide trainer of pilots (single-engine,
helicopter, jet and marine). The company operates in 41 locations,
outfitted with 175 simulators of planes ranging from the very small, such
as Cessna 210s, to Boeing 747s. Simulators are not cheap - they can cost
as much as $19 million - so this business, unlike many of our
operations, is capital intensive. About half of the company's revenues
are derived from the training of corporate pilots, with most of the
balance coming from airlines and the military.

Al may be 79, but he looks and acts about 55. He will run
operations just as he has in the past: We never fool with success. I
have told him that though we don't believe in splitting Berkshire stock,
we will split his age 2-for-1 when he hits 100.

An observer might conclude from our hiring practices that Charlie
and I were traumatized early in life by an EEOC bulletin on age
discrimination. The real explanation, however, is self-interest: It's
difficult to teach a new dog old tricks. The many Berkshire managers who
are past 70 hit home runs today at the same pace that long ago gave them
reputations as young slugging sensations. Therefore, to get a job with
us, just employ the tactic of the 76-year-old who persuaded a dazzling
beauty of 25 to marry him. "How did you ever get her to accept?" asked
his envious contemporaries. The comeback: "I told her I was 86."

* * * * * * * * * * * *

And now we pause for our usual commercial: If you own a large
business with good economic characteristics and wish to become associated
with an exceptional collection of businesses having similar
characteristics, Berkshire may well be the home you seek. Our
requirements are set forth on page 21. If your company meets them - and
if I fail to make the next birthday party you attend - give me a call.


Insurance Operations - Overview

Our insurance business was terrific in 1996. In both primary
insurance, where GEICO is our main unit, and in our "super-cat"
reinsurance business, results were outstanding.

As we've explained in past reports, what counts in our insurance
business is, first, the amount of "float" we generate and, second, its
cost to us. These are matters that are important for you to understand
because float is a major component of Berkshire's intrinsic value that is
not reflected in book value.
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Warren E. Buffett letters :: Commentaires

mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:25 par mihou
To begin with, float is money we hold but don't own. In an
insurance operation, float arises because premiums are received before
losses are paid. Secondly, the premiums that an insurer takes in
typically do not cover the losses and expenses it eventually must pay.
That leaves it running an "underwriting loss," which is the cost of
float. An insurance business has value if its cost of float over time is
less than the cost the company would otherwise incur to obtain funds.
But the business is an albatross if the cost of its float is higher than
market rates for money.

As the numbers in the following table show, Berkshire's insurance
business has been a huge winner. For the table, we have calculated our
float - which we generate in large amounts relative to our premium
volume - by adding loss reserves, loss adjustment reserves, funds held
under reinsurance assumed and unearned premium reserves, and then
subtracting agents' balances, prepaid acquisition costs, prepaid taxes
and deferred charges applicable to assumed reinsurance. Our cost of
float is determined by our underwriting loss or profit. In those years
when we have had an underwriting profit, such as the last four, our cost
of float has been negative. In effect, we have been paid for holding
money.

(1) (2) Yearend Yield
Underwriting Approximat on Long-Term
Loss Average Float Cost of Funds Govt. Bonds
------------ ------------- ---------------- -------------
(In $ Millions) (Ratio of 1 to 2)

1967.......... profit 17.3 less than zero 5.50%
1968.......... profit 19.9 less than zero 5.90%
1969.......... profit 23.4 less than zero 6.79%
1970.......... 0.37 32.4 1.14% 6.25%
1971.......... profit 52.5 less than zero 5.81%
1972.......... profit 69.5 less than zero 5.82%
1973.......... profit 73.3 less than zero 7.27%
1974.......... 7.36 79.1 9.30% 8.13%
1975.......... 11.35 87.6 12.96% 8.03%
1976.......... profit 102.6 less than zero 7.30%
1977.......... profit 139.0 less than zero 7.97%
1978.......... profit 190.4 less than zero 8.93%
1979.......... profit 227.3 less than zero 10.08%
1980.......... profit 237.0 less than zero 11.94%
1981.......... profit 228.4 less than zero 13.61%
1982.......... 21.56 220.6 9.77% 10.64%
1983.......... 33.87 231.3 14.64% 11.84%
1984.......... 48.06 253.2 18.98% 11.58%
1985.......... 44.23 390.2 11.34% 9.34%
1986.......... 55.84 797.5 7.00% 7.60%
1987.......... 55.43 1,266.7 4.38% 8.95%
1988.......... 11.08 1,497.7 0.74% 9.00%
1989.......... 24.40 1,541.3 1.58% 7.97%
1990.......... 26.65 1,637.3 1.63% 8.24%
1991.......... 119.59 1,895.0 6.31% 7.40%
1992.......... 108.96 2,290.4 4.76% 7.39%
1993.......... profit 2,624.7 less than zero 6.35%
1994.......... profit 3,056.6 less than zero 7.88%
1995.......... profit 3,607.2 less than zero 5.95%
1996.......... profit 6,702.0 less than zero 6.64%

Since 1967, when we entered the insurance business, our float has
grown at an annual compounded rate of 22.3%. In more years than not, our
cost of funds has been less than nothing. This access to "free" money has
boosted Berkshire's performance in a major way. Moreover, our acquisition
of GEICO materially increases the probability that we can continue to
obtain "free" funds in increasing amounts.
Super-Cat Insurance

As in the past three years, we once again stress that the good results
we are reporting for Berkshire stem in part from our super-cat business
having a lucky year. In this operation, we sell policies that insurance
and reinsurance companies buy to protect themselves from the effects of
mega-catastrophes. Since truly major catastrophes are rare occurrences,
our super-cat business can be expected to show large profits in most years
- and to record a huge loss occasionally. In other words, the
attractiveness of our super-cat business will take a great many years to
measure. What you must understand, however, is that a truly terrible year
in the super-cat business is not a possibility - it's a certainty. The
only question is when it will come.

I emphasize this lugubrious point because I would not want you to
panic and sell your Berkshire stock upon hearing that some large
catastrophe had cost us a significant amount. If you would tend to react
that way, you should not own Berkshire shares now, just as you should
entirely avoid owning stocks if a crashing market would lead you to panic
and sell. Selling fine businesses on "scary" news is usually a bad
decision. (Robert Woodruff, the business genius who built Coca-Cola over
many decades and who owned a huge position in the company, was once asked
when it might be a good time to sell Coke stock. Woodruff had a simple
answer: "I don't know. I've never sold any.")
In our super-cat operation, our customers are insurers that are
exposed to major earnings volatility and that wish to reduce it. The
product we sell - for what we hope is an appropriate price - is our
willingness to shift that volatility to our own books. Gyrations in
Berkshire's earnings don't bother us in the least: Charlie and I would
much rather earn a lumpy 15% over time than a smooth 12%. (After all, our
earnings swing wildly on a daily and weekly basis - why should we demand
that smoothness accompany each orbit that the earth makes of the sun?) We
are most comfortable with that thinking, however, when we have
shareholder/partners who can also accept volatility, and that's why we
regularly repeat our cautions.

We took on some major super-cat exposures during 1996. At mid-year we
wrote a contract with Allstate that covers Florida hurricanes, and though
there are no definitive records that would allow us to prove this point, we
believe that to have then been the largest single catastrophe risk ever
assumed by one company for its own account. Later in the year, however, we
wrote a policy for the California Earthquake Authority that goes into
effect on April 1, 1997, and that exposes us to a loss more than twice that
possible under the Florida contract. Again we retained all the risk for
our own account. Large as these coverages are, Berkshire's after-tax
"worst-case" loss from a true mega-catastrophe is probably no more than
$600 million, which is less than 3% of our book value and 1.5% of our market
value. To gain some perspective on this exposure, look at the table on
page 2 and note the much greater volatility that security markets have
delivered us.

In the super-cat business, we have three major competitive advantages.
First, the parties buying reinsurance from us know that we both can and
will pay under the most adverse of circumstances. Were a truly cataclysmic
disaster to occur, it is not impossible that a financial panic would
quickly follow. If that happened, there could well be respected reinsurers
that would have difficulty paying at just the moment that their clients
faced extraordinary needs. Indeed, one reason we never "lay off" part of
the risks we insure is that we have reservations about our ability to
collect from others when disaster strikes. When it's Berkshire promising,
insureds know with certainty that they can collect promptly.

Our second advantage - somewhat related - is subtle but important.
After a mega-catastrophe, insurers might well find it difficult to obtain
reinsurance even though their need for coverage would then be particularly
great. At such a time, Berkshire would without question have very
substantial capacity available - but it will naturally be our long-standing
clients that have first call on it. That business reality has made major
insurers and reinsurers throughout the world realize the desirability of
doing business with us. Indeed, we are currently getting sizable "stand-
by" fees from reinsurers that are simply nailing down their ability to get
coverage from us should the market tighten.

Our final competitive advantage is that we can provide dollar
coverages of a size neither matched nor approached elsewhere in the
industry. Insurers looking for huge covers know that a single call to
Berkshire will produce a firm and immediate offering.

A few facts about our exposure to California earthquakes - our largest
risk - seem in order. The Northridge quake of 1994 laid homeowners' losses
on insurers that greatly exceeded what computer models had told them to
expect. Yet the intensity of that quake was mild compared to the "worst-
case" possibility for California. Understandably, insurers became - ahem -
shaken and started contemplating a retreat from writing earthquake coverage
into their homeowners' policies.

In a thoughtful response, Chuck Quackenbush, California's insurance
commissioner, designed a new residential earthquake policy to be written by
a state-sponsored insurer, The California Earthquake Authority. This
entity, which went into operation on December 1, 1996, needed large layers
of reinsurance - and that's where we came in. Berkshire's layer of
approximately $1 billion will be called upon if the Authority's aggregate
losses in the period ending March 31, 2001 exceed about $5 billion. (The
press originally reported larger figures, but these would have applied only
if all California insurers had entered into the arrangement; instead only
72% signed up.)

So what are the true odds of our having to make a payout during the
policy's term? We don't know - nor do we think computer models will help
us, since we believe the precision they project is a chimera. In fact,
such models can lull decision-makers into a false sense of security and
thereby increase their chances of making a really huge mistake. We've
already seen such debacles in both insurance and investments. Witness
"portfolio insurance," whose destructive effects in the 1987 market crash
led one wag to observe that it was the computers that should have been
jumping out of windows.

Even if perfection in assessing risks is unattainable, insurers can
underwrite sensibly. After all, you need not know a man's precise age to
know that he is old enough to vote nor know his exact weight to recognize
his need to diet. In insurance, it is essential to remember that virtually
all surprises are unpleasant, and with that in mind we try to price our
super-cat exposures so that about 90% of total premiums end up being
eventually paid out in losses and expenses. Over time, we will find out
how smart our pricing has been, but that will not be quickly. The super-
cat business is just like the investment business in that it often takes a
long time to find out whether you knew what you were doing.

What I can state with certainty, however, is that we have the best
person in the world to run our super-cat business: Ajit Jain, whose value
to Berkshire is simply enormous. In the reinsurance field, disastrous
propositions abound. I know that because I personally embraced all too
many of these in the 1970s and also because GEICO has a large runoff
portfolio made up of foolish contracts written in the early-1980s, able
though its then-management was. Ajit, I can assure you, won't make
mistakes of this type.

I have mentioned that a mega-catastrophe might cause a catastrophe in
the financial markets, a possibility that is unlikely but not far-fetched.
Were the catastrophe a quake in California of sufficient magnitude to tap
our coverage, we would almost certainly be damaged in other ways as well.
For example, See's, Wells Fargo and Freddie Mac could be hit hard. All in
all, though, we can handle this aggregation of exposures.

In this respect, as in others, we try to "reverse engineer" our future
at Berkshire, bearing in mind Charlie's dictum: "All I want to know is
where I'm going to die so I'll never go there." (Inverting really works:
Try singing country western songs backwards and you will quickly regain
your house, your car and your wife.) If we can't tolerate a possible
consequence, remote though it may be, we steer clear of planting its seeds.
That is why we don't borrow big amounts and why we make sure that our
super-cat business losses, large though the maximums may sound, will not
put a major dent in Berkshire's intrinsic value.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:27 par mihou
Insurance - GEICO and Other Primary Operations

When we moved to total ownership of GEICO early last year, our
expectations were high - and they are all being exceeded. That is true
from both a business and personal perspective: GEICO's operating chief,
Tony Nicely, is a superb business manager and a delight to work with.
Under almost any conditions, GEICO would be an exceptionally valuable
asset. With Tony at the helm, it is reaching levels of performance that
the organization would only a few years ago have thought impossible.

There's nothing esoteric about GEICO's success: The company's
competitive strength flows directly from its position as a low-cost
operator. Low costs permit low prices, and low prices attract and retain
good policyholders. The final segment of a virtuous circle is drawn when
policyholders recommend us to their friends. GEICO gets more than one
million referrals annually and these produce more than half of our new
business, an advantage that gives us enormous savings in acquisition
expenses - and that makes our costs still lower.

This formula worked in spades for GEICO in 1996: Its voluntary auto
policy count grew 10%. During the previous 20 years, the company's best-
ever growth for a year had been 8%, a rate achieved only once. Better yet,
the growth in voluntary policies accelerated during the year, led by major
gains in the nonstandard market, which has been an underdeveloped area at
GEICO. I focus here on voluntary policies because the involuntary business
we get from assigned risk pools and the like is unprofitable. Growth in
that sector is most unwelcome.

GEICO's growth would mean nothing if it did not produce reasonable
underwriting profits. Here, too, the news is good: Last year we hit our
underwriting targets and then some. Our goal, however, is not to widen our
profit margin but rather to enlarge the price advantage we offer customers.
Given that strategy, we believe that 1997's growth will easily top that of
last year.

We expect new competitors to enter the direct-response market, and
some of our existing competitors are likely to expand geographically.
Nonetheless, the economies of scale we enjoy should allow us to maintain or
even widen the protective moat surrounding our economic castle. We do best
on costs in geographical areas in which we enjoy high market penetration.
As our policy count grows, concurrently delivering gains in penetration, we
expect to drive costs materially lower. GEICO's sustainable cost advantage
is what attracted me to the company way back in 1951, when the entire
business was valued at $7 million. It is also why I felt Berkshire should
pay $2.3 billion last year for the 49% of the company that we didn't then
own.

Maximizing the results of a wonderful business requires management and
focus. Lucky for us, we have in Tony a superb manager whose business focus
never wavers. Wanting also to get the entire GEICO organization
concentrating as he does, we needed a compensation plan that was itself
sharply focused - and immediately after our purchase, we put one in.

Today, the bonuses received by dozens of top executives, starting with
Tony, are based upon only two key variables: (1) growth in voluntary auto
policies and (2) underwriting profitability on "seasoned" auto business
(meaning policies that have been on the books for more than one year). In
addition, we use the same yardsticks to calculate the annual contribution
to the company's profit-sharing plan. Everyone at GEICO knows what counts.

The GEICO plan exemplifies Berkshire's incentive compensation
principles: Goals should be (1) tailored to the economics of the specific
operating business; (2) simple in character so that the degree to which
they are being realized can be easily measured; and (3) directly related to
the daily activities of plan participants. As a corollary, we shun
"lottery ticket" arrangements, such as options on Berkshire shares, whose
ultimate value - which could range from zero to huge - is totally out of
the control of the person whose behavior we would like to affect. In our
view, a system that produces quixotic payoffs will not only be wasteful for
owners but may actually discourage the focused behavior we value in
managers.

Every quarter, all 9,000 GEICO associates can see the results that
determine our profit-sharing plan contribution. In 1996, they enjoyed the
experience because the plan literally went off the chart that had been
constructed at the start of the year. Even I knew the answer to that
problem: Enlarge the chart. Ultimately, the results called for a record
contribution of 16.9% ($40 million), compared to a five-year average of
less than 10% for the comparable plans previously in effect. Furthermore,
at Berkshire, we never greet good work by raising the bar. If GEICO's
performance continues to improve, we will happily keep on making larger
charts.
Lou Simpson continues to manage GEICO's money in an outstanding
manner: Last year, the equities in his portfolio outdid the S&P 500 by 6.2
percentage points. In Lou's part of GEICO's operation, we again tie
compensation to performance - but to investment performance over a four-
year period, not to underwriting results nor to the performance of GEICO as
a whole. We think it foolish for an insurance company to pay bonuses that
are tied to overall corporate results when great work on one side of the
business - underwriting or investment - could conceivably be completely
neutralized by bad work on the other. If you bat .350 at Berkshire, you
can be sure you will get paid commensurately even if the rest of the team
bats .200. In Lou and Tony, however, we are lucky to have Hall-of-Famers
in both key positions.

* * * * * * * * * * * *

Though they are, of course, smaller than GEICO, our other primary
insurance operations turned in equally stunning results last year.
National Indemnity's traditional business had a combined ratio of 74.2 and,
as usual, developed a large amount of float compared to premium volume.
Over the last three years, this segment of our business, run by Don
Wurster, has had an average combined ratio of 83.0. Our homestate
operation, managed by Rod Eldred, recorded a combined ratio of 87.1 even
though it absorbed the expenses of expanding to new states. Rod's three-
year combined ratio is an amazing 83.2. Berkshire's workers' compensation
business, run out of California by Brad Kinstler, has now moved into six
other states and, despite the costs of that expansion, again achieved an
excellent underwriting profit. Finally, John Kizer, at Central States
Indemnity, set new records for premium volume while generating good
earnings from underwriting. In aggregate, our smaller insurance operations
(now including Kansas Bankers Surety) have an underwriting record virtually
unmatched in the industry. Don, Rod, Brad and John have all created
significant value for Berkshire, and we believe there is more to come.


Taxes

In 1961, President Kennedy said that we should ask not what our
country can do for us, but rather ask what we can do for our country. Last
year we decided to give his suggestion a try - and who says it never hurts
to ask? We were told to mail $860 million in income taxes to the U.S.
Treasury.
Here's a little perspective on that figure: If an equal amount had
been paid by only 2,000 other taxpayers, the government would have had a
balanced budget in 1996 without needing a dime of taxes - income or Social
Security or what have you - from any other American. Berkshire
shareholders can truly say, "I gave at the office."

Charlie and I believe that large tax payments by Berkshire are
entirely fitting. The contribution we thus make to society's well-being is
at most only proportional to its contribution to ours. Berkshire prospers
in America as it would nowhere else.
Sources of Reported Earnings

The table that follows shows the main sources of Berkshire's reported
earnings. In this presentation, purchase-accounting adjustments are not
assigned to the specific businesses to which they apply, but are instead
aggregated and shown separately. This procedure lets you view the earnings
of our businesses as they would have been reported had we not purchased
them. For the reasons discussed on pages 65 and 66, this form of
presentation seems to us to be more useful to investors and managers than
one utilizing generally-accepted accounting principles (GAAP), which
require purchase-premiums to be charged off business-by-business. The
total earnings we show in the table are, of course, identical to the GAAP
total in our audited financial statements.

(in millions)
--------------------------------------
Berkshire's Share
of Net Earnings
(after taxes and
Pre-tax Earnings minority interests)
---------------- -------------------
1996 1995(1) 1996 1995(1)
------- -------- ------- -------
Operating Earnings:
Insurance Group:
Underwriting.....................$ 222.1 $ 20.5 $ 142.8 $ 11.3
Net Investment Income............ 726.2 501.6 593.1 417.7
Buffalo News........................... 50.4 46.8 29.5 27.3
Fechheimer............................. 17.3 16.9 9.3 8.8
Finance Businesses..................... 23.1 20.8 14.9 12.6
Home Furnishings....................... 43.8 29.7(2) 24.8 16.7(2)
Jewelry................................ 27.8 33.9(3) 16.1 19.1(3)
Kirby.................................. 58.5 50.2 39.9 32.1
Scott Fetzer Manufacturing Group....... 50.6 34.1 32.2 21.2
See's Candies.......................... 51.9 50.2 30.8 29.8
Shoe Group............................. 61.6 58.4 41.0 37.5
World Book............................. 12.6 8.8 9.5 7.0
Purchase-Accounting Adjustments........ (75.7) (27.0) (70.5) (23.4)
Interest Expense(4).................... (94.3) (56.0) (56.6) (34.9)
Shareholder-Designated Contributions... (13.3) (11.6) (8.5) (7.0)
Other.................................. 58.8 37.4 34.8 24.4
------- -------- -------- -------
Operating Earnings.......................1,221.4 814.7 883.1 600.2
Sales of Securities......................2,484.5 194.1 1,605.5 125.0
------- -------- -------- -------
Total Earnings - All Entities...........$3,705.9 $1,008.8 $2,488.6 $ 725.2
======= ======== ======== =======
(1) Before the GEICO-related restatement. (3) Includes Helzberg's from
April 30, 1995.
(2) Includes R.C. Willey from June 29, 1995. (4) Excludes interest expense
of Finance Businesses.

In this section last year, I discussed three businesses that reported
a decline in earnings - Buffalo News, Shoe Group and World Book. All, I'm
happy to say, recorded gains in 1996.

World Book, however, did not find it easy: Despite the operation's
new status as the only direct-seller of encyclopedias in the country
(Encyclopedia Britannica exited the field last year), its unit volume fell.
Additionally, World Book spent heavily on a new CD-ROM product that began
to take in revenues only in early 1997, when it was launched in association
with IBM. In the face of these factors, earnings would have evaporated had
World Book not revamped distribution methods and cut overhead at
headquarters, thereby dramatically reducing its fixed costs. Overall, the
company has gone a long way toward assuring its long-term viability in both
the print and electronic marketplaces.

Our only disappointment last year was in jewelry: Borsheim's did
fine, but Helzberg's suffered a material decline in earnings. Its expense
levels had been geared to a sizable increase in same-store sales,
consistent with the gains achieved in recent years. When sales were
instead flat, profit margins fell. Jeff Comment, CEO of Helzberg's, is
addressing the expense problem in a decisive manner, and the company's
earnings should improve in 1997.

Overall, our operating businesses continue to perform exceptionally,
far outdoing their industry norms. For this, Charlie and I thank our
managers. If you should see any of them at the Annual Meeting, add your
thanks as well.

More information about our various businesses is given on pages 36-
46, where you will also find our segment earnings reported on a GAAP
basis. In addition, on pages 51-57, we have rearranged Berkshire's
financial data into four segments on a non-GAAP basis, a presentation
that corresponds to the way Charlie and I think about the company. Our
intent is to supply you with the financial information that we would wish
you to give us if our positions were reversed.

"Look-Through" Earnings

Reported earnings are a poor measure of economic progress at
Berkshire, in part because the numbers shown in the table presented
earlier include only the dividends we receive from investees - though
these dividends typically represent only a small fraction of the earnings
attributable to our ownership. Not that we mind this division of money,
since on balance we regard the undistributed earnings of investees as
more valuable to us than the portion paid out. The reason is simple:
Our investees often have the opportunity to reinvest earnings at high
rates of return. So why should we want them paid out?

To depict something closer to economic reality at Berkshire than
reported earnings, though, we employ the concept of "look-through"
earnings. As we calculate these, they consist of: (1) the operating
earnings reported in the previous section, plus; (2) our share of the
retained operating earnings of major investees that, under GAAP
accounting, are not reflected in our profits, less; (3) an allowance for
the tax that would be paid by Berkshire if these retained earnings of
investees had instead been distributed to us. When tabulating "operating
earnings" here, we exclude purchase-accounting adjustments as well as
capital gains and other major non-recurring items.

The following table sets forth our 1996 look-through earnings,
though I warn you that the figures can be no more than approximate, since
they are based on a number of judgment calls. (The dividends paid to us
by these investees have been included in the operating earnings itemized
on page 12, mostly under "Insurance Group: Net Investment Income.")
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:27 par mihou
Berkshire's Share
of Undistributed
Berkshire's Approximate Operating Earnings
Berkshire's Major Investees Ownership at Yearend(1) (in millions)(2)
-------------------------------- ----------------------- ------------------

American Express Company........ 10.5% $ 132
The Coca-Cola Company........... 8.1% 180
The Walt Disney Company......... 3.6% 50
Federal Home Loan Mortgage Corp. 8.4% 77
The Gillette Company............ 8.6% 73
McDonald's Corporation.......... 4.3% 38
The Washington Post Company..... 15.8% 27
Wells Fargo & Company........... 8.0% 84
------
Berkshire's share of undistributed earnings of major investees.. 661
Hypothetical tax on these undistributed investee earnings(3).... (93)
Reported operating earnings of Berkshire........................ 954
------
Total look-through earnings of Berkshire..................$2,522
======

(1) Does not include shares allocable to minority interests
(2) Calculated on average ownership for the year
(3) The tax rate used is 14%, which is the rate Berkshire pays on
the dividends it receives


Common Stock Investments

Below we present our common stock investments. Those with a market
value of more than $500 million are itemized.

12/31/96
Shares Company Cost* Market
----------- --------------------------------- -------- ---------
(dollars in millions)
49,456,900 American Express Company...........$2,392.7 $ 2,794.3
200,000,000 The Coca-Cola Company.............. 1,298.9 10,525.0
24,614,214 The Walt Disney Company............ 577.0 1,716.8
64,246,000 Federal Home Loan Mortgage Corp.... 333.4 1,772.8
48,000,000 The Gillette Company............... 600.0 3,732.0
30,156,600 McDonald's Corporation............. 1,265.3 1,368.4
1,727,765 The Washington Post Company........ 10.6 579.0
7,291,418 Wells Fargo & Company.............. 497.8 1,966.9
Others............................. 1,934.5 3,295.4
-------- ---------
Total Common Stocks................$7,910.2 $27,750.6
======== =========

* Represents tax-basis cost which, in aggregate, is $1.2 billion
less than GAAP cost.

Our portfolio shows little change: We continue to make more money
when snoring than when active.

Inactivity strikes us as intelligent behavior. Neither we nor most
business managers would dream of feverishly trading highly-profitable
subsidiaries because a small move in the Federal Reserve's discount rate
was predicted or because some Wall Street pundit had reversed his views
on the market. Why, then, should we behave differently with our minority
positions in wonderful businesses? The art of investing in public
companies successfully is little different from the art of successfully
acquiring subsidiaries. In each case you simply want to acquire, at a
sensible price, a business with excellent economics and able, honest
management. Thereafter, you need only monitor whether these qualities
are being preserved.

When carried out capably, an investment strategy of that type will
often result in its practitioner owning a few securities that will come
to represent a very large portion of his portfolio. This investor would
get a similar result if he followed a policy of purchasing an interest
in, say, 20% of the future earnings of a number of outstanding college
basketball stars. A handful of these would go on to achieve NBA stardom,
and the investor's take from them would soon dominate his royalty stream.
To suggest that this investor should sell off portions of his most
successful investments simply because they have come to dominate his
portfolio is akin to suggesting that the Bulls trade Michael Jordan
because he has become so important to the team.

In studying the investments we have made in both subsidiary
companies and common stocks, you will see that we favor businesses and
industries unlikely to experience major change. The reason for that is
simple: Making either type of purchase, we are searching for operations
that we believe are virtually certain to possess enormous competitive
strength ten or twenty years from now. A fast-changing industry
environment may offer the chance for huge wins, but it precludes the
certainty we seek.

I should emphasize that, as citizens, Charlie and I welcome change:
Fresh ideas, new products, innovative processes and the like cause our
country's standard of living to rise, and that's clearly good. As
investors, however, our reaction to a fermenting industry is much like
our attitude toward space exploration: We applaud the endeavor but
prefer to skip the ride.
Obviously all businesses change to some extent. Today, See's is
different in many ways from what it was in 1972 when we bought it: It
offers a different assortment of candy, employs different machinery and
sells through different distribution channels. But the reasons why
people today buy boxed chocolates, and why they buy them from us rather
than from someone else, are virtually unchanged from what they were in
the 1920s when the See family was building the business. Moreover, these
motivations are not likely to change over the next 20 years, or even 50.

We look for similar predictability in marketable securities. Take
Coca-Cola: The zeal and imagination with which Coke products are sold
has burgeoned under Roberto Goizueta, who has done an absolutely
incredible job in creating value for his shareholders. Aided by Don
Keough and Doug Ivester, Roberto has rethought and improved every aspect
of the company. But the fundamentals of the business - the qualities
that underlie Coke's competitive dominance and stunning economics - have
remained constant through the years.

I was recently studying the 1896 report of Coke (and you think that
you are behind in your reading!). At that time Coke, though it was
already the leading soft drink, had been around for only a decade. But
its blueprint for the next 100 years was already drawn. Reporting sales
of $148,000 that year, Asa Candler, the company's president, said: "We
have not lagged in our efforts to go into all the world teaching that
Coca-Cola is the article, par excellence, for the health and good feeling
of all people." Though "health" may have been a reach, I love the fact
that Coke still relies on Candler's basic theme today - a century later.
Candler went on to say, just as Roberto could now, "No article of like
character has ever so firmly entrenched itself in public favor." Sales
of syrup that year, incidentally, were 116,492 gallons versus about 3.2
billion in 1996.

I can't resist one more Candler quote: "Beginning this year about
March 1st . . . we employed ten traveling salesmen by means of which,
with systematic correspondence from the office, we covered almost the
territory of the Union." That's my kind of sales force.

Companies such as Coca-Cola and Gillette might well be labeled "The
Inevitables." Forecasters may differ a bit in their predictions of
exactly how much soft drink or shaving-equipment business these companies
will be doing in ten or twenty years. Nor is our talk of inevitability
meant to play down the vital work that these companies must continue to
carry out, in such areas as manufacturing, distribution, packaging and
product innovation. In the end, however, no sensible observer - not even
these companies' most vigorous competitors, assuming they are assessing
the matter honestly - questions that Coke and Gillette will dominate
their fields worldwide for an investment lifetime. Indeed, their
dominance will probably strengthen. Both companies have significantly
expanded their already huge shares of market during the past ten years,
and all signs point to their repeating that performance in the next
decade.

Obviously many companies in high-tech businesses or embryonic
industries will grow much faster in percentage terms than will The
Inevitables. But I would rather be certain of a good result than hopeful
of a great one.

Of course, Charlie and I can identify only a few Inevitables, even
after a lifetime of looking for them. Leadership alone provides no
certainties: Witness the shocks some years back at General Motors, IBM
and Sears, all of which had enjoyed long periods of seeming
invincibility. Though some industries or lines of business exhibit
characteristics that endow leaders with virtually insurmountable
advantages, and that tend to establish Survival of the Fattest as almost
a natural law, most do not. Thus, for every Inevitable, there are dozens
of Impostors, companies now riding high but vulnerable to competitive
attacks. Considering what it takes to be an Inevitable, Charlie and I
recognize that we will never be able to come up with a Nifty Fifty or
even a Twinkling Twenty. To the Inevitables in our portfolio, therefore,
we add a few "Highly Probables."

You can, of course, pay too much for even the best of businesses.
The overpayment risk surfaces periodically and, in our opinion, may now
be quite high for the purchasers of virtually all stocks, The Inevitables
included. Investors making purchases in an overheated market need to
recognize that it may often take an extended period for the value of even
an outstanding company to catch up with the price they paid.

A far more serious problem occurs when the management of a great
company gets sidetracked and neglects its wonderful base business while
purchasing other businesses that are so-so or worse. When that happens,
the suffering of investors is often prolonged. Unfortunately, that is
precisely what transpired years ago at both Coke and Gillette. (Would
you believe that a few decades back they were growing shrimp at Coke and
exploring for oil at Gillette?) Loss of focus is what most worries
Charlie and me when we contemplate investing in businesses that in
general look outstanding. All too often, we've seen value stagnate in
the presence of hubris or of boredom that caused the attention of
managers to wander. That's not going to happen again at Coke and
Gillette, however - not given their current and prospective managements.

* * * * * * * * * * * *

Let me add a few thoughts about your own investments. Most
investors, both institutional and individual, will find that the best way
to own common stocks is through an index fund that charges minimal fees.
Those following this path are sure to beat the net results (after fees
and expenses) delivered by the great majority of investment
professionals.

Should you choose, however, to construct your own portfolio, there
are a few thoughts worth remembering. Intelligent investing is not
complex, though that is far from saying that it is easy. What an
investor needs is the ability to correctly evaluate selected businesses.
Note that word "selected": You don't have to be an expert on every
company, or even many. You only have to be able to evaluate companies
within your circle of competence. The size of that circle is not very
important; knowing its boundaries, however, is vital.

To invest successfully, you need not understand beta, efficient
markets, modern portfolio theory, option pricing or emerging markets.
You may, in fact, be better off knowing nothing of these. That, of
course, is not the prevailing view at most business schools, whose
finance curriculum tends to be dominated by such subjects. In our view,
though, investment students need only two well-taught courses - How to
Value a Business, and How to Think About Market Prices.

Your goal as an investor should simply be to purchase, at a rational
price, a part interest in an easily-understandable business whose
earnings are virtually certain to be materially higher five, ten and
twenty years from now. Over time, you will find only a few companies
that meet these standards - so when you see one that qualifies, you
should buy a meaningful amount of stock. You must also resist the
temptation to stray from your guidelines: If you aren't willing to own a
stock for ten years, don't even think about owning it for ten minutes.
Put together a portfolio of companies whose aggregate earnings march
upward over the years, and so also will the portfolio's market value.

Though it's seldom recognized, this is the exact approach that has
produced gains for Berkshire shareholders: Our look-through earnings
have grown at a good clip over the years, and our stock price has risen
correspondingly. Had those gains in earnings not materialized, there
would have been little increase in Berkshire's value.

The greatly enlarged earnings base we now enjoy will inevitably
cause our future gains to lag those of the past. We will continue,
however, to push in the directions we always have. We will try to build
earnings by running our present businesses well - a job made easy because
of the extraordinary talents of our operating managers - and by
purchasing other businesses, in whole or in part, that are not likely to
be roiled by change and that possess important competitive advantages.


USAir

When Richard Branson, the wealthy owner of Virgin Atlantic Airways,
was asked how to become a millionaire, he had a quick answer: "There's
really nothing to it. Start as a billionaire and then buy an airline."
Unwilling to accept Branson's proposition on faith, your Chairman decided
in 1989 to test it by investing $358 million in a 9.25% preferred stock of
USAir.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:28 par mihou
I liked and admired Ed Colodny, the company's then-CEO, and I still
do. But my analysis of USAir's business was both superficial and wrong.
I was so beguiled by the company's long history of profitable
operations, and by the protection that ownership of a senior security
seemingly offered me, that I overlooked the crucial point: USAir's
revenues would increasingly feel the effects of an unregulated, fiercely-
competitive market whereas its cost structure was a holdover from the
days when regulation protected profits. These costs, if left unchecked,
portended disaster, however reassuring the airline's past record might
be. (If history supplied all of the answers, the Forbes 400 would
consist of librarians.)

To rationalize its costs, however, USAir needed major improvements
in its labor contracts - and that's something most airlines have found it
extraordinarily difficult to get, short of credibly threatening, or
actually entering, bankruptcy. USAir was to be no exception.
Immediately after we purchased our preferred stock, the imbalance between
the company's costs and revenues began to grow explosively. In the 1990-
1994 period, USAir lost an aggregate of $2.4 billion, a performance that
totally wiped out the book equity of its common stock.

For much of this period, the company paid us our preferred
dividends, but in 1994 payment was suspended. A bit later, with the
situation looking particularly gloomy, we wrote down our investment by
75%, to $89.5 million. Thereafter, during much of 1995, I offered to
sell our shares at 50% of face value. Fortunately, I was unsuccessful.

Mixed in with my many mistakes at USAir was one thing I got right:
Making our investment, we wrote into the preferred contract a somewhat
unusual provision stipulating that "penalty dividends" - to run five
percentage points over the prime rate - would be accrued on any
arrearages. This meant that when our 9.25% dividend was omitted for two
years, the unpaid amounts compounded at rates ranging between 13.25% and
14%.

Facing this penalty provision, USAir had every incentive to pay
arrearages just as promptly as it could. And in the second half of 1996,
when USAir turned profitable, it indeed began to pay, giving us $47.9
million. We owe Stephen Wolf, the company's CEO, a huge thank-you for
extracting a performance from the airline that permitted this payment.
Even so, USAir's performance has recently been helped significantly by an
industry tailwind that may be cyclical in nature. The company still has
basic cost problems that must be solved.

In any event, the prices of USAir's publicly-traded securities tell
us that our preferred stock is now probably worth its par value of $358
million, give or take a little. In addition, we have over the years
collected an aggregate of $240.5 million in dividends (including $30
million received in 1997).

Early in 1996, before any accrued dividends had been paid, I tried
once more to unload our holdings - this time for about $335 million.
You're lucky: I again failed in my attempt to snatch defeat from the
jaws of victory.

In another context, a friend once asked me: "If you're so rich, why
aren't you smart?" After reviewing my sorry performance with USAir, you
may conclude he had a point.


Financings

We wrote four checks to Salomon Brothers last year and in each case
were delighted with the work for which we were paying. I've already
described one transaction: the FlightSafety purchase in which Salomon was
the initiating investment banker. In a second deal, the firm placed a
small debt offering for our finance subsidiary.

Additionally, we made two good-sized offerings through Salomon, both
with interesting aspects. The first was our sale in May of 517,500
shares of Class B Common, which generated net proceeds of $565 million.
As I have told you before, we made this sale in response to the
threatened creation of unit trusts that would have marketed themselves as
Berkshire look-alikes. In the process, they would have used our past,
and definitely nonrepeatable, record to entice naive small investors and
would have charged these innocents high fees and commissions.

I think it would have been quite easy for such trusts to have sold
many billions of dollars worth of units, and I also believe that early
marketing successes by these trusts would have led to the formation of
others. (In the securities business, whatever can be sold will be sold.)
The trusts would have meanwhile indiscriminately poured the proceeds of
their offerings into a supply of Berkshire shares that is fixed and
limited. The likely result: a speculative bubble in our stock. For at
least a time, the price jump would have been self-validating, in that it
would have pulled new waves of naive and impressionable investors into
the trusts and set off still more buying of Berkshire shares.

Some Berkshire shareholders choosing to exit might have found that
outcome ideal, since they could have profited at the expense of the
buyers entering with false hopes. Continuing shareholders, however,
would have suffered once reality set in, for at that point Berkshire
would have been burdened with both hundreds of thousands of unhappy,
indirect owners (trustholders, that is) and a stained reputation.

Our issuance of the B shares not only arrested the sale of the
trusts, but provided a low-cost way for people to invest in Berkshire if
they still wished to after hearing the warnings we issued. To blunt the
enthusiasm that brokers normally have for pushing new issues - because
that's where the money is - we arranged for our offering to carry a
commission of only 1.5%, the lowest payoff that we have ever seen in a
common stock underwriting. Additionally, we made the amount of the
offering open-ended, thereby repelling the typical IPO buyer who looks
for a short-term price spurt arising from a combination of hype and
scarcity.

Overall, we tried to make sure that the B stock would be purchased
only by investors with a long-term perspective. Those efforts were
generally successful: Trading volume in the B shares immediately
following the offering - a rough index of "flipping" - was far below the
norm for a new issue. In the end we added about 40,000 shareholders,
most of whom we believe both understand what they own and share our time
horizons.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:28 par mihou
Salomon could not have performed better in the handling of this
unusual transaction. Its investment bankers understood perfectly what we
were trying to achieve and tailored every aspect of the offering to meet
these objectives. The firm would have made far more money - perhaps ten
times as much - if our offering had been standard in its make-up. But
the investment bankers involved made no attempt to tweak the specifics in
that direction. Instead they came up with ideas that were counter to
Salomon's financial interest but that made it much more certain
Berkshire's goals would be reached. Terry Fitzgerald captained this
effort, and we thank him for the job that he did.

Given that background, it won't surprise you to learn that we again
went to Terry when we decided late in the year to sell an issue of
Berkshire notes that can be exchanged for a portion of the Salomon shares
that we hold. In this instance, once again, Salomon did an absolutely
first-class job, selling $500 million principal amount of five-year notes
for $447.1 million. Each $1,000 note is exchangeable into 17.65 shares
and is callable in three years at accreted value. Counting the original
issue discount and a 1% coupon, the securities will provide a yield of 3%
to maturity for holders who do not exchange them for Salomon stock. But
it seems quite likely that the notes will be exchanged before their
maturity. If that happens, our interest cost will be about 1.1% for the
period prior to exchange.

In recent years, it has been written that Charlie and I are unhappy
about all investment-banking fees. That's dead wrong. We have paid a
great many fees over the last 30 years - beginning with the check we
wrote to Charlie Heider upon our purchase of National Indemnity in 1967 -
and we are delighted to make payments that are commensurate with
performance. In the case of the 1996 transactions at Salomon Brothers,
we more than got our money's worth.


Miscellaneous

Though it was a close decision, Charlie and I have decided to enter
the 20th Century. Accordingly, we are going to put future quarterly and
annual reports of Berkshire on the Internet, where they can be accessed
via http://www.berkshirehathaway.com. We will always "post" these
reports on a Saturday so that anyone interested will have ample time to
digest the information before trading begins. Our publishing schedule
for the next 12 months is May 17, 1997, August 16, 1997, November 15,
1997, and March 14, 1998. We will also post any press releases that we
issue.

At some point, we may stop mailing our quarterly reports and simply
post these on the Internet. This move would eliminate significant costs.
Also, we have a large number of "street name" holders and have found
that the distribution of our quarterlies to them is highly erratic: Some
holders receive their mailings weeks later than others.

The drawback to Internet-only distribution is that many of our
shareholders lack computers. Most of these holders, however, could
easily obtain printouts at work or through friends. Please let me know
if you prefer that we continue mailing quarterlies. We want your input -
starting with whether you even read these reports - and at a minimum will
make no change in 1997. Also, we will definitely keep delivering the
annual report in its present form in addition to publishing it on the
Internet.

* * * * * * * * * * * *

About 97.2% of all eligible shares participated in Berkshire's 1996
shareholder-designated contributions program. Contributions made were
$13.3 million, and 3,910 charities were recipients. A full description
of the shareholder-designated contributions program appears on pages 48-
49.

Every year a few shareholders miss out on the program because they
don't have their shares registered in their own names on the prescribed
record date or because they fail to get the designation form back to us
within the 60-day period allowed. This is distressing to Charlie and me.
But if replies are received late, we have to reject them because we
can't make exceptions for some shareholders while refusing to make them
for others.

To participate in future programs, you must own Class A shares that
are registered in the name of the actual owner, not the nominee name of a
broker, bank or depository. Shares not so registered on August 31, 1997,
will be ineligible for the 1997 program. When you get the form, return
it promptly so that it does not get put aside or forgotten.


The Annual Meeting

Our capitalist's version of Woodstock -the Berkshire Annual Meeting-
will be held on Monday, May 5. Charlie and I thoroughly enjoy this
event, and we hope that you come. We will start at 9:30 a.m., break for
about 15 minutes at noon (food will be available - but at a price, of
course), and then continue talking to hard-core attendees until at least
3:30. Last year we had representatives from all 50 states, as well as
Australia, Greece, Israel, Portugal, Singapore, Sweden, Switzerland, and
the United Kingdom. The annual meeting is a time for owners to get their
business-related questions answered, and therefore Charlie and I will
stay on stage until we start getting punchy. (When that happens, I hope
you notice a change.)

Last year we had attendance of 5,000 and strained the capacity of
the Holiday Convention Centre, even though we spread out over three
rooms. This year, our new Class B shares have caused a doubling of our
stockholder count, and we are therefore moving the meeting to the
Aksarben Coliseum, which holds about 10,000 and also has a huge parking
lot. The doors will open for the meeting at 7:00 a.m., and at 8:30 we
will - upon popular demand - show a new Berkshire movie produced by Marc
Hamburg, our CFO. (In this company, no one gets by with doing only a
single job.)

Overcoming our legendary repugnance for activities even faintly
commercial, we will also have an abundant array of Berkshire products for
sale in the halls outside the meeting room. Last year we broke all
records, selling 1,270 pounds of See's candy, 1,143 pairs of Dexter
shoes, $29,000 of World Books and related publications, and 700 sets of
knives manufactured by our Quikut subsidiary. Additionally, many
shareholders made inquiries about GEICO auto policies. If you would like
to investigate possible insurance savings, bring your present policy to
the meeting. We estimate that about 40% of our shareholders can save
money by insuring with us. (We'd like to say 100%, but the insurance
business doesn't work that way: Because insurers differ in their
underwriting judgments, some of our shareholders are currently paying
rates that are lower than GEICO's.)

An attachment to the proxy material enclosed with this report
explains how you can obtain the card you will need for admission to the
meeting. We expect a large crowd, so get both plane and hotel
reservations promptly. American Express (800-799-6634) will be happy to
help you with arrangements. As usual, we will have buses servicing the
larger hotels to take you to and from the meeting, and also to take you
to Nebraska Furniture Mart, Borsheim's and the airport after it is over.

NFM's main store, located on a 75-acre site about a mile from
Aksarben, is open from 10 a.m. to 9 p.m. on weekdays, 10 a.m. to 6 p.m.
on Saturdays, and noon to 6 p.m. on Sundays. Come by and say hello to
"Mrs. B" (Rose Blumkin). She's 103 now and sometimes operates with an
oxygen mask that is attached to a tank on her cart. But if you try to
keep pace with her, it will be you who needs oxygen. NFM did about $265
million of business last year - a record for a single-location home
furnishings operation - and you'll see why once you check out its
merchandise and prices.

Borsheim's normally is closed on Sunday but will be open for
shareholders from 10 a.m. to 6 p.m. on May 4th. Last year on
"Shareholder Sunday" we broke every Borsheim's record in terms of
tickets, dollar volume and, no doubt, attendees per square inch. Because
we expect a capacity crowd this year as well, all shareholders attending
on Sunday must bring their admission cards. Shareholders who prefer a
somewhat less frenzied experience will get the same special treatment on
Saturday, when the store is open from 10 a.m. to 5:30 p.m., or on Monday
between 10 a.m. and 8 p.m. Come by at any time this year and let Susan
Jacques, Borsheim's CEO, and her skilled associates perform a painless
walletectomy on you.

My favorite steakhouse, Gorat's, was sold out last year on the
weekend of the annual meeting, even though it added an additional seating
at 4 p.m. on Sunday. You can make reservations beginning on April 1st
(but not earlier) by calling 402-551-3733. I will be at Gorat's on
Sunday after Borsheim's, having my usual rare T-bone and double order of
hashbrowns. I can also recommend - this is the standard fare when Debbie
Bosanek, my invaluable assistant, and I go to lunch - the hot roast beef
sandwich with mashed potatoes and gravy. Mention Debbie's name and you
will be given an extra boat of gravy.

The Omaha Royals and Indianapolis Indians will play baseball on
Saturday evening, May 3rd, at Rosenblatt Stadium. Pitching in my normal
rotation - one throw a year - I will start.

Though Rosenblatt is normal in appearance, it is anything but: The
field sits on a unique geological structure that occasionally emits short
gravitational waves causing even the most smoothly-delivered pitch to
sink violently. I have been the victim of this weird phenomenon several
times in the past but am hoping for benign conditions this year. There
will be lots of opportunities for photos at the ball game, but you will
need incredibly fast reflexes to snap my fast ball en route to the plate.

Our proxy statement includes information about obtaining tickets to
the game. We will also provide an information packet listing restaurants
that will be open on Sunday night and describing various things that you
can do in Omaha on the weekend. The entire gang at Berkshire looks
forward to seeing you.

Warren E. Buffett
February 28, 1997 Chairman of the Board
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:29 par mihou
To the Stockholders of Berkshire Hathaway Inc.:

Operating earnings in 1977 of $21,904,000, or $22.54 per
share, were moderately better than anticipated a year ago. Of
these earnings, $1.43 per share resulted from substantial
realized capital gains by Blue Chip Stamps which, to the extent
of our proportional interest in that company, are included in our
operating earnings figure. Capital gains or losses realized
directly by Berkshire Hathaway Inc. or its insurance subsidiaries
are not included in our calculation of operating earnings. While
too much attention should not be paid to the figure for any
single year, over the longer term the record regarding aggregate
capital gains or losses obviously is of significance.

Textile operations came in well below forecast, while the
results of the Illinois National Bank as well as the operating
earnings attributable to our equity interest in Blue Chip Stamps
were about as anticipated. However, insurance operations, led
again by the truly outstanding results of Phil Liesche’s
managerial group at National Indemnity Company, were even better
than our optimistic expectations.

Most companies define “record” earnings as a new high in
earnings per share. Since businesses customarily add from year
to year to their equity base, we find nothing particularly
noteworthy in a management performance combining, say, a 10%
increase in equity capital and a 5% increase in earnings per
share. After all, even a totally dormant savings account will
produce steadily rising interest earnings each year because of
compounding.

Except for special cases (for example, companies with
unusual debt-equity ratios or those with important assets carried
at unrealistic balance sheet values), we believe a more
appropriate measure of managerial economic performance to be
return on equity capital. In 1977 our operating earnings on
beginning equity capital amounted to 19%, slightly better than
last year and above both our own long-term average and that of
American industry in aggregate. But, while our operating
earnings per share were up 37% from the year before, our
beginning capital was up 24%, making the gain in earnings per
share considerably less impressive than it might appear at first
glance.

We expect difficulty in matching our 1977 rate of return
during the forthcoming year. Beginning equity capital is up 23%
from a year ago, and we expect the trend of insurance
underwriting profit margins to turn down well before the end of
the year. Nevertheless, we expect a reasonably good year and our
present estimate, subject to the usual caveats regarding the
frailties of forecasts, is that operating earnings will improve
somewhat on a per share basis during 1978.

Textile Operations

The textile business again had a very poor year in 1977. We
have mistakenly predicted better results in each of the last two
years. This may say something about our forecasting abilities,
the nature of the textile industry, or both. Despite strenuous
efforts, problems in marketing and manufacturing have persisted.
Many difficulties experienced in the marketing area are due
primarily to industry conditions, but some of the problems have
been of our own making.

A few shareholders have questioned the wisdom of remaining
in the textile business which, over the longer term, is unlikely
to produce returns on capital comparable to those available in
many other businesses. Our reasons are several: (1) Our mills in
both New Bedford and Manchester are among the largest employers
in each town, utilizing a labor force of high average age
possessing relatively non-transferable skills. Our workers and
unions have exhibited unusual understanding and effort in
cooperating with management to achieve a cost structure and
product mix which might allow us to maintain a viable operation.
(2) Management also has been energetic and straightforward in its
approach to our textile problems. In particular, Ken Chace’s
efforts after the change in corporate control took place in 1965
generated capital from the textile division needed to finance the
acquisition and expansion of our profitable insurance operation.
(3) With hard work and some imagination regarding manufacturing
and marketing configurations, it seems reasonable that at least
modest profits in the textile division can be achieved in the
future.

Insurance Underwriting

Our insurance operation continued to grow significantly in
1977. It was early in 1967 that we made our entry into this
industry through the purchase of National Indemnity Company and
National Fire and Marine Insurance Company (sister companies) for
approximately $8.6 million. In that year their premium volume
amounted to $22 million. In 1977 our aggregate insurance premium
volume was $151 million. No additional shares of Berkshire
Hathaway stock have been issued to achieve any of this growth.

Rather, this almost 600% increase has been achieved through
large gains in National Indemnity’s traditional liability areas
plus the starting of new companies (Cornhusker Casualty Company
in 1970, Lakeland Fire and Casualty Company in 1971, Texas United
Insurance Company in 1972, The Insurance Company of Iowa in 1973,
and Kansas Fire and Casualty Company in late 1977), the purchase
for cash of other insurance companies (Home and Automobile
Insurance Company in 1971, Kerkling Reinsurance Corporation, now
named Central Fire and Casualty Company, in 1976, and Cypress
Insurance Company at yearend 1977), and finally through the
marketing of additional products, most significantly reinsurance,
within the National Indemnity Company corporate structure.

In aggregate, the insurance business has worked out very
well. But it hasn’t been a one-way street. Some major mistakes
have been made during the decade, both in products and personnel.
We experienced significant problems from (1) a surety operation
initiated in 1969, (2) the 1973 expansion of Home and
Automobile’s urban auto marketing into the Miami, Florida area,
(3) a still unresolved aviation “fronting” arrangement, and (4)
our Worker’s Compensation operation in California, which we
believe retains an interesting potential upon completion of a
reorganization now in progress. It is comforting to be in a
business where some mistakes can be made and yet a quite
satisfactory overall performance can be achieved. In a sense,
this is the opposite case from our textile business where even
very good management probably can average only modest results.
One of the lessons your management has learned - and,
unfortunately, sometimes re-learned - is the importance of being
in businesses where tailwinds prevail rather than headwinds.

In 1977 the winds in insurance underwriting were squarely
behind us. Very large rate increases were effected throughout
the industry in 1976 to offset the disastrous underwriting
results of 1974 and 1975. But, because insurance policies
typically are written for one-year periods, with pricing mistakes
capable of correction only upon renewal, it was 1977 before the
full impact was felt upon earnings of those earlier rate
increases.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:30 par mihou
The pendulum now is beginning to swing the other way. We
estimate that costs involved in the insurance areas in which we
operate rise at close to 1% per month. This is due to continuous
monetary inflation affecting the cost of repairing humans and
property, as well as “social inflation”, a broadening definition
by society and juries of what is covered by insurance policies.
Unless rates rise at a comparable 1% per month, underwriting
profits must shrink. Recently the pace of rate increases has
slowed dramatically, and it is our expectation that underwriting
margins generally will be declining by the second half of the
year.

We must again give credit to Phil Liesche, greatly assisted
by Roland Miller in Underwriting and Bill Lyons in Claims, for an
extraordinary underwriting achievement in National Indemnity’s
traditional auto and general liability business during 1977.
Large volume gains have been accompanied by excellent
underwriting margins following contraction or withdrawal by many
competitors in the wake of the 1974-75 crisis period. These
conditions will reverse before long. In the meantime, National
Indemnity’s underwriting profitability has increased dramatically
and, in addition, large sums have been made available for
investment. As markets loosen and rates become inadequate, we
again will face the challenge of philosophically accepting
reduced volume. Unusual managerial discipline will be required,
as it runs counter to normal institutional behavior to let the
other fellow take away business - even at foolish prices.

Our reinsurance department, managed by George Young,
improved its underwriting performance during 1977. Although the
combined ratio (see definition on page 12) of 107.1 was
unsatisfactory, its trend was downward throughout the year. In
addition, reinsurance generates unusually high funds for
investment as a percentage of premium volume.

At Home and Auto, John Seward continued to make progress on
all fronts. John was a battlefield promotion several years ago
when Home and Auto’s underwriting was awash in red ink and the
company faced possible extinction. Under his management it
currently is sound, profitable, and growing.

John Ringwalt’s homestate operation now consists of five
companies, with Kansas Fire and Casualty Company becoming
operational late in 1977 under the direction of Floyd Taylor.
The homestate companies had net premium volume of $23 million, up
from $5.5 million just three years ago. All four companies that
operated throughout the year achieved combined ratios below 100,
with Cornhusker Casualty Company, at 93.8, the leader. In
addition to actively supervising the other four homestate
operations, John Ringwalt manages the operations of Cornhusker
which has recorded combined ratios below 100 in six of its seven
full years of existence and, from a standing start in 1970, has
grown to be one of the leading insurance companies operating in
Nebraska utilizing the conventional independent agency system.
Lakeland Fire and Casualty Company, managed by Jim Stodolka, was
the winner of the Chairman’s Cup in 1977 for achieving the lowest
loss ratio among the homestate companies. All in all, the
homestate operation continues to make excellent progress.

The newest addition to our insurance group is Cypress
Insurance Company of South Pasadena, California. This Worker’s
Compensation insurer was purchased for cash in the final days of
1977 and, therefore, its approximate $12.5 million of volume for
that year was not included in our results. Cypress and National
Indemnity’s present California Worker’s Compensation operation
will not be combined, but will operate independently utilizing
somewhat different marketing strategies. Milt Thornton,
President of Cypress since 1968, runs a first-class operation for
policyholders, agents, employees and owners alike. We look
forward to working with him.

Insurance companies offer standardized policies which can be
copied by anyone. Their only products are promises. It is not
difficult to be licensed, and rates are an open book. There are
no important advantages from trademarks, patents, location,
corporate longevity, raw material sources, etc., and very little
consumer differentiation to produce insulation from competition.
It is commonplace, in corporate annual reports, to stress the
difference that people make. Sometimes this is true and
sometimes it isn’t. But there is no question that the nature of
the insurance business magnifies the effect which individual
managers have on company performance. We are very fortunate to
have the group of managers that are associated with us.

Insurance Investments

During the past two years insurance investments at cost
(excluding the investment in our affiliate, Blue Chip Stamps)
have grown from $134.6 million to $252.8 million. Growth in
insurance reserves, produced by our large gain in premium volume,
plus retained earnings, have accounted for this increase in
marketable securities. In turn, net investment income of the
Insurance Group has improved from $8.4 million pre-tax in 1975 to
$12.3 million pre-tax in 1977.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:31 par mihou
In addition to this income from dividends and interest, we
realized capital gains of $6.9 million before tax, about one-
quarter from bonds and the balance from stocks. Our unrealized
gain in stocks at yearend 1977 was approximately $74 million but
this figure, like any other figure of a single date (we had an
unrealized loss of $17 million at the end of 1974), should not be
taken too seriously. Most of our large stock positions are going
to be held for many years and the scorecard on our investment
decisions will be provided by business results over that period,
and not by prices on any given day. Just as it would be foolish
to focus unduly on short-term prospects when acquiring an entire
company, we think it equally unsound to become mesmerized by
prospective near term earnings or recent trends in earnings when
purchasing small pieces of a company; i.e., marketable common
stocks.

A little digression illustrating this point may be
interesting. Berkshire Fine Spinning Associates and Hathaway
Manufacturing were merged in 1955 to form Berkshire Hathaway Inc.
In 1948, on a pro forma combined basis, they had earnings after
tax of almost $18 million and employed 10,000 people at a dozen
large mills throughout New England. In the business world of
that period they were an economic powerhouse. For example, in
that same year earnings of IBM were $28 million (now $2.7
billion), Safeway Stores, $10 million, Minnesota Mining, $13
million, and Time, Inc., $9 million. But, in the decade
following the 1955 merger aggregate sales of $595 million
produced an aggregate loss for Berkshire Hathaway of $10 million.
By 1964 the operation had been reduced to two mills and net worth
had shrunk to $22 million, from $53 million at the time of the
merger. So much for single year snapshots as adequate portrayals
of a business.

Equity holdings of our insurance companies with a market
value of over $5 million on December 31, 1977 were as follows:

No. of Shares Company Cost Market
------------- ------- -------- --------
(000’s omitted)
220,000 Capital Cities Communications, Inc. ..... $ 10,909 $ 13,228
1,986,953 Government Employees Insurance
Company Convertible Preferred ........ 19,417 33,033
1,294,308 Government Employees Insurance
Company Common Stock ................. 4,116 10,516
592,650 The Interpublic Group of Companies, Inc. 4,531 17,187
324,580 Kaiser Aluminum& Chemical Corporation ... 11,218 9,981
1,305,800 Kaiser Industries, Inc. ................. 778 6,039
226,900 Knight-Ridder Newspapers, Inc. .......... 7,534 8,736
170,800 Ogilvy & Mather International, Inc. ..... 2,762 6,960
934,300 The Washington Post Company Class B ..... 10,628 33,401
-------- --------
Total ................................... $ 71,893 $139,081
All Other Holdings ...................... 34,996 41,992
-------- --------
Total Equities .......................... $106,889 $181,073
======== ========

We select our marketable equity securities in much the same
way we would evaluate a business for acquisition in its entirety.
We want the business to be (1) one that we can understand, (2)
with favorable long-term prospects, (3) operated by honest and
competent people, and (4) available at a very attractive price.
We ordinarily make no attempt to buy equities for anticipated
favorable stock price behavior in the short term. In fact, if
their business experience continues to satisfy us, we welcome
lower market prices of stocks we own as an opportunity to acquire
even more of a good thing at a better price.

Our experience has been that pro-rata portions of truly
outstanding businesses sometimes sell in the securities markets
at very large discounts from the prices they would command in
negotiated transactions involving entire companies.
Consequently, bargains in business ownership, which simply are
not available directly through corporate acquisition, can be
obtained indirectly through stock ownership. When prices are
appropriate, we are willing to take very large positions in
selected companies, not with any intention of taking control and
not foreseeing sell-out or merger, but with the expectation that
excellent business results by corporations will translate over
the long term into correspondingly excellent market value and
dividend results for owners, minority as well as majority.

Such investments initially may have negligible impact on our
operating earnings. For example, we invested $10.9 million in
Capital Cities Communications during 1977. Earnings attributable
to the shares we purchased totaled about $1.3 million last year.
But only the cash dividend, which currently provides $40,000
annually, is reflected in our operating earnings figure.

Capital Cities possesses both extraordinary properties and
extraordinary management. And these management skills extend
equally to operations and employment of corporate capital. To
purchase, directly, properties such as Capital Cities owns would
cost in the area of twice our cost of purchase via the stock
market, and direct ownership would offer no important advantages
to us. While control would give us the opportunity - and the
responsibility - to manage operations and corporate resources, we
would not be able to provide management in either of those
respects equal to that now in place. In effect, we can obtain a
better management result through non-control than control. This
is an unorthodox view, but one we believe to be sound.

Banking

In 1977 the Illinois National Bank continued to achieve a
rate of earnings on assets about three times that of most large
banks. As usual, this record was achieved while the bank paid
maximum rates to savers and maintained an asset position
combining low risk and exceptional liquidity. Gene Abegg formed
the bank in 1931 with $250,000. In its first full year of
operation, earnings amounted to $8,782. Since that time, no new
capital has been contributed to the bank; on the contrary, since
our purchase in 1969, dividends of $20 million have been paid.
Earnings in 1977 amounted to $3.6 million, more than achieved by
many banks two or three times its size.

Late last year Gene, now 80 and still running a banking
operation without peer, asked that a successor be brought in.
Accordingly, Peter Jeffrey, formerly President and Chief
Executive Officer of American National Bank of Omaha, has joined
the Illinois National Bank effective March 1st as President and
Chief Executive Officer.

Gene continues in good health as Chairman. We expect a
continued successful operation at Rockford’s leading bank.

Blue Chip Stamps

We again increased our equity interest in Blue Chip Stamps,
and owned approximately 36 1/2% at the end of 1977. Blue Chip
had a fine year, earning approximately $12.9 million from
operations and, in addition, had realized securities gains of
$4.1 million.

Both Wesco Financial Corp., an 80% owned subsidiary of Blue
Chip Stamps, managed by Louis Vincenti, and See’s Candies, a 99%
owned subsidiary, managed by Chuck Huggins, made good progress in
1977. Since See’s was purchased by Blue Chip Stamps at the
beginning of 1972, pre-tax operating earnings have grown from
$4.2 million to $12.6 million with little additional capital
investment. See’s achieved this record while operating in an
industry experiencing practically no unit growth. Shareholders
of Berkshire Hathaway Inc. may obtain the annual report of Blue
Chip Stamps by requesting it from Mr. Robert H. Bird, Blue Chip
Stamps, 5801 South Eastern Avenue, Los Angeles, California 90040.


Warren E. Buffett, Chairman
http://www.berkshirehathaway.com/letters/letters.html
March 14,1978
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:34 par mihou
To the Shareholders of Berkshire Hathaway Inc.:

First, a few words about accounting. The merger with
Diversified Retailing Company, Inc. at yearend adds two new
complications in the presentation of our financial results.
After the merger, our ownership of Blue Chip Stamps increased to
approximately 58% and, therefore, the accounts of that company
must be fully consolidated in the Balance Sheet and Statement of
Earnings presentation of Berkshire. In previous reports, our
share of the net earnings only of Blue Chip had been included as
a single item on Berkshire’s Statement of Earnings, and there had
been a similar one-line inclusion on our Balance Sheet of our
share of their net assets.

This full consolidation of sales, expenses, receivables,
inventories, debt, etc. produces an aggregation of figures from
many diverse businesses - textiles, insurance, candy, newspapers,
trading stamps - with dramatically different economic
characteristics. In some of these your ownership is 100% but, in
those businesses which are owned by Blue Chip but fully
consolidated, your ownership as a Berkshire shareholder is only
58%. (Ownership by others of the balance of these businesses is
accounted for by the large minority interest item on the
liability side of the Balance Sheet.) Such a grouping of Balance
Sheet and Earnings items - some wholly owned, some partly owned -
tends to obscure economic reality more than illuminate it. In
fact, it represents a form of presentation that we never prepare
for internal use during the year and which is of no value to us
in any management activities.

For that reason, throughout the report we provide much
separate financial information and commentary on the various
segments of the business to help you evaluate Berkshire’s
performance and prospects. Much of this segmented information is
mandated by SEC disclosure rules and covered in “Management’s
Discussion” on pages 29 to 34. And in this letter we try to
present to you a view of our various operating entities from the
same perspective that we view them managerially.

A second complication arising from the merger is that the
1977 figures shown in this report are different from the 1977
figures shown in the report we mailed to you last year.
Accounting convention requires that when two entities such as
Diversified and Berkshire are merged, all financial data
subsequently must be presented as if the companies had been
merged at the time they were formed rather than just recently.
So the enclosed financial statements, in effect, pretend that in
1977 (and earlier years) the Diversified-Berkshire merger already
had taken place, even though the actual merger date was December
30, 1978. This shifting base makes comparative commentary
confusing and, from time to time in our narrative report, we will
talk of figures and performance for Berkshire shareholders as
historically reported to you rather than as restated after the
Diversified merger.

With that preamble it can be stated that, with or without
restated figures, 1978 was a good year. Operating earnings,
exclusive of capital gains, at 19.4% of beginning shareholders’
investment were within a fraction of our 1972 record. While we
believe it is improper to include capital gains or losses in
evaluating the performance of a single year, they are an
important component of the longer term record. Because of such
gains, Berkshire’s long-term growth in equity per share has been
greater than would be indicated by compounding the returns from
operating earnings that we have reported annually.

For example, over the last three years - generally a bonanza
period for the insurance industry, our largest profit producer -
Berkshire’s per share net worth virtually has doubled, thereby
compounding at about 25% annually through a combination of good
operating earnings and fairly substantial capital gains. Neither
this 25% equity gain from all sources nor the 19.4% equity gain
from operating earnings in 1978 is sustainable. The insurance
cycle has turned downward in 1979, and it is almost certain that
operating earnings measured by return on equity will fall this
year. However, operating earnings measured in dollars are likely
to increase on the much larger shareholders’ equity now employed
in the business.

In contrast to this cautious view about near term return
from operations, we are optimistic about prospects for long term
return from major equity investments held by our insurance
companies. We make no attempt to predict how security markets
will behave; successfully forecasting short term stock price
movements is something we think neither we nor anyone else can
do. In the longer run, however, we feel that many of our major
equity holdings are going to be worth considerably more money
than we paid, and that investment gains will add significantly to
the operating returns of the insurance group.

Sources of Earnings

To give you a better picture of just where Berkshire’s
earnings are produced, we show below a table which requires a
little explanation. Berkshire owns close to 58% of Blue Chip
which, in addition to 100% ownership of several businesses, owns
80% of Wesco Financial Corporation. Thus, Berkshire’s equity in
Wesco’s earnings is about 46%. In aggregate, businesses that we
control have about 7,000 full-time employees and generate
revenues of over $500 million.

The table shows the overall earnings of each major operating
category on a pre-tax basis (several of the businesses have low
tax rates because of significant amounts of tax-exempt interest
and dividend income), as well as the share of those earnings
belonging to Berkshire both on a pre-tax and after-tax basis.
Significant capital gains or losses attributable to any of the
businesses are not shown in the operating earnings figure, but
are aggregated on the “Realized Securities Gain” line at the
bottom of the table. Because of various accounting and tax
intricacies, the figures in the table should not be treated as
holy writ, but rather viewed as close approximations of the 1977
and 1978 earnings contributions of our constituent businesses.


Net Earnings
Earnings Before Income Taxes After Tax
-------------------------------------- ------------------
Total Berkshire Share Berkshire Share
------------------ ------------------ ------------------
(in thousands of dollars) 1978 1977 1978 1977 1978 1977
-------- -------- -------- -------- -------- --------
Total - all entities ......... $66,180 $57,089 $54,350 $42,234 $39,242 $30,393
======== ======== ======== ======== ======== ========
Earnings from operations:
Insurance Group:
Underwriting ............. $ 3,001 $ 5,802 $ 3,000 $ 5,802 $ 1,560 $ 3,017
Net investment income .... 19,705 12,804 19,691 12,804 16,400 11,360
Berkshire-Waumbec textiles 2,916 (620) 2,916 (620) 1,342 (322)
Associated Retail
Stores, Inc. ............ 2,757 2,775 2,757 2,775 1,176 1,429
See’s Candies .............. 12,482 12,840 7,013 6,598 3,049 2,974
Buffalo Evening News ....... (2,913) 751 (1,637) 389 (738) 158
Blue Chip Stamps - Parent .. 2,133 1,091 1,198 566 1,382 892
Illinois National Bank
and Trust Company ....... 4,822 3,800 4,710 3,706 4,262 3,288
Wesco Financial
Corporation - Parent .... 1,771 2,006 777 813 665 419
Mutual Savings and
Loan Association ........ 10,556 6,779 4,638 2,747 3,042 1,946
Interest on Debt ........... (5,566) (5,302) (4,546) (4,255) (2,349) (2,129)
Other ...................... 720 165 438 102 261 48
-------- -------- -------- -------- -------- --------
Total Earnings from
Operations ............ $52,384 $42,891 $40,955 $31,427 $30,052 $23,080
Realized Securities Gain ..... 13,796 14,198 13,395 10,807 9,190 7,313
-------- -------- -------- -------- -------- --------
Total Earnings ........... $66,180 $57,089 $54,350 $42,234 $39,242 $30,393
======== ======== ======== ======== ======== ========

Blue Chip and Wesco are public companies with reporting
requirements of their own. Later in this report we are
reproducing the narrative reports of the principal executives of
both companies, describing their 1978 operations. Some of the
figures they utilize will not match to the penny the ones we use
in this report, again because of accounting and tax complexities.
But their comments should be helpful to you in understanding the
underlying economic characteristics of these important partly-
owned businesses. A copy of the full annual report of either
company will be mailed to any shareholder of Berkshire upon
request to Mr. Robert H. Bird for Blue Chips Stamps, 5801 South
Eastern Avenue, Los Angeles, California 90040, or to Mrs. Bette
Deckard for Wesco Financial Corporation, 315 East Colorado
Boulevard, Pasadena, California 91109.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:34 par mihou
Textiles

Earnings of $1.3 million in 1978, while much improved from
1977, still represent a low return on the $17 million of capital
employed in this business. Textile plant and equipment are on
the books for a very small fraction of what it would cost to
replace such equipment today. And, despite the age of the
equipment, much of it is functionally similar to new equipment
being installed by the industry. But despite this “bargain cost”
of fixed assets, capital turnover is relatively low reflecting
required high investment levels in receivables and inventory
compared to sales. Slow capital turnover, coupled with low
profit margins on sales, inevitably produces inadequate returns
on capital. Obvious approaches to improved profit margins
involve differentiation of product, lowered manufacturing costs
through more efficient equipment or better utilization of people,
redirection toward fabrics enjoying stronger market trends, etc.
Our management is diligent in pursuing such objectives. The
problem, of course, is that our competitors are just as
diligently doing the same thing.

The textile industry illustrates in textbook style how
producers of relatively undifferentiated goods in capital
intensive businesses must earn inadequate returns except under
conditions of tight supply or real shortage. As long as excess
productive capacity exists, prices tend to reflect direct
operating costs rather than capital employed. Such a supply-
excess condition appears likely to prevail most of the time in
the textile industry, and our expectations are for profits of
relatively modest amounts in relation to capital.

We hope we don’t get into too many more businesses with such
tough economic characteristics. But, as we have stated before:
(1) our textile businesses are very important employers in their
communities, (2) management has been straightforward in reporting
on problems and energetic in attacking them, (3) labor has been
cooperative and understanding in facing our common problems, and
(4) the business should average modest cash returns relative to
investment. As long as these conditions prevail - and we expect
that they will - we intend to continue to support our textile
business despite more attractive alternative uses for capital.

Insurance Underwriting

The number one contributor to Berkshire’s overall excellent
results in 1978 was the segment of National Indemnity Company’s
insurance operation run by Phil Liesche. On about $90 million of
earned premiums, an underwriting profit of approximately $11
million was realized, a truly extraordinary achievement even
against the background of excellent industry conditions. Under
Phil’s leadership, with outstanding assistance by Roland Miller
in Underwriting and Bill Lyons in Claims, this segment of
National Indemnity (including National Fire and Marine Insurance
Company, which operates as a running mate) had one of its best
years in a long history of performances which, in aggregate, far
outshine those of the industry. Present successes reflect credit
not only upon present managers, but equally upon the business
talents of Jack Ringwalt, founder of National Indemnity, whose
operating philosophy remains etched upon the company.

Home and Automobile Insurance Company had its best year
since John Seward stepped in and straightened things out in 1975.
Its results are combined in this report with those of Phil
Liesche’s operation under the insurance category entitled
“Specialized Auto and General Liability”.

Worker’s Compensation was a mixed bag in 1978. In its first
year as a subsidiary, Cypress Insurance Company, managed by Milt
Thornton, turned in outstanding results. The worker’s
compensation line can cause large underwriting losses when rapid
inflation interacts with changing social concepts, but Milt has a
cautious and highly professional staff to cope with these
problems. His performance in 1978 has reinforced our very good
feelings about this purchase.

Frank DeNardo came with us in the spring of 1978 to
straighten out National Indemnity’s California Worker’s
Compensation business which, up to that point, had been a
disaster. Frank has the experience and intellect needed to
correct the major problems of the Los Angeles office. Our volume
in this department now is running only about 25% of what it was
eighteen months ago, and early indications are that Frank is
making good progress.

George Young’s reinsurance department continues to produce
very large sums for investment relative to premium volume, and
thus gives us reasonably satisfactory overall results. However,
underwriting results still are not what they should be and can
be. It is very easy to fool yourself regarding underwriting
results in reinsurance (particularly in casualty lines involving
long delays in settlement), and we believe this situation
prevails with many of our competitors. Unfortunately, self-
delusion in company reserving almost always leads to inadequate
industry rate levels. If major factors in the market don’t know
their true costs, the competitive “fall-out” hits all - even
those with adequate cost knowledge. George is quite willing to
reduce volume significantly, if needed, to achieve satisfactory
underwriting, and we have a great deal of confidence in the long
term soundness of this business under his direction.

The homestate operation was disappointing in 1978. Our
unsatisfactory underwriting, even though partially explained by
an unusual incidence of Midwestern storms, is particularly
worrisome against the backdrop of very favorable industry results
in the conventional lines written by our homestate group. We
have confidence in John Ringwalt’s ability to correct this
situation. The bright spot in the group was the performance of
Kansas Fire and Casualty in its first full year of business.
Under Floyd Taylor, this subsidiary got off to a truly remarkable
start. Of course, it takes at least several years to evaluate
underwriting results, but the early signs are encouraging and
Floyd’s operation achieved the best loss ratio among the
homestate companies in 1978.

Although some segments were disappointing, overall our
insurance operation had an excellent year. But of course we
should expect a good year when the industry is flying high, as in
1978. It is a virtual certainty that in 1979 the combined ratio
(see definition on page 31) for the industry will move up at
least a few points, perhaps enough to throw the industry as a
whole into an underwriting loss position. For example, in the
auto lines - by far the most important area for the industry and
for us - CPI figures indicate rates overall were only 3% higher
in January 1979 than a year ago. But the items that make up loss
costs - auto repair and medical care costs - were up over 9%.
How different than yearend 1976 when rates had advanced over 22%
in the preceding twelve months, but costs were up 8%.

Margins will remain steady only if rates rise as fast as
costs. This assuredly will not be the case in 1979, and
conditions probably will worsen in 1980. Our present thinking is
that our underwriting performance relative to the industry will
improve somewhat in 1979, but every other insurance management
probably views its relative prospects with similar optimism -
someone is going to be disappointed. Even if we do improve
relative to others, we may well have a higher combined ratio and
lower underwriting profits in 1979 than we achieved last year.

We continue to look for ways to expand our insurance
operation. But your reaction to this intent should not be
unrestrained joy. Some of our expansion efforts - largely
initiated by your Chairman have been lackluster, others have been
expensive failures. We entered the business in 1967 through
purchase of the segment which Phil Liesche now manages, and it
still remains, by a large margin, the best portion of our
insurance business. It is not easy to buy a good insurance
business, but our experience has been that it is easier to buy
one than create one. However, we will continue to try both
approaches, since the rewards for success in this field can be
exceptional.

Insurance Investments

We confess considerable optimism regarding our insurance
equity investments. Of course, our enthusiasm for stocks is not
unconditional. Under some circumstances, common stock
investments by insurers make very little sense.

We get excited enough to commit a big percentage of
insurance company net worth to equities only when we find (1)
businesses we can understand, (2) with favorable long-term
prospects, (3) operated by honest and competent people, and (4)
priced very attractively. We usually can identify a small number
of potential investments meeting requirements (1), (2) and (3),
but (4) often prevents action. For example, in 1971 our total
common stock position at Berkshire’s insurance subsidiaries
amounted to only $10.7 million at cost, and $11.7 million at
market. There were equities of identifiably excellent companies
available - but very few at interesting prices. (An irresistible
footnote: in 1971, pension fund managers invested a record 122%
of net funds available in equities - at full prices they couldn’t
buy enough of them. In 1974, after the bottom had fallen out,
they committed a then record low of 21% to stocks.)

The past few years have been a different story for us. At
the end of 1975 our insurance subsidiaries held common equities
with a market value exactly equal to cost of $39.3 million. At
the end of 1978 this position had been increased to equities
(including a convertible preferred) with a cost of $129.1 million
and a market value of $216.5 million. During the intervening
three years we also had realized pre-tax gains from common
equities of approximately $24.7 million. Therefore, our overall
unrealized and realized pre-tax gains in equities for the three
year period came to approximately $112 million. During this same
interval the Dow-Jones Industrial Average declined from 852 to
805. It was a marvelous period for the value-oriented equity
buyer.

We continue to find for our insurance portfolios small
portions of really outstanding businesses that are available,
through the auction pricing mechanism of security markets, at
prices dramatically cheaper than the valuations inferior
businesses command on negotiated sales.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:35 par mihou
This program of acquisition of small fractions of businesses
(common stocks) at bargain prices, for which little enthusiasm
exists, contrasts sharply with general corporate acquisition
activity, for which much enthusiasm exists. It seems quite clear
to us that either corporations are making very significant
mistakes in purchasing entire businesses at prices prevailing in
negotiated transactions and takeover bids, or that we eventually
are going to make considerable sums of money buying small
portions of such businesses at the greatly discounted valuations
prevailing in the stock market. (A second footnote: in 1978
pension managers, a group that logically should maintain the
longest of investment perspectives, put only 9% of net available
funds into equities - breaking the record low figure set in 1974
and tied in 1977.)

We are not concerned with whether the market quickly
revalues upward securities that we believe are selling at bargain
prices. In fact, we prefer just the opposite since, in most
years, we expect to have funds available to be a net buyer of
securities. And consistent attractive purchasing is likely to
prove to be of more eventual benefit to us than any selling
opportunities provided by a short-term run up in stock prices to
levels at which we are unwilling to continue buying.

Our policy is to concentrate holdings. We try to avoid
buying a little of this or that when we are only lukewarm about
the business or its price. When we are convinced as to
attractiveness, we believe in buying worthwhile amounts.

Equity holdings of our insurance companies with a market value of
over $8 million on December 31, 1978 were as follows:

No. of
Shares Company Cost Market
---------- ------- ---------- ----------
(000s omitted)
246,450 American Broadcasting Companies, Inc. ... $ 6,082 $ 8,626
1,294,308 Government Employees Insurance Company
Common Stock ......................... 4,116 9,060
1,986,953 Government Employees Insurance Company
Convertible Preferred ................ 19,417 28,314
592,650 Interpublic Group of Companies, Inc. .... 4,531 19,039
1,066,934 Kaiser Aluminum and Chemical Corporation 18,085 18,671
453,800 Knight-Ridder Newspapers, Inc. .......... 7,534 10,267
953,750 SAFECO Corporation ...................... 23,867 26,467
934,300 The Washington Post Company ............. 10,628 43,445
---------- ----------
Total ................................... $ 94,260 $163,889
All Other Holdings ...................... 39,506 57,040
---------- ----------
Total Equities .......................... $133,766 $220,929
========== ==========

In some cases our indirect interest in earning power is
becoming quite substantial. For example, note our holdings of
953,750 shares of SAFECO Corp. SAFECO probably is the best run
large property and casualty insurance company in the United
States. Their underwriting abilities are simply superb, their
loss reserving is conservative, and their investment policies
make great sense.

SAFECO is a much better insurance operation than our own
(although we believe certain segments of ours are much better
than average), is better than one we could develop and,
similarly, is far better than any in which we might negotiate
purchase of a controlling interest. Yet our purchase of SAFECO
was made at substantially under book value. We paid less than
100 cents on the dollar for the best company in the business,
when far more than 100 cents on the dollar is being paid for
mediocre companies in corporate transactions. And there is no
way to start a new operation - with necessarily uncertain
prospects - at less than 100 cents on the dollar.

Of course, with a minor interest we do not have the right to
direct or even influence management policies of SAFECO. But why
should we wish to do this? The record would indicate that they
do a better job of managing their operations than we could do
ourselves. While there may be less excitement and prestige in
sitting back and letting others do the work, we think that is all
one loses by accepting a passive participation in excellent
management. Because, quite clearly, if one controlled a company
run as well as SAFECO, the proper policy also would be to sit
back and let management do its job.

Earnings attributable to the shares of SAFECO owned by
Berkshire at yearend amounted to $6.1 million during 1978, but
only the dividends received (about 18% of earnings) are reflected
in our operating earnings. We believe the balance, although not
reportable, to be just as real in terms of eventual benefit to us
as the amount distributed. In fact, SAFECO’s retained earnings
(or those of other well-run companies if they have opportunities
to employ additional capital advantageously) may well eventually
have a value to shareholders greater than 100 cents on the
dollar.

We are not at all unhappy when our wholly-owned businesses
retain all of their earnings if they can utilize internally those
funds at attractive rates. Why should we feel differently about
retention of earnings by companies in which we hold small equity
interests, but where the record indicates even better prospects
for profitable employment of capital? (This proposition cuts the
other way, of course, in industries with low capital
requirements, or if management has a record of plowing capital
into projects of low profitability; then earnings should be paid
out or used to repurchase shares - often by far the most
attractive option for capital utilization.)

The aggregate level of such retained earnings attributable
to our equity interests in fine companies is becoming quite
substantial. It does not enter into our reported operating
earnings, but we feel it well may have equal long-term
significance to our shareholders. Our hope is that conditions
continue to prevail in securities markets which allow our
insurance companies to buy large amounts of underlying earning
power for relatively modest outlays. At some point market
conditions undoubtedly will again preclude such bargain buying
but, in the meantime, we will try to make the most of
opportunities.

Banking

Under Gene Abegg and Pete Jeffrey, the Illinois National
Bank and Trust Company in Rockford continues to establish new
records. Last year’s earnings amounted to approximately 2.1% of
average assets, about three times the level averaged by major
banks. In our opinion, this extraordinary level of earnings is
being achieved while maintaining significantly less asset risk
than prevails at most of the larger banks.

We purchased the Illinois National Bank in March 1969. It
was a first-class operation then, just as it had been ever since
Gene Abegg opened the doors in 1931. Since 1968, consumer time
deposits have quadrupled, net income has tripled and trust
department income has more than doubled, while costs have been
closely controlled.

Our experience has been that the manager of an already high-
cost operation frequently is uncommonly resourceful in finding
new ways to add to overhead, while the manager of a tightly-run
operation usually continues to find additional methods to curtail
costs, even when his costs are already well below those of his
competitors. No one has demonstrated this latter ability better
than Gene Abegg.

We are required to divest our bank by December 31, 1980.
The most likely approach is to spin it off to Berkshire
shareholders some time in the second half of 1980.

Retailing

Upon merging with Diversified, we acquired 100% ownership of
Associated Retail Stores, Inc., a chain of about 75 popular
priced women’s apparel stores. Associated was launched in
Chicago on March 7, 1931 with one store, $3200, and two
extraordinary partners, Ben Rosner and Leo Simon. After Mr.
Simon’s death, the business was offered to Diversified for cash
in 1967. Ben was to continue running the business - and run it,
he has.

Associated’s business has not grown, and it consistently has
faced adverse demographic and retailing trends. But Ben’s
combination of merchandising, real estate and cost-containment
skills has produced an outstanding record of profitability, with
returns on capital necessarily employed in the business often in
the 20% after-tax area.

Ben is now 75 and, like Gene Abegg, 81, at Illinois National
and Louie Vincenti, 73, at Wesco, continues daily to bring an
almost passionately proprietary attitude to the business. This
group of top managers must appear to an outsider to be an
overreaction on our part to an OEO bulletin on age
discrimination. While unorthodox, these relationships have been
exceptionally rewarding, both financially and personally. It is
a real pleasure to work with managers who enjoy coming to work
each morning and, once there, instinctively and unerringly think
like owners. We are associated with some of the very best.


Warren E. Buffett, Chairman

March 26, 1979
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:36 par mihou
To the Shareholders of Berkshire Hathaway Inc.:

Again, we must lead off with a few words about accounting.
Since our last annual report, the accounting profession has
decided that equity securities owned by insurance companies must
be carried on the balance sheet at market value. We previously
have carried such equity securities at the lower of aggregate
cost or aggregate market value. Because we have large unrealized
gains in our insurance equity holdings, the result of this new
policy is to increase substantially both the 1978 and 1979
yearend net worth, even after the appropriate liability is
established for taxes on capital gains that would be payable
should equities be sold at such market valuations.

As you know, Blue Chip Stamps, our 60% owned subsidiary, is
fully consolidated in Berkshire Hathaway’s financial statements.
However, Blue Chip still is required to carry its equity
investments at the lower of aggregate cost or aggregate market
value, just as Berkshire Hathaway’s insurance subsidiaries did
prior to this year. Should the same equities be purchased at an
identical price by an insurance subsidiary of Berkshire Hathaway
and by Blue Chip Stamps, present accounting principles often
would require that they end up carried on our consolidated
balance sheet at two different values. (That should keep you on
your toes.) Market values of Blue Chip Stamps’ equity holdings
are given in footnote 3 on page 18.

1979 Operating Results

We continue to feel that the ratio of operating earnings
(before securities gains or losses) to shareholders’ equity with
all securities valued at cost is the most appropriate way to
measure any single year’s operating performance.

Measuring such results against shareholders’ equity with
securities valued at market could significantly distort the
operating performance percentage because of wide year-to-year
market value changes in the net worth figure that serves as the
denominator. For example, a large decline in securities values
could result in a very low “market value” net worth that, in
turn, could cause mediocre operating earnings to look
unrealistically good. Alternatively, the more successful that
equity investments have been, the larger the net worth base
becomes and the poorer the operating performance figure appears.
Therefore, we will continue to report operating performance
measured against beginning net worth, with securities valued at
cost.

On this basis, we had a reasonably good operating
performance in 1979 - but not quite as good as that of 1978 -
with operating earnings amounting to 18.6% of beginning net
worth. Earnings per share, of course, increased somewhat (about
20%) but we regard this as an improper figure upon which to
focus. We had substantially more capital to work with in 1979
than in 1978, and our performance in utilizing that capital fell
short of the earlier year, even though per-share earnings rose.
“Earnings per share” will rise constantly on a dormant savings
account or on a U.S. Savings Bond bearing a fixed rate of return
simply because “earnings” (the stated interest rate) are
continuously plowed back and added to the capital base. Thus,
even a “stopped clock” can look like a growth stock if the
dividend payout ratio is low.

The primary test of managerial economic performance is the
achievement of a high earnings rate on equity capital employed
(without undue leverage, accounting gimmickry, etc.) and not the
achievement of consistent gains in earnings per share. In our
view, many businesses would be better understood by their
shareholder owners, as well as the general public, if managements
and financial analysts modified the primary emphasis they place
upon earnings per share, and upon yearly changes in that figure.

Long Term Results

In measuring long term economic performance - in contrast to
yearly performance - we believe it is appropriate to recognize
fully any realized capital gains or losses as well as
extraordinary items, and also to utilize financial statements
presenting equity securities at market value. Such capital gains
or losses, either realized or unrealized, are fully as important
to shareholders over a period of years as earnings realized in a
more routine manner through operations; it is just that their
impact is often extremely capricious in the short run, a
characteristic that makes them inappropriate as an indicator of
single year managerial performance.

The book value per share of Berkshire Hathaway on September
30, 1964 (the fiscal yearend prior to the time that your present
management assumed responsibility) was $19.46 per share. At
yearend 1979, book value with equity holdings carried at market
value was $335.85 per share. The gain in book value comes to
20.5% compounded annually. This figure, of course, is far higher
than any average of our yearly operating earnings calculations,
and reflects the importance of capital appreciation of insurance
equity investments in determining the overall results for our
shareholders. It probably also is fair to say that the quoted
book value in 1964 somewhat overstated the intrinsic value of the
enterprise, since the assets owned at that time on either a going
concern basis or a liquidating value basis were not worth 100
cents on the dollar. (The liabilities were solid, however.)

We have achieved this result while utilizing a low amount of
leverage (both financial leverage measured by debt to equity, and
operating leverage measured by premium volume to capital funds of
our insurance business), and also without significant issuance or
repurchase of shares. Basically, we have worked with the capital
with which we started. From our textile base we, or our Blue
Chip and Wesco subsidiaries, have acquired total ownership of
thirteen businesses through negotiated purchases from private
owners for cash, and have started six others. (It’s worth a
mention that those who have sold to us have, almost without
exception, treated us with exceptional honor and fairness, both
at the time of sale and subsequently.)

But before we drown in a sea of self-congratulation, a
further - and crucial - observation must be made. A few years
ago, a business whose per-share net worth compounded at 20%
annually would have guaranteed its owners a highly successful
real investment return. Now such an outcome seems less certain.
For the inflation rate, coupled with individual tax rates, will
be the ultimate determinant as to whether our internal operating
performance produces successful investment results - i.e., a
reasonable gain in purchasing power from funds committed - for
you as shareholders.

Just as the original 3% savings bond, a 5% passbook savings
account or an 8% U.S. Treasury Note have, in turn, been
transformed by inflation into financial instruments that chew up,
rather than enhance, purchasing power over their investment
lives, a business earning 20% on capital can produce a negative
real return for its owners under inflationary conditions not much
more severe than presently prevail.

If we should continue to achieve a 20% compounded gain - not
an easy or certain result by any means - and this gain is
translated into a corresponding increase in the market value of
Berkshire Hathaway stock as it has been over the last fifteen
years, your after-tax purchasing power gain is likely to be very
close to zero at a 14% inflation rate. Most of the remaining six
percentage points will go for income tax any time you wish to
convert your twenty percentage points of nominal annual gain into
cash.

That combination - the inflation rate plus the percentage of
capital that must be paid by the owner to transfer into his own
pocket the annual earnings achieved by the business (i.e.,
ordinary income tax on dividends and capital gains tax on
retained earnings) - can be thought of as an “investor’s misery
index”. When this index exceeds the rate of return earned on
equity by the business, the investor’s purchasing power (real
capital) shrinks even though he consumes nothing at all. We have
no corporate solution to this problem; high inflation rates will
not help us earn higher rates of return on equity.

One friendly but sharp-eyed commentator on Berkshire has
pointed out that our book value at the end of 1964 would have
bought about one-half ounce of gold and, fifteen years later,
after we have plowed back all earnings along with much blood,
sweat and tears, the book value produced will buy about the same
half ounce. A similar comparison could be drawn with Middle
Eastern oil. The rub has been that government has been
exceptionally able in printing money and creating promises, but
is unable to print gold or create oil.

We intend to continue to do as well as we can in managing
the internal affairs of the business. But you should understand
that external conditions affecting the stability of currency may
very well be the most important factor in determining whether
there are any real rewards from your investment in Berkshire
Hathaway.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:37 par mihou
Sources of Earnings

We again present a table showing the sources of Berkshire’s
earnings. As explained last year, Berkshire owns about 60% of
Blue Chip Stamps which, in turn, owns 80% of Wesco Financial
Corporation. The table shows both aggregate earnings of the
various business entities, as well as Berkshire’s share. All of
the significant capital gains or losses attributable to any of
the business entities are aggregated in the realized securities
gain figure at the bottom of the table, and are not included in
operating earnings.

Net Earnings
Earnings Before Income Taxes After Tax
-------------------------------------- ------------------
Total Berkshire Share Berkshire Share
------------------ ------------------ ------------------
(in thousands of dollars) 1979 1978 1979 1978 1979 1978
-------- -------- -------- -------- -------- --------
Total - all entities ......... $68,632 $66,180 $56,427 $54,350 $42,817 $39,242
======== ======== ======== ======== ======== ========
Earnings from Operations:
Insurance Group:
Underwriting ............ $ 3,742 $ 3,001 $ 3,741 $ 3,000 $ 2,214 $ 1,560
Net Investment Income ... 24,224 19,705 24,216 19,691 20,106 16,400
Berkshire-Waumbec textiles 1,723 2,916 1,723 2,916 848 1,342
Associated Retail
Stores, Inc. ........... 2,775 2,757 2,775 2,757 1,280 1,176
See’s Candies ............. 12,785 12,482 7,598 7,013 3,448 3,049
Buffalo Evening News ...... (4,617) (2,913) (2,744) (1,637) (1,333) (738)
Blue Chip Stamps - Parent 2,397 2,133 1,425 1,198 1,624 1,382
Illinois National Bank and
Trust Company .......... 5,747 4,822 5,614 4,710 5,027 4,262
Wesco Financial
Corporation - Parent ... 2,413 1,771 1,098 777 937 665
Mutual Savings and Loan
Association ............ 10,447 10,556 4,751 4,638 3,261 3,042
Precision Steel ........... 3,254 -- 1,480 -- 723 --
Interest on Debt .......... (8,248) (5,566) (5,860) (4,546) (2,900) (2,349)
Other ..................... 1,342 720 996 438 753 261
-------- -------- -------- -------- -------- --------
Total Earnings from
Operations .......... $57,984 $52,384 $46,813 $40,955 $35,988 $30,052
Realized Securities Gain 10,648 13,796 9,614 13,395 6,829 9,190
-------- -------- -------- -------- -------- --------
Total Earnings ......... $68,632 $66,180 $56,427 $54,350 $42,817 $39,242
======== ======== ======== ======== ======== ========

Blue Chip and Wesco are public companies with reporting
requirements of their own. On pages 37-43 of this report, we
have reproduced the narrative reports of the principal executives
of both companies, in which they describe 1979 operations. Some
of the numbers they mention in their reports are not precisely
identical to those in the above table because of accounting and
tax complexities. (The Yanomamo Indians employ only three
numbers: one, two, and more than two. Maybe their time will
come.) However, the commentary in those reports should be helpful
to you in understanding the underlying economic characteristics
and future prospects of the important businesses that they
manage.

A copy of the full annual report of either company will be
mailed to any shareholder of Berkshire upon request to Mr.
Robert H. Bird for Blue Chip Stamps, 5801 South Eastern Avenue,
Los Angeles, California 90040, or to Mrs. Bette Deckard for Wesco
Financial Corporation, 315 East Colorado Boulevard, Pasadena,
California 91109.

Textiles and Retailing

The relative significance of these two areas has diminished
somewhat over the years as our insurance business has grown
dramatically in size and earnings. Ben Rosner, at Associated
Retail Stores, continues to pull rabbits out of the hat - big
rabbits from a small hat. Year after year, he produces very
large earnings relative to capital employed - realized in cash
and not in increased receivables and inventories as in many other
retail businesses - in a segment of the market with little growth
and unexciting demographics. Ben is now 76 and, like our other
“up-and-comers”, Gene Abegg, 82, at Illinois National and Louis
Vincenti, 74, at Wesco, regularly achieves more each year.

Our textile business also continues to produce some cash,
but at a low rate compared to capital employed. This is not a
reflection on the managers, but rather on the industry in which
they operate. In some businesses - a network TV station, for
example - it is virtually impossible to avoid earning
extraordinary returns on tangible capital employed in the
business. And assets in such businesses sell at equally
extraordinary prices, one thousand cents or more on the dollar, a
valuation reflecting the splendid, almost unavoidable, economic
results obtainable. Despite a fancy price tag, the “easy”
business may be the better route to go.

We can speak from experience, having tried the other route.
Your Chairman made the decision a few years ago to purchase
Waumbec Mills in Manchester, New Hampshire, thereby expanding our
textile commitment. By any statistical test, the purchase price
was an extraordinary bargain; we bought well below the working
capital of the business and, in effect, got very substantial
amounts of machinery and real estate for less than nothing. But
the purchase was a mistake. While we labored mightily, new
problems arose as fast as old problems were tamed.

Both our operating and investment experience cause us to
conclude that “turnarounds” seldom turn, and that the same
energies and talent are much better employed in a good business
purchased at a fair price than in a poor business purchased at a
bargain price. Although a mistake, the Waumbec acquisition has
not been a disaster. Certain portions of the operation are
proving to be valuable additions to our decorator line (our
strongest franchise) at New Bedford, and it’s possible that we
may be able to run profitably on a considerably reduced scale at
Manchester. However, our original rationale did not prove out.

Insurance Underwriting

We predicted last year that the combined underwriting ratio
(see definition on page 36) for the insurance industry would
“move up at least a few points, perhaps enough to throw the
industry as a whole into an underwriting loss position”. That is
just about the way it worked out. The industry underwriting
ratio rose in 1979 over three points, from roughly 97.4% to
100.7%. We also said that we thought our underwriting performance
relative to the industry would improve somewhat in 1979 and,
again, things worked out as expected. Our own underwriting ratio
actually decreased from 98.2% to 97.1%. Our forecast for 1980 is
similar in one respect; again we feel that the industry’s
performance will worsen by at least another few points. However,
this year we have no reason to think that our performance
relative to the industry will further improve. (Don’t worry - we
won’t hold back to try to validate that forecast.)

Really extraordinary results were turned in by the portion
of National Indemnity Company’s insurance operation run by Phil
Liesche. Aided by Roland Miller in Underwriting and Bill Lyons
in Claims, this section of the business produced an underwriting
profit of $8.4 million on about $82 million of earned premiums.
Only a very few companies in the entire industry produced a
result comparable to this.

You will notice that earned premiums in this segment were
down somewhat from those of 1978. We hear a great many insurance
managers talk about being willing to reduce volume in order to
underwrite profitably, but we find that very few actually do so.
Phil Liesche is an exception: if business makes sense, he writes
it; if it doesn’t, he rejects it. It is our policy not to lay
off people because of the large fluctuations in work load
produced by such voluntary volume changes. We would rather have
some slack in the organization from time to time than keep
everyone terribly busy writing business on which we are going to
lose money. Jack Ringwalt, the founder of National Indemnity
Company, instilled this underwriting discipline at the inception
of the company, and Phil Liesche never has wavered in maintaining
it. We believe such strong-mindedness is as rare as it is sound
- and absolutely essential to the running of a first-class
casualty insurance operation.

John Seward continues to make solid progress at Home and
Automobile Insurance Company, in large part by significantly
expanding the marketing scope of that company in general
liability lines. These lines can be dynamite, but the record to
date is excellent and, in John McGowan and Paul Springman, we
have two cautious liability managers extending our capabilities.

Our reinsurance division, led by George Young, continues to
give us reasonably satisfactory overall results after allowing
for investment income, but underwriting performance remains
unsatisfactory. We think the reinsurance business is a very
tough business that is likely to get much tougher. In fact, the
influx of capital into the business and the resulting softer
price levels for continually increasing exposures may well
produce disastrous results for many entrants (of which they may
be blissfully unaware until they are in over their heads; much
reinsurance business involves an exceptionally “long tail”, a
characteristic that allows catastrophic current loss experience
to fester undetected for many years). It will be hard for us to
be a whole lot smarter than the crowd and thus our reinsurance
activity may decline substantially during the projected prolonged
period of extraordinary competition.

The Homestate operation was disappointing in 1979.
Excellent results again were turned in by George Billings at
Texas United Insurance Company, winner of the annual award for
the low loss ratio among Homestate companies, and Floyd Taylor at
Kansas Fire and Casualty Company. But several of the other
operations, particularly Cornhusker Casualty Company, our first
and largest Homestate operation and historically a winner, had
poor underwriting results which were accentuated by data
processing, administrative and personnel problems. We have made
some major mistakes in reorganizing our data processing
activities, and those mistakes will not be cured immediately or
without cost. However, John Ringwalt has thrown himself into the
task of getting things straightened out and we have confidence
that he, aided by several strong people who recently have been
brought aboard, will succeed.

Our performance in Worker’s Compensation was far, far better
than we had any right to expect at the beginning of 1979. We had
a very favorable climate in California for the achievement of
good results but, beyond this, Milt Thornton at Cypress Insurance
Company and Frank DeNardo at National Indemnity’s California
Worker’s Compensation operation both performed in a simply
outstanding manner. We have admitted - and with good reason -
some mistakes on the acquisition front, but the Cypress purchase
has turned out to be an absolute gem. Milt Thornton, like Phil
Liesche, follows the policy of sticking with business that he
understands and wants, without giving consideration to the impact
on volume. As a result, he has an outstanding book of business
and an exceptionally well functioning group of employees. Frank
DeNardo has straightened out the mess he inherited in Los Angeles
in a manner far beyond our expectations, producing savings
measured in seven figures. He now can begin to build on a sound
base.

At yearend we entered the specialized area of surety
reinsurance under the management of Chet Noble. At least
initially, this operation will be relatively small since our
policy will be to seek client companies who appreciate the need
for a long term “partnership” relationship with their reinsurers.
We are pleased by the quality of the insurers we have attracted,
and hope to add several more of the best primary writers as our
financial strength and stability become better known in the
surety field.

The conventional wisdom is that insurance underwriting
overall will be poor in 1980, but that rates will start to firm
in a year or so, leading to a turn in the cycle some time in
1981. We disagree with this view. Present interest rates
encourage the obtaining of business at underwriting loss levels
formerly regarded as totally unacceptable. Managers decry the
folly of underwriting at a loss to obtain investment income, but
we believe that many will. Thus we expect that competition will
create a new threshold of tolerance for underwriting losses, and
that combined ratios will average higher in the future than in
the past.

To some extent, the day of reckoning has been postponed
because of marked reduction in the frequency of auto accidents -
probably brought on in major part by changes in driving habits
induced by higher gas prices. In our opinion, if the habits
hadn’t changed, auto insurance rates would have been very little
higher and underwriting results would have been much worse. This
dosage of serendipity won’t last indefinitely.

Our forecast is for an average combined ratio for the
industry in the 105 area over the next five years. While we have
a high degree of confidence that certain of our operations will
do considerably better than average, it will be a challenge to us
to operate below the industry figure. You can get a lot of
surprises in insurance.

Nevertheless, we believe that insurance can be a very good
business. It tends to magnify, to an unusual degree, human
managerial talent - or the lack of it. We have a number of
managers whose talent is both proven and growing. (And, in
addition, we have a very large indirect interest in two truly
outstanding management groups through our investments in SAFECO
and GEICO.) Thus we expect to do well in insurance over a period
of years. However, the business has the potential for really
terrible results in a single specific year. If accident
frequency should turn around quickly in the auto field, we, along
with others, are likely to experience such a year.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:37 par mihou
Insurance Investments

In recent years we have written at length in this section
about our insurance equity investments. In 1979 they continued
to perform well, largely because the underlying companies in
which we have invested, in practically all cases, turned in
outstanding performances. Retained earnings applicable to our
insurance equity investments, not reported in our financial
statements, continue to mount annually and, in aggregate, now
come to a very substantial number. We have faith that the
managements of these companies will utilize those retained
earnings effectively and will translate a dollar retained by them
into a dollar or more of subsequent market value for us. In
part, our unrealized gains reflect this process.

Below we show the equity investments which had a yearend
market value of over $5 million:

No. of Sh. Company Cost Market
---------- ------- ---------- ----------
(000s omitted)
289,700 Affiliated Publications, Inc. ........... $ 2,821 $ 8,800
112,545 Amerada Hess ............................ 2,861 5,487
246,450 American Broadcasting Companies, Inc. ... 6,082 9,673
5,730,114 GEICO Corp. (Common Stock) .............. 28,288 68,045
328,700 General Foods, Inc. ..................... 11,437 11,053
1,007,500 Handy & Harman .......................... 21,825 38,537
711,180 Interpublic Group of Companies, Inc. .... 4,531 23,736
1,211,834 Kaiser Aluminum & Chemical Corp. ........ 20,629 23,328
282,500 Media General, Inc. ..................... 4,545 7,345
391,400 Ogilvy & Mather International ........... 3,709 7,828
953,750 SAFECO Corporation ...................... 23,867 35,527
1,868,000 The Washington Post Company ............. 10,628 39,241
771,900 F. W. Woolworth Company ................. 15,515 19,394
---------- ----------
Total ................................... $156,738 $297,994
All Other Holdings ...................... 28,675 38,686
---------- ----------
Total Equities .......................... $185,413 $336,680
========== ==========
We currently believe that equity markets in 1980 are likely
to evolve in a manner that will result in an underperformance by
our portfolio for the first time in recent years. We very much
like the companies in which we have major investments, and plan
no changes to try to attune ourselves to the markets of a
specific year.

Since we have covered our philosophy regarding equities
extensively in recent annual reports, a more extended discussion
of bond investments may be appropriate for this one, particularly
in light of what has happened since yearend. An extraordinary
amount of money has been lost by the insurance industry in the
bond area - notwithstanding the accounting convention that allows
insurance companies to carry their bond investments at amortized
cost, regardless of impaired market value. Actually, that very
accounting convention may have contributed in a major way to the
losses; had management been forced to recognize market values,
its attention might have been focused much earlier on the dangers
of a very long-term bond contract.

Ironically, many insurance companies have decided that a
one-year auto policy is inappropriate during a time of inflation,
and six-month policies have been brought in as replacements.
“How,” say many of the insurance managers, “can we be expected to
look forward twelve months and estimate such imponderables as
hospital costs, auto parts prices, etc.?” But, having decided
that one year is too long a period for which to set a fixed price
for insurance in an inflationary world, they then have turned
around, taken the proceeds from the sale of that six-month
policy, and sold the money at a fixed price for thirty or forty
years.

The very long-term bond contract has been the last major
fixed price contract of extended duration still regularly
initiated in an inflation-ridden world. The buyer of money to be
used between 1980 and 2020 has been able to obtain a firm price
now for each year of its use while the buyer of auto insurance,
medical services, newsprint, office space - or just about any
other product or service - would be greeted with laughter if he
were to request a firm price now to apply through 1985. For in
virtually all other areas of commerce, parties to long-term
contracts now either index prices in some manner, or insist on
the right to review the situation every year or so.

A cultural lag has prevailed in the bond area. The buyers
(borrowers) and middlemen (underwriters) of money hardly could be
expected to raise the question of whether it all made sense, and
the sellers (lenders) slept through an economic and contractual
revolution.

For the last few years our insurance companies have not been
a net purchaser of any straight long-term bonds (those without
conversion rights or other attributes offering profit
possibilities). There have been some purchases in the straight
bond area, of course, but they have been offset by sales or
maturities. Even prior to this period, we never would buy thirty
or forty-year bonds; instead we tried to concentrate in the
straight bond area on shorter issues with sinking funds and on
issues that seemed relatively undervalued because of bond market
inefficiencies.

However, the mild degree of caution that we exercised was an
improper response to the world unfolding about us. You do not
adequately protect yourself by being half awake while others are
sleeping. It was a mistake to buy fifteen-year bonds, and yet we
did; we made an even more serious mistake in not selling them (at
losses, if necessary) when our present views began to
crystallize. (Naturally, those views are much clearer and
definite in retrospect; it would be fair for you to ask why we
weren’t writing about this subject last year.)

Of course, we must hold significant amounts of bonds or
other fixed dollar obligations in conjunction with our insurance
operations. In the last several years our net fixed dollar
commitments have been limited to the purchase of convertible
bonds. We believe that the conversion options obtained, in
effect, give that portion of the bond portfolio a far shorter
average life than implied by the maturity terms of the issues
(i.e., at an appropriate time of our choosing, we can terminate
the bond contract by conversion into stock).

This bond policy has given us significantly lower unrealized
losses than those experienced by the great majority of property
and casualty insurance companies. We also have been helped by
our strong preference for equities in recent years that has kept
our overall bond segment relatively low. Nevertheless, we are
taking our lumps in bonds and feel that, in a sense, our mistakes
should be viewed less charitably than the mistakes of those who
went about their business unmindful of the developing problems.

Harking back to our textile experience, we should have
realized the futility of trying to be very clever (via sinking
funds and other special type issues) in an area where the tide
was running heavily against us.

We have severe doubts as to whether a very long-term fixed-
interest bond, denominated in dollars, remains an appropriate
business contract in a world where the value of dollars seems
almost certain to shrink by the day. Those dollars, as well as
paper creations of other governments, simply may have too many
structural weaknesses to appropriately serve as a unit of long
term commercial reference. If so, really long bonds may turn out
to be obsolete instruments and insurers who have bought those
maturities of 2010 or 2020 could have major and continuing
problems on their hands. We, likewise, will be unhappy with our
fifteen-year bonds and will annually pay a price in terms of
earning power that reflects that mistake.

Some of our convertible bonds appear exceptionally
attractive to us, and have the same sort of earnings retention
factor (applicable to the stock into which they may be converted)
that prevails in our conventional equity portfolio. We expect to
make money in these bonds (we already have, in a few cases) and
have hopes that our profits in this area may offset losses in
straight bonds.

And, of course, there is the possibility that our present
analysis is much too negative. The chances for very low rates of
inflation are not nil. Inflation is man-made; perhaps it can be
man-mastered. The threat which alarms us may also alarm
legislators and other powerful groups, prompting some appropriate
response.

Furthermore, present interest rates incorporate much higher
inflation projections than those of a year or two ago. Such
rates may prove adequate or more than adequate to protect bond
buyers. We even may miss large profits from a major rebound in
bond prices. However, our unwillingness to fix a price now for a
pound of See’s candy or a yard of Berkshire cloth to be delivered
in 2010 or 2020 makes us equally unwilling to buy bonds which set
a price on money now for use in those years. Overall, we opt for
Polonius (slightly restated): “Neither a short-term borrower nor
a long-term lender be.”

Banking

This will be the last year that we can report on the
Illinois National Bank and Trust Company as a subsidiary of
Berkshire Hathaway. Therefore, it is particularly pleasant to
report that, under Gene Abegg’s and Pete Jeffrey’s management,
the bank broke all previous records and earned approximately 2.3%
on average assets last year, a level again over three times that
achieved by the average major bank, and more than double that of
banks regarded as outstanding. The record is simply
extraordinary, and the shareholders of Berkshire Hathaway owe a
standing ovation to Gene Abegg for the performance this year and
every year since our purchase in 1969.

As you know, the Bank Holding Company Act of 1969 requires
that we divest the bank by December 31, 1980. For some years we
have expected to comply by effecting a spin-off during 1980.
However, the Federal Reserve Board has taken the firm position
that if the bank is spun off, no officer or director of Berkshire
Hathaway can be an officer or director of the spun-off bank or
bank holding company, even in a case such as ours in which one
individual would own over 40% of both companies.

Under these conditions, we are investigating the possible
sale of between 80% and 100% of the stock of the bank. We will
be most choosy about any purchaser, and our selection will not be
based solely on price. The bank and its management have treated
us exceptionally well and, if we have to sell, we want to be sure
that they are treated equally as well. A spin-off still is a
possibility if a fair price along with a proper purchaser cannot
be obtained by early fall.

However, you should be aware that we do not expect to be
able to fully, or even in very large part, replace the earning
power represented by the bank from the proceeds of the sale of
the bank. You simply can’t buy high quality businesses at the
sort of price/earnings multiple likely to prevail on our bank
sale.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:38 par mihou
Financial Reporting

During 1979, NASDAQ trading was initiated in the stock of
Berkshire Hathaway This means that the stock now is quoted on the
Over-the-Counter page of the Wall Street journal under
“Additional OTC Quotes”. Prior to such listing, the Wall Street
journal and the Dow-Jones news ticker would not report our
earnings, even though such earnings were one hundred or more
times the level of some companies whose reports they regularly
picked up.

Now, however, the Dow-Jones news ticker reports our
quarterly earnings promptly after we release them and, in
addition, both the ticker and the Wall Street journal report our
annual earnings. This solves a dissemination problem that had
bothered us.

In some ways, our shareholder group is a rather unusual one,
and this affects our manner of reporting to you. For example, at
the end of each year about 98% of the shares outstanding are held
by people who also were shareholders at the beginning of the
year. Therefore, in our annual report we build upon what we have
told you in previous years instead of restating a lot of
material. You get more useful information this way, and we don’t
get bored.

Furthermore, perhaps 90% of our shares are owned by
investors for whom Berkshire is their largest security holding,
very often far and away the largest. Many of these owners are
willing to spend a significant amount of time with the annual
report, and we attempt to provide them with the same information
we would find useful if the roles were reversed.

In contrast, we include no narrative with our quarterly
reports. Our owners and managers both have very long time-
horizons in regard to this business, and it is difficult to say
anything new or meaningful each quarter about events of long-term
significance.

But when you do receive a communication from us, it will
come from the fellow you are paying to run the business. Your
Chairman has a firm belief that owners are entitled to hear
directly from the CEO as to what is going on and how he evaluates
the business, currently and prospectively. You would demand that
in a private company; you should expect no less in a public
company. A once-a-year report of stewardship should not be
turned over to a staff specialist or public relations consultant
who is unlikely to be in a position to talk frankly on a manager-
to-owner basis.

We feel that you, as owners, are entitled to the same sort
of reporting by your manager as we feel is owed to us at
Berkshire Hathaway by managers of our business units. Obviously,
the degree of detail must be different, particularly where
information would be useful to a business competitor or the like.
But the general scope, balance, and level of candor should be
similar. We don’t expect a public relations document when our
operating managers tell us what is going on, and we don’t feel
you should receive such a document.

In large part, companies obtain the shareholder constituency
that they seek and deserve. If they focus their thinking and
communications on short-term results or short-term stock market
consequences they will, in large part, attract shareholders who
focus on the same factors. And if they are cynical in their
treatment of investors, eventually that cynicism is highly likely
to be returned by the investment community.

Phil Fisher, a respected investor and author, once likened
the policies of the corporation in attracting shareholders to
those of a restaurant attracting potential customers. A
restaurant could seek a given clientele - patrons of fast foods,
elegant dining, Oriental food, etc. - and eventually obtain an
appropriate group of devotees. If the job were expertly done,
that clientele, pleased with the service, menu, and price level
offered, would return consistently. But the restaurant could not
change its character constantly and end up with a happy and
stable clientele. If the business vacillated between French
cuisine and take-out chicken, the result would be a revolving
door of confused and dissatisfied customers.

So it is with corporations and the shareholder constituency
they seek. You can’t be all things to all men, simultaneously
seeking different owners whose primary interests run from high
current yield to long-term capital growth to stock market
pyrotechnics, etc.

The reasoning of managements that seek large trading
activity in their shares puzzles us. In effect, such managements
are saying that they want a good many of the existing clientele
continually to desert them in favor of new ones - because you
can’t add lots of new owners (with new expectations) without
losing lots of former owners.

We much prefer owners who like our service and menu and who
return year after year. It would be hard to find a better group
to sit in the Berkshire Hathaway shareholder “seats” than those
already occupying them. So we hope to continue to have a very
low turnover among our owners, reflecting a constituency that
understands our operation, approves of our policies, and shares
our expectations. And we hope to deliver on those expectations.

Prospects

Last year we said that we expected operating earnings in
dollars to improve but return on equity to decrease. This turned
out to be correct. Our forecast for 1980 is the same. If we are
wrong, it will be on the downside. In other words, we are
virtually certain that our operating earnings expressed as a
percentage of the new equity base of approximately $236 million,
valuing securities at cost, will decline from the 18.6% attained
in 1979. There is also a fair chance that operating earnings in
aggregate dollars will fall short of 1979; the outcome depends
partly upon the date of disposition of the bank, partly upon the
degree of slippage in insurance underwriting profitability, and
partly upon the severity of earnings problems in the savings and
loan industry.

We continue to feel very good about our insurance equity
investments. Over a period of years, we expect to develop very
large and growing amounts of underlying earning power
attributable to our fractional ownership of these companies. In
most cases they are splendid businesses, splendidly managed,
purchased at highly attractive prices.

Your company is run on the principle of centralization of
financial decisions at the top (the very top, it might be added),
and rather extreme delegation of operating authority to a number
of key managers at the individual company or business unit level.
We could just field a basketball team with our corporate
headquarters group (which utilizes only about 1500 square feet of
space).

This approach produces an occasional major mistake that
might have been eliminated or minimized through closer operating
controls. But it also eliminates large layers of costs and
dramatically speeds decision-making. Because everyone has a
great deal to do, a very great deal gets done. Most important of
all, it enables us to attract and retain some extraordinarily
talented individuals - people who simply can’t be hired in the
normal course of events - who find working for Berkshire to be
almost identical to running their own show.

We have placed much trust in them - and their achievements
have far exceeded that trust.



Warren E. Buffett, Chairman
March 3, 1980
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:38 par mihou
To the Shareholders of Berkshire Hathaway Inc.:

Operating earnings improved to $41.9 million in 1980 from
$36.0 million in 1979, but return on beginning equity capital
(with securities valued at cost) fell to 17.8% from 18.6%. We
believe the latter yardstick to be the most appropriate measure
of single-year managerial economic performance. Informed use of
that yardstick, however, requires an understanding of many
factors, including accounting policies, historical carrying
values of assets, financial leverage, and industry conditions.

In your evaluation of our economic performance, we suggest
that two factors should receive your special attention - one of a
positive nature peculiar, to a large extent, to our own
operation, and one of a negative nature applicable to corporate
performance generally. Let’s look at the bright side first.

Non-Controlled Ownership Earnings

When one company owns part of another company, appropriate
accounting procedures pertaining to that ownership interest must
be selected from one of three major categories. The percentage
of voting stock that is owned, in large part, determines which
category of accounting principles should be utilized.

Generally accepted accounting principles require (subject to
exceptions, naturally, as with our former bank subsidiary) full
consolidation of sales, expenses, taxes, and earnings of business
holdings more than 50% owned. Blue Chip Stamps, 60% owned by
Berkshire Hathaway Inc., falls into this category. Therefore,
all Blue Chip income and expense items are included in full in
Berkshire’s Consolidated Statement of Earnings, with the 40%
ownership interest of others in Blue Chip’s net earnings
reflected in the Statement as a deduction for “minority
interest”.

Full inclusion of underlying earnings from another class of
holdings, companies owned 20% to 50% (usually called
“investees”), also normally occurs. Earnings from such companies
- for example, Wesco Financial, controlled by Berkshire but only
48% owned - are included via a one-line entry in the owner’s
Statement of Earnings. Unlike the over-50% category, all items
of revenue and expense are omitted; just the proportional share
of net income is included. Thus, if Corporation A owns one-third
of Corporation B, one-third of B’s earnings, whether or not
distributed by B, will end up in A’s earnings. There are some
modifications, both in this and the over-50% category, for
intercorporate taxes and purchase price adjustments, the
explanation of which we will save for a later day. (We know you
can hardly wait.)

Finally come holdings representing less than 20% ownership
of another corporation’s voting securities. In these cases,
accounting rules dictate that the owning companies include in
their earnings only dividends received from such holdings.
Undistributed earnings are ignored. Thus, should we own 10% of
Corporation X with earnings of $10 million in 1980, we would
report in our earnings (ignoring relatively minor taxes on
intercorporate dividends) either (a) $1 million if X declared the
full $10 million in dividends; (b) $500,000 if X paid out 50%, or
$5 million, in dividends; or (c) zero if X reinvested all
earnings.

We impose this short - and over-simplified - course in
accounting upon you because Berkshire’s concentration of
resources in the insurance field produces a corresponding
concentration of its assets in companies in that third (less than
20% owned) category. Many of these companies pay out relatively
small proportions of their earnings in dividends. This means
that only a small proportion of their current earning power is
recorded in our own current operating earnings. But, while our
reported operating earnings reflect only the dividends received
from such companies, our economic well-being is determined by
their earnings, not their dividends.

Our holdings in this third category of companies have
increased dramatically in recent years as our insurance business
has prospered and as securities markets have presented
particularly attractive opportunities in the common stock area.
The large increase in such holdings, plus the growth of earnings
experienced by those partially-owned companies, has produced an
unusual result; the part of “our” earnings that these companies
retained last year (the part not paid to us in dividends)
exceeded the total reported annual operating earnings of
Berkshire Hathaway. Thus, conventional accounting only allows
less than half of our earnings “iceberg” to appear above the
surface, in plain view. Within the corporate world such a result
is quite rare; in our case it is likely to be recurring.

Our own analysis of earnings reality differs somewhat from
generally accepted accounting principles, particularly when those
principles must be applied in a world of high and uncertain rates
of inflation. (But it’s much easier to criticize than to improve
such accounting rules. The inherent problems are monumental.) We
have owned 100% of businesses whose reported earnings were not
worth close to 100 cents on the dollar to us even though, in an
accounting sense, we totally controlled their disposition. (The
“control” was theoretical. Unless we reinvested all earnings,
massive deterioration in the value of assets already in place
would occur. But those reinvested earnings had no prospect of
earning anything close to a market return on capital.) We have
also owned small fractions of businesses with extraordinary
reinvestment possibilities whose retained earnings had an
economic value to us far in excess of 100 cents on the dollar.

The value to Berkshire Hathaway of retained earnings is not
determined by whether we own 100%, 50%, 20% or 1% of the
businesses in which they reside. Rather, the value of those
retained earnings is determined by the use to which they are put
and the subsequent level of earnings produced by that usage.
This is true whether we determine the usage, or whether managers
we did not hire - but did elect to join - determine that usage.
(It’s the act that counts, not the actors.) And the value is in
no way affected by the inclusion or non-inclusion of those
retained earnings in our own reported operating earnings. If a
tree grows in a forest partially owned by us, but we don’t record
the growth in our financial statements, we still own part of the
tree.

Our view, we warn you, is non-conventional. But we would
rather have earnings for which we did not get accounting credit
put to good use in a 10%-owned company by a management we did not
personally hire, than have earnings for which we did get credit
put into projects of more dubious potential by another management
- even if we are that management.

(We can’t resist pausing here for a short commercial. One
usage of retained earnings we often greet with special enthusiasm
when practiced by companies in which we have an investment
interest is repurchase of their own shares. The reasoning is
simple: if a fine business is selling in the market place for far
less than intrinsic value, what more certain or more profitable
utilization of capital can there be than significant enlargement
of the interests of all owners at that bargain price? The
competitive nature of corporate acquisition activity almost
guarantees the payment of a full - frequently more than full
price when a company buys the entire ownership of another
enterprise. But the auction nature of security markets often
allows finely-run companies the opportunity to purchase portions
of their own businesses at a price under 50% of that needed to
acquire the same earning power through the negotiated acquisition
of another enterprise.)

Long-Term Corporate Results

As we have noted, we evaluate single-year corporate
performance by comparing operating earnings to shareholders’
equity with securities valued at cost. Our long-term yardstick
of performance, however, includes all capital gains or losses,
realized or unrealized. We continue to achieve a long-term
return on equity that considerably exceeds the average of our
yearly returns. The major factor causing this pleasant result is
a simple one: the retained earnings of those non-controlled
holdings we discussed earlier have been translated into gains in
market value.

Of course, this translation of retained earnings into market
price appreciation is highly uneven (it goes in reverse some
years), unpredictable as to timing, and unlikely to materialize
on a precise dollar-for-dollar basis. And a silly purchase price
for a block of stock in a corporation can negate the effects of a
decade of earnings retention by that corporation. But when
purchase prices are sensible, some long-term market recognition
of the accumulation of retained earnings almost certainly will
occur. Periodically you even will receive some frosting on the
cake, with market appreciation far exceeding post-purchase
retained earnings.

In the sixteen years since present management assumed
responsibility for Berkshire, book value per share with
insurance-held equities valued at market has increased from
$19.46 to $400.80, or 20.5% compounded annually. (You’ve done
better: the value of the mineral content in the human body
compounded at 22% annually during the past decade.) It is
encouraging, moreover, to realize that our record was achieved
despite many mistakes. The list is too painful and lengthy to
detail here. But it clearly shows that a reasonably competitive
corporate batting average can be achieved in spite of a lot of
managerial strikeouts.

Our insurance companies will continue to make large
investments in well-run, favorably-situated, non-controlled
companies that very often will pay out in dividends only small
proportions of their earnings. Following this policy, we would
expect our long-term returns to continue to exceed the returns
derived annually from reported operating earnings. Our
confidence in this belief can easily be quantified: if we were to
sell the equities that we hold and replace them with long-term
tax-free bonds, our reported operating earnings would rise
immediately by over $30 million annually. Such a shift tempts us
not at all.

So much for the good news.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:40 par mihou
Results for Owners

Unfortunately, earnings reported in corporate financial
statements are no longer the dominant variable that determines
whether there are any real earnings for you, the owner. For only
gains in purchasing power represent real earnings on investment.
If you (a) forego ten hamburgers to purchase an investment; (b)
receive dividends which, after tax, buy two hamburgers; and (c)
receive, upon sale of your holdings, after-tax proceeds that will
buy eight hamburgers, then (d) you have had no real income from
your investment, no matter how much it appreciated in dollars.
You may feel richer, but you won’t eat richer.

High rates of inflation create a tax on capital that makes
much corporate investment unwise - at least if measured by the
criterion of a positive real investment return to owners. This
“hurdle rate” the return on equity that must be achieved by a
corporation in order to produce any real return for its
individual owners - has increased dramatically in recent years.
The average tax-paying investor is now running up a down
escalator whose pace has accelerated to the point where his
upward progress is nil.

For example, in a world of 12% inflation a business earning
20% on equity (which very few manage consistently to do) and
distributing it all to individuals in the 50% bracket is chewing
up their real capital, not enhancing it. (Half of the 20% will go
for income tax; the remaining 10% leaves the owners of the
business with only 98% of the purchasing power they possessed at
the start of the year - even though they have not spent a penny
of their “earnings”). The investors in this bracket would
actually be better off with a combination of stable prices and
corporate earnings on equity capital of only a few per cent.

Explicit income taxes alone, unaccompanied by any implicit
inflation tax, never can turn a positive corporate return into a
negative owner return. (Even if there were 90% personal income
tax rates on both dividends and capital gains, some real income
would be left for the owner at a zero inflation rate.) But the
inflation tax is not limited by reported income. Inflation rates
not far from those recently experienced can turn the level of
positive returns achieved by a majority of corporations into
negative returns for all owners, including those not required to
pay explicit taxes. (For example, if inflation reached 16%,
owners of the 60% plus of corporate America earning less than
this rate of return would be realizing a negative real return -
even if income taxes on dividends and capital gains were
eliminated.)

Of course, the two forms of taxation co-exist and interact
since explicit taxes are levied on nominal, not real, income.
Thus you pay income taxes on what would be deficits if returns to
stockholders were measured in constant dollars.

At present inflation rates, we believe individual owners in
medium or high tax brackets (as distinguished from tax-free
entities such as pension funds, eleemosynary institutions, etc.)
should expect no real long-term return from the average American
corporation, even though these individuals reinvest the entire
after-tax proceeds from all dividends they receive. The average
return on equity of corporations is fully offset by the
combination of the implicit tax on capital levied by inflation
and the explicit taxes levied both on dividends and gains in
value produced by retained earnings.

As we said last year, Berkshire has no corporate solution to
the problem. (We’ll say it again next year, too.) Inflation does
not improve our return on equity.

Indexing is the insulation that all seek against inflation.
But the great bulk (although there are important exceptions) of
corporate capital is not even partially indexed. Of course,
earnings and dividends per share usually will rise if significant
earnings are “saved” by a corporation; i.e., reinvested instead
of paid as dividends. But that would be true without inflation.
A thrifty wage earner, likewise, could achieve regular annual
increases in his total income without ever getting a pay increase
- if he were willing to take only half of his paycheck in cash
(his wage “dividend”) and consistently add the other half (his
“retained earnings”) to a savings account. Neither this high-
saving wage earner nor the stockholder in a high-saving
corporation whose annual dividend rate increases while its rate
of return on equity remains flat is truly indexed.

For capital to be truly indexed, return on equity must rise,
i.e., business earnings consistently must increase in proportion
to the increase in the price level without any need for the
business to add to capital - including working capital -
employed. (Increased earnings produced by increased investment
don’t count.) Only a few businesses come close to exhibiting this
ability. And Berkshire Hathaway isn’t one of them.

We, of course, have a corporate policy of reinvesting
earnings for growth, diversity and strength, which has the
incidental effect of minimizing the current imposition of
explicit taxes on our owners. However, on a day-by-day basis,
you will be subjected to the implicit inflation tax, and when you
wish to transfer your investment in Berkshire into another form
of investment, or into consumption, you also will face explicit
taxes.

Sources of Earnings

The table below shows the sources of Berkshire’s reported
earnings. Berkshire owns about 60% of Blue Chip Stamps, which in
turn owns 80% of Wesco Financial Corporation. The table shows
aggregate earnings of the various business entities, as well as
Berkshire’s share of those earnings. All of the significant
capital gains and losses attributable to any of the business
entities are aggregated in the realized securities gains figure
at the bottom of the table, and are not included in operating
earnings. Our calculation of operating earnings also excludes
the gain from sale of Mutual’s branch offices. In this respect
it differs from the presentation in our audited financial
statements that includes this item in the calculation of
“Earnings Before Realized Investment Gain”.



Net Earnings
Earnings Before Income Taxes After Tax
-------------------------------------- ------------------
Total Berkshire Share Berkshire Share
------------------ ------------------ ------------------
(in thousands of dollars) 1980 1979 1980 1979 1980 1979
-------- -------- -------- -------- -------- --------
Total Earnings - all entities $ 85,945 $ 68,632 $ 70,146 $ 56,427 $ 53,122 $ 42,817
======== ======== ======== ======== ======== ========
Earnings from Operations:
Insurance Group:
Underwriting ............ $ 6,738 $ 3,742 $ 6,737 $ 3,741 $ 3,637 $ 2,214
Net Investment Income ... 30,939 24,224 30,927 24,216 25,607 20,106
Berkshire-Waumbec Textiles (508) 1,723 (508) 1,723 202 848
Associated Retail Stores .. 2,440 2,775 2,440 2,775 1,169 1,280
See’s Candies ............. 15,031 12,785 8,958 7,598 4,212 3,448
Buffalo Evening News ...... (2,805) (4,617) (1,672) (2,744) (816) (1,333)
Blue Chip Stamps - Parent 7,699 2,397 4,588 1,425 3,060 1,624
Illinois National Bank .... 5,324 5,747 5,200 5,614 4,731 5,027
Wesco Financial - Parent .. 2,916 2,413 1,392 1,098 1,044 937
Mutual Savings and Loan ... 5,814 10,447 2,775 4,751 1,974 3,261
Precision Steel ........... 2,833 3,254 1,352 1,480 656 723
Interest on Debt .......... (12,230) (8,248) (9,390) (5,860) (4,809) (2,900)
Other ..................... 2,170 1,342 1,590 996 1,255 753
-------- -------- -------- -------- -------- --------
Total Earnings from
Operations ........... $ 66,361 $ 57,984 $ 54,389 $ 46,813 $ 41,922 $ 35,988
Mutual Savings and Loan -
sale of branches ....... 5,873 -- 2,803 -- 1,293 --
Realized Securities Gain .... 13,711 10,648 12,954 9,614 9,907 6,829
-------- -------- -------- -------- -------- --------
Total Earnings - all entities $ 85,945 $ 68,632 $ 70,146 $ 56,427 $ 53,122 $ 42,817
======== ======== ======== ======== ======== ========

Blue Chip Stamps and Wesco are public companies with
reporting requirements of their own. On pages 40 to 53 of this
report we have reproduced the narrative reports of the principal
executives of both companies, in which they describe 1980
operations. We recommend a careful reading, and suggest that you
particularly note the superb job done by Louie Vincenti and
Charlie Munger in repositioning Mutual Savings and Loan. A copy
of the full annual report of either company will be mailed to any
Berkshire shareholder upon request to Mr. Robert H. Bird for Blue
Chip Stamps, 5801 South Eastern Avenue, Los Angeles, California
90040, or to Mrs. Bette Deckard for Wesco Financial Corporation,
315 East Colorado Boulevard, Pasadena, California 91109.

As indicated earlier, undistributed earnings in companies we
do not control are now fully as important as the reported
operating earnings detailed in the preceding table. The
distributed portion, of course, finds its way into the table
primarily through the net investment income section of Insurance
Group earnings.

We show below Berkshire’s proportional holdings in those
non-controlled businesses for which only distributed earnings
(dividends) are included in our own earnings.

No. of Shares Cost Market
------------- ---------- ----------
(000s omitted)
434,550 (a) Affiliated Publications, Inc. ......... $ 2,821 $ 12,222
464,317 (a) Aluminum Company of America ........... 25,577 27,685
475,217 (b) Cleveland-Cliffs Iron Company ......... 12,942 15,894
1,983,812 (b) General Foods, Inc. ................... 62,507 59,889
7,200,000 (a) GEICO Corporation ..................... 47,138 105,300
2,015,000 (a) Handy & Harman ........................ 21,825 58,435
711,180 (a) Interpublic Group of Companies, Inc. .. 4,531 22,135
1,211,834 (a) Kaiser Aluminum & Chemical Corp. ...... 20,629 27,569
282,500 (a) Media General ......................... 4,545 8,334
247,039 (b) National Detroit Corporation .......... 5,930 6,299
881,500 (a) National Student Marketing ............ 5,128 5,895
391,400 (a) Ogilvy & Mather Int’l. Inc. ........... 3,709 9,981
370,088 (b) Pinkerton’s, Inc. ..................... 12,144 16,489
245,700 (b) R. J. Reynolds Industries ............. 8,702 11,228
1,250,525 (b) SAFECO Corporation .................... 32,062 45,177
151,104 (b) The Times Mirror Company .............. 4,447 6,271
1,868,600 (a) The Washington Post Company ........... 10,628 42,277
667,124 (b) E W Woolworth Company ................. 13,583 16,511
---------- ----------
$298,848 $497,591
All Other Common Stockholdings ........ 26,313 32,096
---------- ----------
Total Common Stocks ................... $325,161 $529,687
========== ==========

(a) All owned by Berkshire or its insurance subsidiaries.
(b) Blue Chip and/or Wesco own shares of these companies. All
numbers represent Berkshire’s net interest in the larger
gross holdings of the group.

From this table, you can see that our sources of underlying
earning power are distributed far differently among industries
than would superficially seem the case. For example, our
insurance subsidiaries own approximately 3% of Kaiser Aluminum,
and 1 1/4% of Alcoa. Our share of the 1980 earnings of those
companies amounts to about $13 million. (If translated dollar for
dollar into a combination of eventual market value gain and
dividends, this figure would have to be reduced by a significant,
but not precisely determinable, amount of tax; perhaps 25% would
be a fair assumption.) Thus, we have a much larger economic
interest in the aluminum business than in practically any of the
operating businesses we control and on which we report in more
detail. If we maintain our holdings, our long-term performance
will be more affected by the future economics of the aluminum
industry than it will by direct operating decisions we make
concerning most companies over which we exercise managerial
control.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:41 par mihou
GEICO Corp.

Our largest non-controlled holding is 7.2 million shares of
GEICO Corp., equal to about a 33% equity interest. Normally, an
interest of this magnitude (over 20%) would qualify as an
“investee” holding and would require us to reflect a
proportionate share of GEICO’s earnings in our own. However, we
purchased our GEICO stock pursuant to special orders of the
District of Columbia and New York Insurance Departments, which
required that the right to vote the stock be placed with an
independent party. Absent the vote, our 33% interest does not
qualify for investee treatment. (Pinkerton’s is a similar
situation.)

Of course, whether or not the undistributed earnings of
GEICO are picked up annually in our operating earnings figure has
nothing to do with their economic value to us, or to you as
owners of Berkshire. The value of these retained earnings will
be determined by the skill with which they are put to use by
GEICO management.

On this score, we simply couldn’t feel better. GEICO
represents the best of all investment worlds - the coupling of a
very important and very hard to duplicate business advantage with
an extraordinary management whose skills in operations are
matched by skills in capital allocation.

As you can see, our holdings cost us $47 million, with about
half of this amount invested in 1976 and most of the remainder
invested in 1980. At the present dividend rate, our reported
earnings from GEICO amount to a little over $3 million annually.
But we estimate our share of its earning power is on the order of
$20 million annually. Thus, undistributed earnings applicable to
this holding alone may amount to 40% of total reported operating
earnings of Berkshire.

We should emphasize that we feel as comfortable with GEICO
management retaining an estimated $17 million of earnings
applicable to our ownership as we would if that sum were in our
own hands. In just the last two years GEICO, through repurchases
of its own stock, has reduced the share equivalents it has
outstanding from 34.2 million to 21.6 million, dramatically
enhancing the interests of shareholders in a business that simply
can’t be replicated. The owners could not have been better
served.

We have written in past reports about the disappointments
that usually result from purchase and operation of “turnaround”
businesses. Literally hundreds of turnaround possibilities in
dozens of industries have been described to us over the years
and, either as participants or as observers, we have tracked
performance against expectations. Our conclusion is that, with
few exceptions, when a management with a reputation for
brilliance tackles a business with a reputation for poor
fundamental economics, it is the reputation of the business that
remains intact.

GEICO may appear to be an exception, having been turned
around from the very edge of bankruptcy in 1976. It certainly is
true that managerial brilliance was needed for its resuscitation,
and that Jack Byrne, upon arrival in that year, supplied that
ingredient in abundance.

But it also is true that the fundamental business advantage
that GEICO had enjoyed - an advantage that previously had
produced staggering success - was still intact within the
company, although submerged in a sea of financial and operating
troubles.

GEICO was designed to be the low-cost operation in an
enormous marketplace (auto insurance) populated largely by
companies whose marketing structures restricted adaptation. Run
as designed, it could offer unusual value to its customers while
earning unusual returns for itself. For decades it had been run
in just this manner. Its troubles in the mid-70s were not
produced by any diminution or disappearance of this essential
economic advantage.

GEICO’s problems at that time put it in a position analogous
to that of American Express in 1964 following the salad oil
scandal. Both were one-of-a-kind companies, temporarily reeling
from the effects of a fiscal blow that did not destroy their
exceptional underlying economics. The GEICO and American Express
situations, extraordinary business franchises with a localized
excisable cancer (needing, to be sure, a skilled surgeon), should
be distinguished from the true “turnaround” situation in which
the managers expect - and need - to pull off a corporate
Pygmalion.

Whatever the appellation, we are delighted with our GEICO
holding which, as noted, cost us $47 million. To buy a similar
$20 million of earning power in a business with first-class
economic characteristics and bright prospects would cost a
minimum of $200 million (much more in some industries) if it had
to be accomplished through negotiated purchase of an entire
company. A 100% interest of that kind gives the owner the
options of leveraging the purchase, changing managements,
directing cash flow, and selling the business. It may also
provide some excitement around corporate headquarters (less
frequently mentioned).

We find it perfectly satisfying that the nature of our
insurance business dictates we buy many minority portions of
already well-run businesses (at prices far below our share of the
total value of the entire business) that do not need management
change, re-direction of cash flow, or sale. There aren’t many
Jack Byrnes in the managerial world, or GEICOs in the business
world. What could be better than buying into a partnership with
both of them?
Insurance Industry Conditions

The insurance industry’s underwriting picture continues to
unfold about as we anticipated, with the combined ratio (see
definition on page 37) rising from 100.6 in 1979 to an estimated
103.5 in 1980. It is virtually certain that this trend will
continue and that industry underwriting losses will mount,
significantly and progressively, in 1981 and 1982. To understand
why, we recommend that you read the excellent analysis of
property-casualty competitive dynamics done by Barbara Stewart of
Chubb Corp. in an October 1980 paper. (Chubb’s annual report
consistently presents the most insightful, candid and well-
written discussion of industry conditions; you should get on the
company’s mailing list.) Mrs. Stewart’s analysis may not be
cheerful, but we think it is very likely to be accurate.

And, unfortunately, a largely unreported but particularly
pernicious problem may well prolong and intensify the coming
industry agony. It is not only likely to keep many insurers
scrambling for business when underwriting losses hit record
levels - it is likely to cause them at such a time to redouble
their efforts.

This problem arises from the decline in bond prices and the
insurance accounting convention that allows companies to carry
bonds at amortized cost, regardless of market value. Many
insurers own long-term bonds that, at amortized cost, amount to
two to three times net worth. If the level is three times, of
course, a one-third shrink from cost in bond prices - if it were
to be recognized on the books - would wipe out net worth. And
shrink they have. Some of the largest and best known property-
casualty companies currently find themselves with nominal, or
even negative, net worth when bond holdings are valued at market.
Of course their bonds could rise in price, thereby partially, or
conceivably even fully, restoring the integrity of stated net
worth. Or they could fall further. (We believe that short-term
forecasts of stock or bond prices are useless. The forecasts may
tell you a great deal about the forecaster; they tell you nothing
about the future.)

It might strike some as strange that an insurance company’s
survival is threatened when its stock portfolio falls
sufficiently in price to reduce net worth significantly, but that
an even greater decline in bond prices produces no reaction at
all. The industry would respond by pointing out that, no matter
what the current price, the bonds will be paid in full at
maturity, thereby eventually eliminating any interim price
decline. It may take twenty, thirty, or even forty years, this
argument says, but, as long as the bonds don’t have to be sold,
in the end they’ll all be worth face value. Of course, if they
are sold even if they are replaced with similar bonds offering
better relative value - the loss must be booked immediately.
And, just as promptly, published net worth must be adjusted
downward by the amount of the loss.

Under such circumstances, a great many investment options
disappear, perhaps for decades. For example, when large
underwriting losses are in prospect, it may make excellent
business logic for some insurers to shift from tax-exempt bonds
into taxable bonds. Unwillingness to recognize major bond losses
may be the sole factor that prevents such a sensible move.

But the full implications flowing from massive unrealized
bond losses are far more serious than just the immobilization of
investment intellect. For the source of funds to purchase and
hold those bonds is a pool of money derived from policyholders
and claimants (with changing faces) - money which, in effect, is
temporarily on deposit with the insurer. As long as this pool
retains its size, no bonds must be sold. If the pool of funds
shrinks - which it will if the volume of business declines
significantly - assets must be sold to pay off the liabilities.
And if those assets consist of bonds with big unrealized losses,
such losses will rapidly become realized, decimating net worth in
the process.

Thus, an insurance company with a bond market value
shrinkage approaching stated net worth (of which there are now
many) and also faced with inadequate rate levels that are sure to
deteriorate further has two options. One option for management
is to tell the underwriters to keep pricing according to the
exposure involved - “be sure to get a dollar of premium for every
dollar of expense cost plus expectable loss cost”.

The consequences of this directive are predictable: (a) with
most business both price sensitive and renewable annually, many
policies presently on the books will be lost to competitors in
rather short order; (b) as premium volume shrinks significantly,
there will be a lagged but corresponding decrease in liabilities
(unearned premiums and claims payable); (c) assets (bonds) must
be sold to match the decrease in liabilities; and (d) the
formerly unrecognized disappearance of net worth will become
partially recognized (depending upon the extent of such sales) in
the insurer’s published financial statements.

Variations of this depressing sequence involve a smaller
penalty to stated net worth. The reaction of some companies at
(c) would be to sell either stocks that are already carried at
market values or recently purchased bonds involving less severe
losses. This ostrich-like behavior - selling the better assets
and keeping the biggest losers - while less painful in the short
term, is unlikely to be a winner in the long term.

The second option is much simpler: just keep writing
business regardless of rate levels and whopping prospective
underwriting losses, thereby maintaining the present levels of
premiums, assets and liabilities - and then pray for a better
day, either for underwriting or for bond prices. There is much
criticism in the trade press of “cash flow” underwriting; i.e.,
writing business regardless of prospective underwriting losses in
order to obtain funds to invest at current high interest rates.
This second option might properly be termed “asset maintenance”
underwriting - the acceptance of terrible business just to keep
the assets you now have.

Of course you know which option will be selected. And it
also is clear that as long as many large insurers feel compelled
to choose that second option, there will be no better day for
underwriting. For if much of the industry feels it must maintain
premium volume levels regardless of price adequacy, all insurers
will have to come close to meeting those prices. Right behind
having financial problems yourself, the next worst plight is to
have a large group of competitors with financial problems that
they can defer by a “sell-at-any-price” policy.

We mentioned earlier that companies that were unwilling -
for any of a number of reasons, including public reaction,
institutional pride, or protection of stated net worth - to sell
bonds at price levels forcing recognition of major losses might
find themselves frozen in investment posture for a decade or
longer. But, as noted, that’s only half of the problem.
Companies that have made extensive commitments to long-term bonds
may have lost, for a considerable period of time, not only many
of their investment options, but many of their underwriting
options as well.

Our own position in this respect is satisfactory. We
believe our net worth, valuing bonds of all insurers at amortized
cost, is the strongest relative to premium volume among all large
property-casualty stockholder-owned groups. When bonds are
valued at market, our relative strength becomes far more
dramatic. (But lest we get too puffed up, we remind ourselves
that our asset and liability maturities still are far more
mismatched than we would wish and that we, too, lost important
sums in bonds because your Chairman was talking when he should
have been acting.)

Our abundant capital and investment flexibility will enable
us to do whatever we think makes the most sense during the
prospective extended period of inadequate pricing. But troubles
for the industry mean troubles for us. Our financial strength
doesn’t remove us from the hostile pricing environment now
enveloping the entire property-casualty insurance industry. It
just gives us more staying power and more options.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:41 par mihou
Insurance Operations

The National Indemnity managers, led by Phil Liesche with
the usual able assistance of Roland Miller and Bill Lyons, outdid
themselves in 1980. While volume was flat, underwriting margins
relative to the industry were at an all-time high. We expect
decreased volume from this operation in 1981. But its managers
will hear no complaints from corporate headquarters, nor will
employment or salaries suffer. We enormously admire the National
Indemnity underwriting discipline - embedded from origin by the
founder, Jack Ringwalt - and know that this discipline, if
suspended, probably could not be fully regained.

John Seward at Home and Auto continues to make good progress
in replacing a diminishing number of auto policies with volume
from less competitive lines, primarily small-premium general
liability. Operations are being slowly expanded, both
geographically and by product line, as warranted by underwriting
results.

The reinsurance business continues to reflect the excesses
and problems of the primary writers. Worse yet, it has the
potential for magnifying such excesses. Reinsurance is
characterized by extreme ease of entry, large premium payments in
advance, and much-delayed loss reports and loss payments.
Initially, the morning mail brings lots of cash and few claims.
This state of affairs can produce a blissful, almost euphoric,
feeling akin to that experienced by an innocent upon receipt of
his first credit card.

The magnetic lure of such cash-generating characteristics,
currently enhanced by the presence of high interest rates, is
transforming the reinsurance market into “amateur night”.
Without a super catastrophe, industry underwriting will be poor
in the next few years. If we experience such a catastrophe,
there could be a bloodbath with some companies not able to live
up to contractual commitments. George Young continues to do a
first-class job for us in this business. Results, with
investment income included, have been reasonably profitable. We
will retain an active reinsurance presence but, for the
foreseeable future, we expect no premium growth from this
activity.

We continue to have serious problems in the Homestate
operation. Floyd Taylor in Kansas has done an outstanding job
but our underwriting record elsewhere is considerably below
average. Our poorest performer has been Insurance Company of
Iowa, at which large losses have been sustained annually since
its founding in 1973. Late in the fall we abandoned underwriting
in that state, and have merged the company into Cornhusker
Casualty. There is potential in the homestate concept, but much
work needs to be done in order to realize it.

Our Workers Compensation operation suffered a severe loss
when Frank DeNardo died last year at 37. Frank instinctively
thought like an underwriter. He was a superb technician and a
fierce competitor; in short order he had straightened out major
problems at the California Workers Compensation Division of
National Indemnity. Dan Grossman, who originally brought Frank
to us, stepped in immediately after Frank’s death to continue
that operation, which now utilizes Redwood Fire and Casualty,
another Berkshire subsidiary, as the insuring vehicle.

Our major Workers Compensation operation, Cypress Insurance
Company, run by Milt Thornton, continues its outstanding record.
Year after year Milt, like Phil Liesche, runs an underwriting
operation that far outpaces his competition. In the industry he
is admired and copied, but not matched.

Overall, we look for a significant decline in insurance
volume in 1981 along with a poorer underwriting result. We
expect underwriting experience somewhat superior to that of the
industry but, of course, so does most of the industry. There
will be some disappointments.

Textile and Retail Operations

During the past year we have cut back the scope of our
textile business. Operations at Waumbec Mills have been
terminated, reluctantly but necessarily. Some equipment was
transferred to New Bedford but most has been sold, or will be,
along with real estate. Your Chairman made a costly mistake in
not facing the realities of this situation sooner.

At New Bedford we have reduced the number of looms operated
by about one-third, abandoning some high-volume lines in which
product differentiation was insignificant. Even assuming
everything went right - which it seldom did - these lines could
not generate adequate returns related to investment. And, over a
full industry cycle, losses were the most likely result.

Our remaining textile operation, still sizable, has been
divided into a manufacturing and a sales division, each free to
do business independent of the other. Thus, distribution
strengths and mill capabilities will not be wedded to each other.
We have more than doubled capacity in our most profitable textile
segment through a recent purchase of used 130-inch Saurer looms.
Current conditions indicate another tough year in textiles, but
with substantially less capital employed in the operation.

Ben Rosner’s record at Associated Retail Stores continues to
amaze us. In a poor retailing year, Associated’s earnings
continued excellent - and those earnings all were translated into
cash. On March 7, 1981 Associated will celebrate its 50th
birthday. Ben has run the business (along with Leo Simon, his
partner from 1931 to 1966) in each of those fifty years.

Disposition of Illinois National Bank and Trust of Rockford
On December 31, 1980 we completed the exchange of 41,086
shares of Rockford Bancorp Inc. (which owns 97.7% of Illinois
National Bank) for a like number of shares of Berkshire Hathaway
Inc.

Our method of exchange allowed all Berkshire shareholders to
maintain their proportional interest in the Bank (except for me;
I was permitted 80% of my proportional share). They were thus
guaranteed an ownership position identical to that they would
have attained had we followed a more conventional spinoff
approach. Twenty-four shareholders (of our approximate 1300)
chose this proportional exchange option.

We also allowed overexchanges, and thirty-nine additional
shareholders accepted this option, thereby increasing their
ownership in the Bank and decreasing their proportional ownership
in Berkshire. All got the full amount of Bancorp stock they
requested, since the total shares desired by these thirty-nine
holders was just slightly less than the number left available by
the remaining 1200-plus holders of Berkshire who elected not to
part with any Berkshire shares at all. As the exchanger of last
resort, I took the small balance (3% of Bancorp’s stock). These
shares, added to shares I received from my basic exchange
allotment (80% of normal), gave me a slightly reduced
proportional interest in the Bank and a slightly enlarged
proportional interest in Berkshire.

Management of the Bank is pleased with the outcome. Bancorp
will operate as an inexpensive and uncomplicated holding company
owned by 65 shareholders. And all of those shareholders will
have become Bancorp owners through a conscious affirmative
decision.

Financing

In August we sold $60 million of 12 3/4% notes due August 1,
2005, with a sinking fund to begin in 1991.

The managing underwriters, Donaldson, Lufkin & Jenrette
Securities Corporation, represented by Bill Fisher, and Chiles,
Heider & Company, Inc., represented by Charlie Heider, did an
absolutely first-class job from start to finish of the financing.

Unlike most businesses, Berkshire did not finance because of
any specific immediate needs. Rather, we borrowed because we
think that, over a period far shorter than the life of the loan,
we will have many opportunities to put the money to good use.
The most attractive opportunities may present themselves at a
time when credit is extremely expensive - or even unavailable.
At such a time we want to have plenty of financial firepower.

Our acquisition preferences run toward businesses that
generate cash, not those that consume it. As inflation
intensifies, more and more companies find that they must spend
all funds they generate internally just to maintain their
existing physical volume of business. There is a certain mirage-
like quality to such operations. However attractive the earnings
numbers, we remain leery of businesses that never seem able to
convert such pretty numbers into no-strings-attached cash.

Businesses meeting our standards are not easy to find. (Each
year we read of hundreds of corporate acquisitions; only a
handful would have been of interest to us.) And logical expansion
of our present operations is not easy to implement. But we’ll
continue to utilize both avenues in our attempts to further
Berkshire’s growth.

Under all circumstances we plan to operate with plenty of
liquidity, with debt that is moderate in size and properly
structured, and with an abundance of capital strength. Our
return on equity is penalized somewhat by this conservative
approach, but it is the only one with which we feel comfortable.


* * * * * * * * * * * *


Gene Abegg, founder of our long-owned bank in Rockford, died
on July 2, 1980 at the age of 82. As a friend, banker and
citizen, he was unsurpassed.

You learn a great deal about a person when you purchase a
business from him and he then stays on to run it as an employee
rather than as an owner. Before the purchase the seller knows
the business intimately, whereas you start from scratch. The
seller has dozens of opportunities to mislead the buyer - through
omissions, ambiguities, and misdirection. After the check has
changed hands, subtle (and not so subtle) changes of attitude can
occur and implicit understandings can evaporate. As in the
courtship-marriage sequence, disappointments are not infrequent.

From the time we first met, Gene shot straight 100% of the
time - the only behavior pattern he had within him. At the
outset of negotiations, he laid all negative factors face up on
the table; on the other hand, for years after the transaction was
completed he would tell me periodically of some previously
undiscussed items of value that had come with our purchase.

Though he was already 71 years of age when he sold us the
Bank, Gene subsequently worked harder for us than he had for
himself. He never delayed reporting a problem for a minute, but
problems were few with Gene. What else would you expect from a
man who, at the time of the bank holiday in 1933, had enough cash
on the premises to pay all depositors in full? Gene never forgot
he was handling other people’s money. Though this fiduciary
attitude was always dominant, his superb managerial skills
enabled the Bank to regularly achieve the top position nationally
in profitability.

Gene was in charge of the Illinois National for close to
fifty years - almost one-quarter of the lifetime of our country.
George Mead, a wealthy industrialist, brought him in from Chicago
to open a new bank after a number of other banks in Rockford had
failed. Mr. Mead put up the money and Gene ran the show. His
talent for leadership soon put its stamp on virtually every major
civic activity in Rockford.

Dozens of Rockford citizens have told me over the years of
help Gene extended to them. In some cases this help was
financial; in all cases it involved much wisdom, empathy and
friendship. He always offered the same to me. Because of our
respective ages and positions I was sometimes the junior partner,
sometimes the senior. Whichever the relationship, it always was
a special one, and I miss it.


Warren E. Buffett
February 27, 1981 Chairman of the Board
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:42 par mihou
February 26, 1982



To the Shareholders of Berkshire Hathaway Inc.:

Operating earnings of $39.7 million in 1981 amounted to
15.2% of beginning equity capital (valuing securities at cost)
compared to 17.8% in 1980. Our new plan that allows stockholders
to designate corporate charitable contributions (detailed later)
reduced earnings by about $900,000 in 1981. This program, which
we expect to continue subject to annual evaluation of our
corporate tax position, had not been initiated in 1980.


Non-Controlled Ownership Earnings

In the 1980 annual report we discussed extensively the
concept of non-controlled ownership earnings, i.e., Berkshire’s
share of the undistributed earnings of companies we don’t control
or significantly influence but in which we, nevertheless, have
important investments. (We will be glad to make available to new
or prospective shareholders copies of that discussion or others
from earlier reports to which we refer in this report.) No
portion of those undistributed earnings is included in the
operating earnings of Berkshire.

However, our belief is that, in aggregate, those
undistributed and, therefore, unrecorded earnings will be
translated into tangible value for Berkshire shareholders just as
surely as if subsidiaries we control had earned, retained - and
reported - similar earnings.

We know that this translation of non-controlled ownership
earnings into corresponding realized and unrealized capital gains
for Berkshire will be extremely irregular as to time of
occurrence. While market values track business values quite well
over long periods, in any given year the relationship can gyrate
capriciously. Market recognition of retained earnings also will
be unevenly realized among companies. It will be disappointingly
low or negative in cases where earnings are employed non-
productively, and far greater than dollar-for-dollar of retained
earnings in cases of companies that achieve high returns with
their augmented capital. Overall, if a group of non-controlled
companies is selected with reasonable skill, the group result
should be quite satisfactory.

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.


General Acquisition Behavior

As our history indicates, we are comfortable both with total
ownership of businesses and with marketable securities
representing small portions of businesses. We continually look
for ways to employ large sums in each area. (But we try to avoid
small commitments - “If something’s not worth doing at all, it’s
not worth doing well”.) Indeed, the liquidity requirements of our
insurance and trading stamp businesses mandate major investments
in marketable securities.

Our acquisition decisions will be aimed at maximizing real
economic benefits, not at maximizing either managerial domain or
reported numbers for accounting purposes. (In the long run,
managements stressing accounting appearance over economic
substance usually achieve little of either.)

Regardless of the impact upon immediately reportable
earnings, we would rather buy 10% of Wonderful Business T at X
per share than 100% of T at 2X per share. Most corporate
managers prefer just the reverse, and have no shortage of stated
rationales for their behavior.

However, we suspect three motivations - usually unspoken -
to be, singly or in combination, the important ones in most high-
premium takeovers:

(1) Leaders, business or otherwise, seldom are deficient in
animal spirits and often relish increased activity and
challenge. At Berkshire, the corporate pulse never
beats faster than when an acquisition is in prospect.

(2) Most organizations, business or otherwise, measure
themselves, are measured by others, and compensate their
managers far more by the yardstick of size than by any
other yardstick. (Ask a Fortune 500 manager where his
corporation stands on that famous list and, invariably,
the number responded will be from the list ranked by
size of sales; he may well not even know where his
corporation places on the list Fortune just as
faithfully compiles ranking the same 500 corporations by
profitability.)

(3) Many managements apparently were overexposed in
impressionable childhood years to the story in which the
imprisoned handsome prince is released from a toad’s
body by a kiss from a beautiful princess. Consequently,
they are certain their managerial kiss will do wonders
for the profitability of Company T(arget).

Such optimism is essential. Absent that rosy view,
why else should the shareholders of Company A(cquisitor)
want to own an interest in T at the 2X takeover cost
rather than at the X market price they would pay if they
made direct purchases on their own?

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.

In fairness, we should acknowledge that some acquisition
records have been dazzling. Two major categories stand out.

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.

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. We salute such managers as Ben Heineman at
Northwest Industries, Henry Singleton at Teledyne, Erwin Zaban at
National Service Industries, and especially Tom Murphy at Capital
Cities Communications (a real managerial “twofer”, whose
acquisition efforts have been properly focused in Category 1 and
whose operating talents also make him a leader of Category 2).
From both direct and vicarious experience, we recognize the
difficulty and rarity of these executives’ achievements. (So do
they; these champs have made very few deals in recent years, and
often have found repurchase of their own shares to be the most
sensible employment of corporate capital.)

Your Chairman, unfortunately, does not qualify for Category
2. And, despite a reasonably good understanding of the economic
factors compelling concentration in Category 1, our actual
acquisition activity in that category has been sporadic and
inadequate. Our preaching was better than our performance. (We
neglected the Noah principle: predicting rain doesn’t count,
building arks does.)

We have tried occasionally to buy toads at bargain prices
with results that have been chronicled in past reports. Clearly
our kisses fell flat. We have done well with a couple of princes
- but they were princes when purchased. At least our kisses
didn’t turn them into toads. And, finally, we have occasionally
been quite successful in purchasing fractional interests in
easily-identifiable princes at toad-like prices.


Berkshire Acquisition Objectives

We will continue to seek the acquisition of businesses in
their entirety at prices that will make sense, even should the
future of the acquired enterprise develop much along the lines of
its past. We may very well pay a fairly fancy price for a
Category 1 business if we are reasonably confident of what we are
getting. But we will not normally pay a lot in any purchase for
what we are supposed to bring to the party - for we find that we
ordinarily don’t bring a lot.

During 1981 we came quite close to a major purchase
involving both a business and a manager we liked very much.
However, the price finally demanded, considering alternative uses
for the funds involved, would have left our owners worse off than
before the purchase. The empire would have been larger, but the
citizenry would have been poorer.

Although we had no success in 1981, from time to time in the
future we will be able to purchase 100% of businesses meeting our
standards. Additionally, we expect an occasional offering of a
major “non-voting partnership” as discussed under the Pinkerton’s
heading on page 47 of this report. We welcome suggestions
regarding such companies where we, as a substantial junior
partner, can achieve good economic results while furthering the
long-term objectives of present owners and managers.

Currently, we find values most easily obtained through the
open-market purchase of fractional positions in companies with
excellent business franchises and competent, honest managements.
We never expect to run these companies, but we do expect to
profit from them.

We expect that undistributed earnings from such companies
will produce full value (subject to tax when realized) for
Berkshire and its shareholders. If they don’t, we have made
mistakes as to either: (1) the management we have elected to
join; (2) the future economics of the business; or (3) the price
we have paid.

We have made plenty of such mistakes - both in the purchase
of non-controlling and controlling interests in businesses.
Category (2) miscalculations are the most common. Of course, it
is necessary to dig deep into our history to find illustrations
of such mistakes - sometimes as deep as two or three months back.
For example, last year your Chairman volunteered his expert
opinion on the rosy future of the aluminum business. Several
minor adjustments to that opinion - now aggregating approximately
180 degrees - have since been required.

For personal as well as more objective reasons, however, we
generally have been able to correct such mistakes far more
quickly in the case of non-controlled businesses (marketable
securities) than in the case of controlled subsidiaries. Lack of
control, in effect, often has turned out to be an economic plus.

As we mentioned last year, the magnitude of our non-recorded
“ownership” earnings has grown to the point where their total is
greater than our reported operating earnings. We expect this
situation will continue. In just four ownership positions in
this category - GEICO Corporation, General Foods Corporation, R.
J. Reynolds Industries, Inc. and The Washington Post Company -
our share of undistributed and therefore unrecorded earnings
probably will total well over $35 million in 1982. The
accounting rules that entirely ignore these undistributed
earnings diminish the utility of our annual return on equity
calculation, or any other single year measure of economic
performance.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:43 par mihou
Long-Term Corporate Performance

In measuring long-term economic performance, equities held
by our insurance subsidiaries are valued at market subject to a
charge reflecting the amount of taxes that would have to be paid
if unrealized gains were actually realized. If we are correct in
the premise stressed in the preceding section of this report, our
unreported ownership earnings will find their way, irregularly
but inevitably, into our net worth. To date, this has been the
case.

An even purer calculation of performance would involve a
valuation of bonds and non-insurance held equities at market.
However, GAAP accounting does not prescribe this procedure, and
the added purity would change results only very slightly. Should
any valuation difference widen to significant proportions, as it
has at most major insurance companies, we will report its effect
to you.

On a GAAP basis, during the present management’s term of
seventeen years, book value has increased from $19.46 per share
to $526.02 per share, or 21.1% compounded annually. This rate of
return number is highly likely to drift downward in future years.
We hope, however, that it can be maintained significantly above
the rate of return achieved by the average large American
corporation.

Over half of the large gain in Berkshire’s net worth during
1981 - it totaled $124 million, or about 31% - resulted from the
market performance of a single investment, GEICO Corporation. In
aggregate, our market gain from securities during the year
considerably outstripped the gain in underlying business values.
Such market variations will not always be on the pleasant side.

In past reports we have explained how inflation has caused
our apparently satisfactory long-term corporate performance to be
illusory as a measure of true investment results for our owners.
We applaud the efforts of Federal Reserve Chairman Volcker and
note the currently more moderate increases in various price
indices. Nevertheless, our views regarding long-term
inflationary trends are as negative as ever. Like virginity, a
stable price level seems capable of maintenance, but not of
restoration.

Despite the overriding importance of inflation in the
investment equation, we will not punish you further with another
full recital of our views; inflation itself will be punishment
enough. (Copies of previous discussions are available for
masochists.) But, because of the unrelenting destruction of
currency values, our corporate efforts will continue to do a much
better job of filling your wallet than of filling your stomach.


Equity Value-Added

An additional factor should further subdue any residual
enthusiasm you may retain regarding our long-term rate of return.
The economic case justifying equity investment is that, in
aggregate, additional earnings above passive investment returns -
interest on fixed-income securities - will be derived through the
employment of managerial and entrepreneurial skills in
conjunction with that equity capital. Furthermore, the case says
that since the equity capital position is associated with greater
risk than passive forms of investment, it is “entitled” to higher
returns. A “value-added” bonus from equity capital seems natural
and certain.

But is it? Several decades back, a return on equity of as
little as 10% enabled a corporation to be classified as a “good”
business - i.e., one in which a dollar reinvested in the business
logically could be expected to be valued by the market at more
than one hundred cents. For, with long-term taxable bonds
yielding 5% and long-term tax-exempt bonds 3%, a business
operation that could utilize equity capital at 10% clearly was
worth some premium to investors over the equity capital employed.
That was true even though a combination of taxes on dividends and
on capital gains would reduce the 10% earned by the corporation
to perhaps 6%-8% in the hands of the individual investor.

Investment markets recognized this truth. During that
earlier period, American business earned an average of 11% or so
on equity capital employed and stocks, in aggregate, sold at
valuations far above that equity capital (book value), averaging
over 150 cents on the dollar. Most businesses were “good”
businesses because they earned far more than their keep (the
return on long-term passive money). The value-added produced by
equity investment, in aggregate, was substantial.

That day is gone. But the lessons learned during its
existence are difficult to discard. While investors and managers
must place their feet in the future, their memories and nervous
systems often remain plugged into the past. It is much easier
for investors to utilize historic p/e ratios or for managers to
utilize historic business valuation yardsticks than it is for
either group to rethink their premises daily. When change is
slow, constant rethinking is actually undesirable; it achieves
little and slows response time. But when change is great,
yesterday’s assumptions can be retained only at great cost. And
the pace of economic change has become breathtaking.

During the past year, long-term taxable bond yields exceeded
16% and long-term tax-exempts 14%. The total return achieved
from such tax-exempts, of course, goes directly into the pocket
of the individual owner. Meanwhile, American business is
producing earnings of only about 14% on equity. And this 14%
will be substantially reduced by taxation before it can be banked
by the individual owner. The extent of such shrinkage depends
upon the dividend policy of the corporation and the tax rates
applicable to the investor.

Thus, with interest rates on passive investments at late
1981 levels, a typical American business is no longer worth one
hundred cents on the dollar to owners who are individuals. (If
the business is owned by pension funds or other tax-exempt
investors, the arithmetic, although still unenticing, changes
substantially for the better.) Assume an investor in a 50% tax
bracket; if our typical company pays out all earnings, the income
return to the investor will be equivalent to that from a 7% tax-
exempt bond. And, if conditions persist - if all earnings are
paid out and return on equity stays at 14% - the 7% tax-exempt
equivalent to the higher-bracket individual investor is just as
frozen as is the coupon on a tax-exempt bond. Such a perpetual
7% tax-exempt bond might be worth fifty cents on the dollar as
this is written.

If, on the other hand, all earnings of our typical American
business are retained and return on equity again remains
constant, earnings will grow at 14% per year. If the p/e ratio
remains constant, the price of our typical stock will also grow
at 14% per year. But that 14% is not yet in the pocket of the
shareholder. Putting it there will require the payment of a
capital gains tax, presently assessed at a maximum rate of 20%.
This net return, of course, works out to a poorer rate of return
than the currently available passive after-tax rate.

Unless passive rates fall, companies achieving 14% per year
gains in earnings per share while paying no cash dividend are an
economic failure for their individual shareholders. The returns
from passive capital outstrip the returns from active capital.
This is an unpleasant fact for both investors and corporate
managers and, therefore, one they may wish to ignore. But facts
do not cease to exist, either because they are unpleasant or
because they are ignored.

Most American businesses pay out a significant portion of
their earnings and thus fall between the two examples. And most
American businesses are currently “bad” businesses economically -
producing less for their individual investors after-tax than the
tax-exempt passive rate of return on money. Of course, some
high-return businesses still remain attractive, even under
present conditions. But American equity capital, in aggregate,
produces no value-added for individual investors.

It should be stressed that this depressing situation does
not occur because corporations are jumping, economically, less
high than previously. In fact, they are jumping somewhat higher:
return on equity has improved a few points in the past decade.
But the crossbar of passive return has been elevated much faster.
Unhappily, most companies can do little but hope that the bar
will be lowered significantly; there are few industries in which
the prospects seem bright for substantial gains in return on
equity.

Inflationary experience and expectations will be major (but
not the only) factors affecting the height of the crossbar in
future years. If the causes of long-term inflation can be
tempered, passive returns are likely to fall and the intrinsic
position of American equity capital should significantly improve.
Many businesses that now must be classified as economically “bad”
would be restored to the “good” category under such
circumstances.

A further, particularly ironic, punishment is inflicted by
an inflationary environment upon the owners of the “bad”
business. To continue operating in its present mode, such a low-
return business usually must retain much of its earnings - no
matter what penalty such a policy produces for shareholders.

Reason, of course, would prescribe just the opposite policy.
An individual, stuck with a 5% bond with many years to run before
maturity, does not take the coupons from that bond and pay one
hundred cents on the dollar for more 5% bonds while similar bonds
are available at, say, forty cents on the dollar. Instead, he
takes those coupons from his low-return bond and - if inclined to
reinvest - looks for the highest return with safety currently
available. Good money is not thrown after bad.

What makes sense for the bondholder makes sense for the
shareholder. Logically, a company with historic and prospective
high returns on equity should retain much or all of its earnings
so that shareholders can earn premium returns on enhanced
capital. Conversely, low returns on corporate equity would
suggest a very high dividend payout so that owners could direct
capital toward more attractive areas. (The Scriptures concur. In
the parable of the talents, the two high-earning servants are
rewarded with 100% retention of earnings and encouraged to expand
their operations. However, the non-earning third servant is not
only chastised - “wicked and slothful” - but also is required to
redirect all of his capital to the top performer. Matthew 25:
14-30)

But inflation takes us through the looking glass into the
upside-down world of Alice in Wonderland. When prices
continuously rise, the “bad” business must retain every nickel
that it can. Not because it is attractive as a repository for
equity capital, but precisely because it is so unattractive, the
low-return business must follow a high retention policy. If it
wishes to continue operating in the future as it has in the past
- and most entities, including businesses, do - it simply has no
choice.

For inflation acts as a gigantic corporate tapeworm. That
tapeworm preemptively consumes its requisite daily diet of
investment dollars regardless of the health of the host organism.
Whatever the level of reported profits (even if nil), more
dollars for receivables, inventory and fixed assets are
continuously required by the business in order to merely match
the unit volume of the previous year. The less prosperous the
enterprise, the greater the proportion of available sustenance
claimed by the tapeworm.

Under present conditions, a business earning 8% or 10% on
equity often has no leftovers for expansion, debt reduction or
“real” dividends. The tapeworm of inflation simply cleans the
plate. (The low-return company’s inability to pay dividends,
understandably, is often disguised. Corporate America
increasingly is turning to dividend reinvestment plans, sometimes
even embodying a discount arrangement that all but forces
shareholders to reinvest. Other companies sell newly issued
shares to Peter in order to pay dividends to Paul. Beware of
“dividends” that can be paid out only if someone promises to
replace the capital distributed.)

Berkshire continues to retain its earnings for offensive,
not defensive or obligatory, reasons. But in no way are we
immune from the pressures that escalating passive returns exert
on equity capital. We continue to clear the crossbar of after-
tax passive return - but barely. Our historic 21% return - not
at all assured for the future - still provides, after the current
capital gain tax rate (which we expect to rise considerably in
future years), a modest margin over current after-tax rates on
passive money. It would be a bit humiliating to have our
corporate value-added turn negative. But it can happen here as
it has elsewhere, either from events outside anyone’s control or
from poor relative adaptation on our part.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:43 par mihou
Sources of Reported Earnings

The table below shows the sources of Berkshire’s reported
earnings. Berkshire owns about 60% of Blue Chip Stamps which, in
turn, owns 80% of Wesco Financial Corporation. The table
displays aggregate operating earnings of the various business
entities, as well as Berkshire’s share of those earnings. All of
the significant gains and losses attributable to unusual sales of
assets by any of the business entities are aggregated with
securities transactions in the line near the bottom of the table
and are not included in operating earnings.

Net Earnings
Earnings Before Income Taxes After Tax
-------------------------------------- ------------------
Total Berkshire Share Berkshire Share
------------------ ------------------ ------------------
1981 1980 1981 1980 1981 1980
-------- -------- -------- -------- -------- --------
(000s omitted)
Operating Earnings:
Insurance Group:
Underwriting ............ $ 1,478 $ 6,738 $ 1,478 $ 6,737 $ 798 $ 3,637
Net Investment Income ... 38,823 30,939 38,823 30,927 32,401 25,607
Berkshire-Waumbec Textiles (2,669) (508) (2,669) (508) (1,493) 202
Associated Retail Stores .. 1,763 2,440 1,763 2,440 759 1,169
See’s Candies ............. 21,891 15,475 13,046 9,223 6,289 4,459
Buffalo Evening News ...... (1,057) (2,777) (630) (1,655) (276) (800)
Blue Chip Stamps - Parent 3,642 7,699 2,171 4,588 2,134 3,060
Wesco Financial - Parent .. 4,495 2,916 2,145 1,392 1,590 1,044
Mutual Savings and Loan ... 1,605 5,814 766 2,775 1,536 1,974
Precision Steel ........... 3,453 2,833 1,648 1,352 841 656
Interest on Debt .......... (14,656) (12,230) (12,649) (9,390) (6,671) (4,809)
Other* .................... 1,895 1,698 1,344 1,308 1,513 992
-------- -------- -------- -------- -------- --------
Sub-total - Continuing
Operations ............. $ 60,663 $ 61,037 $ 47,236 $ 49,189 $ 39,421 $ 37,191
Illinois National Bank** .. -- 5,324 -- 5,200 -- 4,731
-------- -------- -------- -------- -------- --------
Operating Earnings .......... 60,663 66,361 47,236 54,389 39,421 41,922
Sales of securities and
unusual sales of assets .. 37,801 19,584 33,150 15,757 23,183 11,200
-------- -------- -------- -------- -------- --------
Total Earnings - all entities $ 98,464 $ 85,945 $ 80,386 $ 70,146 $ 62,604 $ 53,122
======== ======== ======== ======== ======== ========

*Amortization of intangibles arising in accounting for
purchases of businesses (i.e. See’s, Mutual and Buffalo
Evening News) is reflected in the category designated as
“Other”.

**Berkshire divested itself of its ownership of the Illinois
National Bank on December 31, 1980.

Blue Chip Stamps and Wesco are public companies with
reporting requirements of their own. On pages 38-50 of this
report we have reproduced the narrative reports of the principal
executives of both companies, in which they describe 1981
operations. A copy of the full annual report of either company
will be mailed to any Berkshire shareholder upon request to Mr.
Robert H. Bird for Blue Chip Stamps, 5801 South Eastern Avenue,
Los Angeles, California 90040, or to Mrs. Jeanne Leach for Wesco
Financial Corporation, 315 East Colorado Boulevard, Pasadena,
California 91109.

As we indicated earlier, undistributed earnings in companies
we do not control are now fully as important as the reported
operating earnings detailed in the preceding table. The
distributed portion of earnings, of course, finds its way into
the table primarily through the net investment income segment of
Insurance Group earnings.

We show below Berkshire’s proportional holdings in those
non-controlled businesses for which only distributed earnings
(dividends) are included in our earnings.

No. of Shares Cost Market
------------- ---------- ----------
(000s omitted)
451,650 (a) Affiliated Publications, Inc. ........ $ 3,297 $ 14,114
703,634 (a) Aluminum Company of America .......... 19,359 18,031
420,441 (a) Arcata Corporation
(including common equivalents) ..... 14,076 15,136
475,217 (b) Cleveland-Cliffs Iron Company ........ 12,942 14,362
441,522 (a) GATX Corporation ..................... 17,147 13,466
2,101,244 (b) General Foods, Inc. .................. 66,277 66,714
7,200,000 (a) GEICO Corporation .................... 47,138 199,800
2,015,000 (a) Handy & Harman ....................... 21,825 36,270
711,180 (a) Interpublic Group of Companies, Inc. 4,531 23,202
282,500 (a) Media General ........................ 4,545 11,088
391,400 (a) Ogilvy & Mather International Inc. ... 3,709 12,329
370,088 (b) Pinkerton’s, Inc. .................... 12,144 19,675
1,764,824 (b) R. J. Reynolds Industries, Inc. ...... 76,668 83,127
785,225 (b) SAFECO Corporation ................... 21,329 31,016
1,868,600 (a) The Washington Post Company .......... 10,628 58,160
---------- ----------
$335,615 $616,490
All Other Common Stockholdings ...................... 16,131 22,739
---------- ----------
Total Common Stocks ................................. $351,746 $639,229
========== ==========

(a) All owned by Berkshire or its insurance subsidiaries.
(b) Blue Chip and/or Wesco own shares of these companies. All
numbers represent Berkshire’s net interest in the larger
gross holdings of the group.

Our controlled and non-controlled businesses operate over
such a wide spectrum of activities that detailed commentary here
would prove too lengthy. Much additional financial information
is included in Management’s Discussion on pages 34-37 and in the
narrative reports on pages 38-50. However, our largest area of
both controlled and non-controlled activity has been, and almost
certainly will continue to be, the property-casualty insurance
area, and commentary on important developments in that industry
is appropriate.


Insurance Industry Conditions

“Forecasts”, said Sam Goldwyn, “are dangerous, particularly
those about the future.” (Berkshire shareholders may have reached
a similar conclusion after rereading our past annual reports
featuring your Chairman’s prescient analysis of textile
prospects.)

There is no danger, however, in forecasting that 1982 will
be the worst year in recent history for insurance underwriting.
That result already has been guaranteed by present pricing
behavior, coupled with the term nature of the insurance contract.

While many auto policies are priced and sold at six-month
intervals - and many property policies are sold for a three-year
term - a weighted average of the duration of all property-
casualty insurance policies probably runs a little under twelve
months. And prices for the insurance coverage, of course, are
frozen for the life of the contract. Thus, this year’s sales
contracts (“premium written” in the parlance of the industry)
determine about one-half of next year’s level of revenue
(“premiums earned”). The remaining half will be determined by
sales contracts written next year that will be about 50% earned
in that year. The profitability consequences are automatic: if
you make a mistake in pricing, you have to live with it for an
uncomfortable period of time.

Note in the table below the year-over-year gain in industry-
wide premiums written and the impact that it has on the current
and following year’s level of underwriting profitability. The
result is exactly as you would expect in an inflationary world.
When the volume gain is well up in double digits, it bodes well
for profitability trends in the current and following year. When
the industry volume gain is small, underwriting experience very
shortly will get worse, no matter how unsatisfactory the current
level.

The Best’s data in the table reflect the experience of
practically the entire industry, including stock, mutual and
reciprocal companies. The combined ratio indicates total
operating and loss costs as compared to premiums; a ratio below
100 indicates an underwriting profit, and one above 100 indicates
a loss.

Yearly Change Yearly Change Combined Ratio
in Premium in Premium after Policy-
Written (%) Earned (%) holder Dividends
------------- ------------- ----------------
1972 ............... 10.2 10.9 96.2
1973 ............... 8.0 8.8 99.2
1974 ............... 6.2 6.9 105.4
1975 ............... 11.0 9.6 107.9
1976 ............... 21.9 19.4 102.4
1977 ............... 19.8 20.5 97.2
1978 ............... 12.8 14.3 97.5
1979 ............... 10.3 10.4 100.6
1980 ............... 6.0 7.8 103.1
1981 ............... 3.6 4.1 105.7

Source: Best’s Aggregates and Averages.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:44 par mihou
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.

And, of course the twin inflations, monetary and “social”
(the tendency of courts and juries to stretch the coverage of
policies beyond what insurers, relying upon contract terminology
and precedent, had expected), are unstoppable. Costs of
repairing both property and people - and the extent to which
these repairs are deemed to be the responsibility of the insurer
- will advance relentlessly.

Absent any bad luck (catastrophes, increased driving, etc.),
an immediate industry volume gain of at least 10% per year
probably is necessary to stabilize the record level of
underwriting losses that will automatically prevail in mid-1982.
(Most underwriters expect incurred losses in aggregate to rise at
least 10% annually; each, of course, counts on getting less than
his share.) Every percentage point of annual premium growth below
the 10% equilibrium figure quickens the pace of deterioration.
Quarterly data in 1981 underscore the conclusion that a terrible
underwriting picture is worsening at an accelerating rate.

In the 1980 annual report we discussed the investment
policies that have destroyed the integrity of many insurers’
balance sheets, forcing them to abandon underwriting discipline
and write business at any price in order to avoid negative cash
flow. It was clear that insurers with large holdings of bonds
valued, for accounting purposes, at nonsensically high prices
would have little choice but to keep the money revolving by
selling large numbers of policies at nonsensically low prices.
Such insurers necessarily fear a major decrease in volume more
than they fear a major underwriting loss.

But, unfortunately, all insurers are affected; it’s
difficult to price much differently than your most threatened
competitor. This pressure continues unabated and adds a new
motivation to the others that drive many insurance managers to
push for business; worship of size over profitability, and the
fear that market share surrendered never can be regained.

Whatever the reasons, we believe it is true that virtually
no major property-casualty insurer - despite protests by the
entire industry that rates are inadequate and great selectivity
should be exercised - has been willing to turn down business to
the point where cash flow has turned significantly negative.
Absent such a willingness, prices will remain under severe
pressure.

Commentators continue to talk of the underwriting cycle,
usually implying a regularity of rhythm and a relatively constant
midpoint of profitability Our own view is different. We believe
that very large, although obviously varying, underwriting losses
will be the norm for the industry, and that the best underwriting
years in the future decade may appear substandard against the
average year of the past decade.

We have no magic formula to insulate our controlled
insurance companies against this deteriorating future. Our
managers, particularly Phil Liesche, Bill Lyons, Roland Miller,
Floyd Taylor and Milt Thornton, have done a magnificent job of
swimming against the tide. We have sacrificed much volume, but
have maintained a substantial underwriting superiority in
relation to industry-wide results. The outlook at Berkshire is
for continued low volume. Our financial position offers us
maximum flexibility, a very rare condition in the property-
casualty insurance industry. And, at some point, should fear
ever prevail throughout the industry, our financial strength
could become an operational asset of immense value.

We believe that GEICO Corporation, our major non-controlled
business operating in this field, is, by virtue of its extreme
and improving operating efficiency, in a considerably more
protected position than almost any other major insurer. GEICO is
a brilliantly run implementation of a very important business
idea.


Shareholder Designated Contributions

Our new program enabling shareholders to designate the
recipients of corporate charitable contributions was greeted with
extraordinary enthusiasm. A copy of the letter sent October 14,
1981 describing this program appears on pages 51-53. Of 932,206
shares eligible for participation (shares where the name of the
actual owner appeared on our stockholder record), 95.6%
responded. Even excluding Buffet-related shares, the response
topped 90%.

In addition, more than 3% of our shareholders voluntarily
wrote letters or notes, all but one approving of the program.
Both the level of participation and of commentary surpass any
shareholder response we have witnessed, even when such response
has been intensively solicited by corporate staff and highly paid
professional proxy organizations. In contrast, your
extraordinary level of response occurred without even the nudge
of a company-provided return envelope. This self-propelled
behavior speaks well for the program, and speaks well for our
shareholders.

Apparently the owners of our corporation like both
possessing and exercising the ability to determine where gifts of
their funds shall be made. The “father-knows-best” school of
corporate governance will be surprised to find that none of our
shareholders sent in a designation sheet with instructions that
the officers of Berkshire - in their superior wisdom, of course -
make the decision on charitable funds applicable to his shares.
Nor did anyone suggest that his share of our charitable funds be
used to match contributions made by our corporate directors to
charities of the directors’ choice (a popular, proliferating and
non-publicized policy at many large corporations).

All told, $1,783,655 of shareholder-designed contributions
were distributed to about 675 charities. In addition, Berkshire
and subsidiaries continue to make certain contributions pursuant
to local level decisions made by our operating managers.

There will be some years, perhaps two or three out of ten,
when contributions by Berkshire will produce substandard tax
deductions - or none at all. In those years we will not effect
our shareholder designated charitable program. In all other
years we expect to inform you about October 10th of the amount
per share that you may designate. A reply form will accompany
the notice, and you will be given about three weeks to respond
with your designation. To qualify, your shares must be
registered in your own name or the name of an owning trust,
corporation, partnership or estate, if applicable, on our
stockholder list of September 30th, or the Friday preceding if
such date falls on a Saturday or Sunday.

Our only disappointment with this program in 1981 was that
some of our shareholders, through no fault of their own, missed
the opportunity to participate. The Treasury Department ruling
allowing us to proceed without tax uncertainty was received early
in October. The ruling did not cover participation by
shareholders whose stock was registered in the name of nominees,
such as brokers, and additionally required that the owners of all
designating shares make certain assurances to Berkshire. These
assurances could not be given us in effective form by nominee
holders.

Under these circumstances, we attempted to communicate with
all of our owners promptly (via the October 14th letter) so that,
if they wished, they could prepare themselves to participate by
the November 13th record date. It was particularly important
that this information be communicated promptly to stockholders
whose holdings were in nominee name, since they would not be
eligible unless they took action to re-register their shares
before the record date.

Unfortunately, communication to such non-record shareholders
could take place only through the nominees. We therefore
strongly urged those nominees, mostly brokerage houses, to
promptly transmit our letter to the real owners. We explained
that their failure to do so could deprive such owners of an
important benefit.

The results from our urgings would not strengthen the case
for private ownership of the U.S. Postal Service. Many of our
shareholders never heard from their brokers (as some shareholders
told us after reading news accounts of the program). Others were
forwarded our letter too late for action.

One of the largest brokerage houses claiming to hold stock
for sixty of its clients (about 4% of our shareholder
population), apparently transmitted our letter about three weeks
after receipt - too late for any of the sixty to participate.
(Such lassitude did not pervade all departments of that firm; it
billed Berkshire for mailing services within six days of that
belated and ineffectual action.)

We recite such horror stories for two reasons: (1) if you
wish to participate in future designated contribution programs,
be sure to have your stock registered in your name well before
September 30th; and (2) even if you don’t care to participate and
prefer to leave your stock in nominee form, it would be wise to
have at least one share registered in your own name. By so
doing, you can be sure that you will be notified of any important
corporate news at the same time as all other shareholders.

The designated-contributions idea, along with many other
ideas that have turned out well for us, was conceived by Charlie
Munger, Vice Chairman of Berkshire and Chairman of Blue Chip.
Irrespective of titles, Charlie and I work as partners in
managing all controlled companies. To almost a sinful degree, we
enjoy our work as managing partners. And we enjoy having you as
our financial partners.


Warren E. Buffett
Chairman of the Board
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:45 par mihou
March 3, 1983



To the Stockholders of Berkshire Hathaway Inc.:

Operating earnings of $31.5 million in 1982 amounted to only
9.8% of beginning equity capital (valuing securities at cost),
down from 15.2% in 1981 and far below our recent high of 19.4% in
1978. This decline largely resulted from:

(1) a significant deterioration in insurance underwriting
results;

(2) a considerable expansion of equity capital without a
corresponding growth in the businesses we operate
directly; and

(3) a continually-enlarging commitment of our resources to
investment in partially-owned, nonoperated businesses;
accounting rules dictate that a major part of our
pro-rata share of earnings from such businesses must be
excluded from Berkshire’s reported earnings.

It was only a few years ago that we told you that the
operating earnings/equity capital percentage, with proper
allowance for a few other variables, was the most important
yardstick of single-year managerial performance. While we still
believe this to be the case with the vast majority of companies,
we believe its utility in our own case has greatly diminished.
You should be suspicious of such an assertion. 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.

To managers faced with such deterioration, a more flexible
measurement system often suggests itself: just shoot the arrow of
business performance into a blank canvas and then carefully draw
the bullseye around the implanted arrow. We generally believe in
pre-set, long-lived and small bullseyes. However, because of the
importance of item (3) above, further explained in the following
section, we believe our abandonment of the operating
earnings/equity capital bullseye to be warranted.


Non-Reported Ownership Earnings

The appended financial statements reflect “accounting”
earnings that generally include our proportionate share of
earnings from any underlying business in which our ownership is
at least 20%. Below the 20% ownership figure, however, only our
share of dividends paid by the underlying business units is
included in our accounting numbers; undistributed earnings of
such less-than-20%-owned businesses are totally ignored.

There are a few exceptions to this rule; e.g., we own about
35% of GEICO Corporation but, because we have assigned our voting
rights, the company is treated for accounting purposes as a less-
than-20% holding. Thus, dividends received from GEICO in 1982 of
$3.5 million after tax are the only item included in our
“accounting”earnings. An additional $23 million that represents
our share of GEICO’s undistributed operating earnings for 1982 is
totally excluded from our reported operating earnings. If GEICO
had earned less money in 1982 but had paid an additional $1
million in dividends, our reported earnings would have been
larger despite the poorer business results. Conversely, if GEICO
had earned an additional $100 million - and retained it all - our
reported earnings would have been unchanged. Clearly
“accounting” earnings can seriously misrepresent economic
reality.

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. If you have owned .01 of 1% of Berkshire during the
past decade, you have benefited economically in full measure from
your share of our retained earnings, no matter what your
accounting system. Proportionately, you have done just as well
as if you had owned the magic 20%. But if you have owned 100% of
a great many capital-intensive businesses during the decade,
retained earnings that were credited fully and with painstaking
precision to you under standard accounting methods have resulted
in minor or zero economic value. This is not a criticism of
accounting procedures. We would not like to have the job of
designing a better system. It’s simply to say that managers and
investors alike must understand that accounting numbers are the
beginning, not the end, of business valuation.

In most corporations, less-than-20% ownership positions are
unimportant (perhaps, in part, because they prevent maximization
of cherished reported earnings) and the distinction between
accounting and economic results we have just discussed matters
little. But in our own case, such positions are of very large
and growing importance. Their magnitude, we believe, is what
makes our reported operating earnings figure of limited
significance.

In our 1981 annual report we predicted that our share of
undistributed earnings from four of our major non-controlled
holdings would aggregate over $35 million in 1982. With no
change in our holdings of three of these companies - GEICO,
General Foods and The Washington Post - and a considerable
increase in our ownership of the fourth, R. J. Reynolds
Industries, our share of undistributed 1982 operating earnings of
this group came to well over $40 million. This number - not
reflected at all in our earnings - is greater than our total
reported earnings, which include only the $14 million in
dividends received from these companies. And, of course, we have
a number of smaller ownership interests that, in aggregate, had
substantial additional undistributed earnings.

We attach real significance to the general magnitude of
these numbers, but we don’t believe they should be carried to ten
decimal places. Realization by Berkshire of such retained
earnings through improved market valuations is subject to very
substantial, but indeterminate, taxation. And while retained
earnings over the years, and in the aggregate, have translated
into at least equal market value for shareholders, the
translation has been both extraordinarily uneven among companies
and irregular and unpredictable in timing.

However, this very unevenness and irregularity offers
advantages to the value-oriented purchaser of fractional portions
of businesses. This investor may select from almost the entire
array of major American corporations, including many far superior
to virtually any of the businesses that could be bought in their
entirety in a negotiated deal. And fractional-interest purchases
can be made in an auction market where prices are set by
participants with behavior patterns that sometimes resemble those
of an army of manic-depressive lemmings.

Within this gigantic auction arena, it is our job to select
businesses with economic characteristics allowing each dollar of
retained earnings to be translated eventually into at least a
dollar of market value. Despite a lot of mistakes, we have so
far achieved this goal. In doing so, we have been greatly
assisted by Arthur Okun’s patron saint for economists - St.
Offset. In some cases, that is, retained earnings attributable
to our ownership position have had insignificant or even negative
impact on market value, while in other major positions a dollar
retained by an investee corporation has been translated into two
or more dollars of market value. To date, our corporate over-
achievers have more than offset the laggards. If we can continue
this record, it will validate our efforts to maximize “economic”
earnings, regardless of the impact upon “accounting” earnings.

Satisfactory as our partial-ownership approach has been,
what really makes us dance is the purchase of 100% of good
businesses at reasonable prices. We’ve accomplished this feat a
few times (and expect to do so again), but it is an
extraordinarily difficult job - far more difficult than the
purchase at attractive prices of fractional interests.

As we look at the major acquisitions that others made during
1982, our reaction is not envy, but relief that we were non-
participants. For in many of these acquisitions, managerial
intellect wilted in competition with managerial adrenaline The
thrill of the chase blinded the pursuers to the consequences of
the catch. Pascal’s observation seems apt: “It has struck me
that all men’s misfortunes spring from the single cause that they
are unable to stay quietly in one room.”

(Your Chairman left the room once too often last year and
almost starred in the Acquisition Follies of 1982. In
retrospect, our major accomplishment of the year was that a very
large purchase to which we had firmly committed was unable to be
completed for reasons totally beyond our control. Had it come
off, this transaction would have consumed extraordinary amounts
of time and energy, all for a most uncertain payoff. If we were
to introduce graphics to this report, illustrating favorable
business developments of the past year, two blank pages depicting
this blown deal would be the appropriate centerfold.)

Our partial-ownership approach can be continued soundly only
as long as portions of attractive businesses can be acquired at
attractive prices. We need a moderately-priced stock market to
assist us in this endeavor. The market, like the Lord, helps
those who help themselves. But, unlike the Lord, the market does
not forgive those who know not what they do. For the investor, a
too-high purchase price for the stock of an excellent company can
undo the effects of a subsequent decade of favorable business
developments.

Should the stock market advance to considerably higher
levels, our ability to utilize capital effectively in partial-
ownership positions will be reduced or eliminated. This will
happen periodically: just ten years ago, at the height of the
two-tier market mania (with high-return-on-equity businesses bid
to the sky by institutional investors), Berkshire’s insurance
subsidiaries owned only $18 million in market value of equities,
excluding their interest in Blue Chip Stamps. At that time, such
equity holdings amounted to about 15% of our insurance company
investments versus the present 80%. There were as many good
businesses around in 1972 as in 1982, but the prices the stock
market placed upon those businesses in 1972 looked absurd. While
high stock prices in the future would make our performance look
good temporarily, they would hurt our long-term business
prospects rather than help them. We currently are seeing early
traces of this problem.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:45 par mihou
Long-Term Corporate Performance

Our gain in net worth during 1982, valuing equities held by
our insurance subsidiaries at market value (less capital gain
taxes payable if unrealized gains were actually realized)
amounted to $208 million. On a beginning net worth base of $519
million, the percentage gain was 40%.

During the 18-year tenure of present management, book value
has grown from $19.46 per share to $737.43 per share, or 22.0%
compounded annually. You can be certain that this percentage
will diminish in the future. Geometric progressions eventually
forge their own anchors.

Berkshire’s economic goal remains to produce a long-term
rate of return well above the return achieved by the average
large American corporation. Our willingness to purchase either
partial or total ownership positions in favorably-situated
businesses, coupled with reasonable discipline about the prices
we are willing to pay, should give us a good chance of achieving
our goal.

Again this year the gain in market valuation of partially-
owned businesses outpaced the gain in underlying economic value
of those businesses. For example, $79 million of our $208
million gain is attributable to an increased market price for
GEICO. This company continues to do exceptionally well, and we
are more impressed than ever by the strength of GEICO’s basic
business idea and by the management skills of Jack Byrne.
(Although not found in the catechism of the better business
schools, “Let Jack Do It” works fine as a corporate creed for
us.)

However, GEICO’s increase in market value during the past
two years has been considerably greater than the gain in its
intrinsic business value, impressive as the latter has been. We
expected such a favorable variation at some point, as the
perception of investors converged with business reality. And we
look forward to substantial future gains in underlying business
value accompanied by irregular, but eventually full, market
recognition of such gains.

Year-to-year variances, however, cannot consistently be in
our favor. Even if our partially-owned businesses continue to
perform well in an economic sense, there will be years when they
perform poorly in the market. At such times our net worth could
shrink significantly. We will not be distressed by such a
shrinkage; if the businesses continue to look attractive and we
have cash available, we simply will add to our holdings at even
more favorable prices.


Sources of Reported Earnings

The table below shows the sources of Berkshire’s reported
earnings. In 1981 and 1982 Berkshire owned about 60% of Blue
Chip Stamps which, in turn, owned 80% of Wesco Financial
Corporation. The table displays aggregate operating earnings of
the various business entities, as well as Berkshire’s share of
those earnings. All of the significant gains and losses
attributable to unusual sales of assets by any of the business
entities are aggregated with securities transactions in the line
near the bottom of the table, and are not included in operating
earnings.

Net Earnings
Earnings Before Income Taxes After Tax
-------------------------------------- ------------------
Total Berkshire Share Berkshire Share
------------------ ------------------ ------------------
1982 1981 1982 1981 1982 1981
-------- -------- -------- -------- -------- --------
(000s omitted)
Operating Earnings:
Insurance Group:
Underwriting ............ $(21,558) $ 1,478 $(21,558) $ 1,478 $(11,345) $ 798
Net Investment Income ... 41,620 38,823 41,620 38,823 35,270 32,401
Berkshire-Waumbec Textiles (1,545) (2,669) (1,545) (2,669) (862) (1,493)
Associated Retail Stores .. 914 1,763 914 1,763 446 759
See’s Candies ............. 23,884 20,961 14,235 12,493 6,914 5,910
Buffalo Evening News ...... (1,215) (1,217) (724) (725) (226) (320)
Blue Chip Stamps - Parent 4,182 3,642 2,492 2,171 2,472 2,134
Wesco Financial - Parent .. 6,156 4,495 2,937 2,145 2,210 1,590
Mutual Savings and Loan ... (6) 1,605 (2) 766 1,524 1,536
Precision Steel ........... 1,035 3,453 493 1,648 265 841
Interest on Debt .......... (14,996) (14,656) (12,977) (12,649) (6,951) (6,671)
Other* .................... 2,631 2,985 1,857 1,992 1,780 1,936
-------- -------- -------- -------- -------- --------
Operating Earnings .......... 41,102 60,663 27,742 47,236 31,497 39,421
Sales of securities and
unusual sales of assets .. 36,651 37,801 21,875 33,150 14,877 23,183
-------- -------- -------- -------- -------- --------
Total Earnings - all entities $ 77,753 $ 98,464 $ 49,617 $ 80,386 $ 46,374 $ 62,604
======== ======== ======== ======== ======== ========

* Amortization of intangibles arising in accounting for purchases
of businesses (i.e. See’s, Mutual and Buffalo Evening News) is
reflected in the category designated as “Other”.

On pages 45-61 of this report we have reproduced the
narrative reports of the principal executives of Blue Chip and
Wesco, in which they describe 1982 operations. A copy of the
full annual report of either company will be mailed to any
Berkshire shareholder upon request to Mr. Robert H. Bird for
Blue Chip Stamps, 5801 South Eastern Avenue, Los Angeles,
California 90040, or to Mrs. Jeanne Leach for Wesco Financial
Corporation, 315 East Colorado Boulevard, Pasadena, California
91109.

I believe you will find the Blue Chip chronicle of
developments in the Buffalo newspaper situation particularly
interesting. There are now only 14 cities in the United States
with a daily newspaper whose weekday circulation exceeds that of
the Buffalo News. But the real story has been the growth in
Sunday circulation. Six years ago, prior to introduction of a
Sunday edition of the News, the long-established Courier-Express,
as the only Sunday newspaper published in Buffalo, had
circulation of 272,000. The News now has Sunday circulation of
367,000, a 35% gain - even though the number of households within
the primary circulation area has shown little change during the
six years. We know of no city in the United States with a long
history of seven-day newspaper publication in which the
percentage of households purchasing the Sunday newspaper has
grown at anything like this rate. To the contrary, in most
cities household penetration figures have grown negligibly, or
not at all. Our key managers in Buffalo - Henry Urban, Stan
Lipsey, Murray Light, Clyde Pinson, Dave Perona and Dick Feather
- deserve great credit for this unmatched expansion in Sunday
readership.

As we indicated earlier, undistributed earnings in companies
we do not control are now fully as important as the reported
operating earnings detailed in the preceding table. The
distributed portion of non-controlled earnings, of course, finds
its way into that table primarily through the net investment
income segment of Insurance Group earnings.

We show below Berkshire’s proportional holdings in those
non-controlled businesses for which only distributed earnings
(dividends) are included in our earnings.

No. of Shares
or Share Equiv. Cost Market
--------------- ---------- ----------
(000s omitted)
460,650 (a) Affiliated Publications, Inc. ...... $ 3,516 $ 16,929
908,800 (c) Crum & Forster ..................... 47,144 48,962
2,101,244 (b) General Foods, Inc. ................ 66,277 83,680
7,200,000 (a) GEICO Corporation .................. 47,138 309,600
2,379,200 (a) Handy & Harman ..................... 27,318 46,692
711,180 (a) Interpublic Group of Companies, Inc. 4,531 34,314
282,500 (a) Media General ...................... 4,545 12,289
391,400 (a) Ogilvy & Mather Int’l. Inc. ........ 3,709 17,319
3,107,675 (b) R. J. Reynolds Industries .......... 142,343 158,715
1,531,391 (a) Time, Inc. ......................... 45,273 79,824
1,868,600 (a) The Washington Post Company ........ 10,628 103,240
---------- ----------
$402,422 $911,564
All Other Common Stockholdings ..... 21,611 34,058
---------- ----------
Total Common Stocks $424,033 $945,622
========== ==========

(a) All owned by Berkshire or its insurance subsidiaries.

(b) Blue Chip and/or Wesco own shares of these companies. All
numbers represent Berkshire’s net interest in the larger
gross holdings of the group.

(c) Temporary holding as cash substitute.

In case you haven’t noticed, there is an important
investment lesson to be derived from this table: nostalgia should
be weighted heavily in stock selection. Our two largest
unrealized gains are in Washington Post and GEICO, companies with
which your Chairman formed his first commercial connections at
the ages of 13 and 20, respectively After straying for roughly 25
years, we returned as investors in the mid-1970s. The table
quantifies the rewards for even long-delayed corporate fidelity.

Our controlled and non-controlled businesses operate over
such a wide spectrum that detailed commentary here would prove
too lengthy. Much financial and operational information
regarding the controlled businesses is included in Management’s
Discussion on pages 34-39, and in the narrative reports on pages
45-61. However, our largest area of business activity has been,
and almost certainly will continue to be, the property-casualty
insurance area. So commentary on developments in that industry
is appropriate.


Insurance Industry Conditions

We show below an updated table of the industry statistics we
utilized in last year’s annual report. Its message is clear:
underwriting results in 1983 will not be a sight for the
squeamish.

Yearly Change Yearly Change Combined Ratio
in Premiums in Premiums after Policy-
Written (%) Earned (%) holder Dividends
------------- ------------- ----------------
1972 ................ 10.2 10.9 96.2
1973 ................ 8.0 8.8 99.2
1974 ................ 6.2 6.9 105.4
1975 ................ 11.0 9.6 107.9
1976 ................ 21.9 19.4 102.4
1977 ................ 19.8 20.5 97.2
1978 ................ 12.8 14.3 97.5
1979 ................ 10.3 10.4 100.6
1980 ................ 6.0 7.8 103.1
1981 (Rev.) ......... 3.9 4.1 106.0
1982 (Est.) ......... 5.1 4.6 109.5

Source: Best’s Aggregates and Averages.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:46 par mihou
The Best’s data reflect the experience of practically the
entire industry, including stock, mutual and reciprocal
companies. The combined ratio represents total operating and
loss costs as compared to revenue from premiums; a ratio below
100 indicates an underwriting profit, and one above 100 indicates
a loss.

For reasons outlined in last year’s report, as long as the
annual gain in industry premiums written falls well below 10%,
you can expect the underwriting picture in the next year to
deteriorate. This will be true even at today’s lower general
rate of inflation. With the number of policies increasing
annually, medical inflation far exceeding general inflation, and
concepts of insured liability broadening, it is highly unlikely
that yearly increases in insured losses will fall much below 10%.

You should be further aware that the 1982 combined ratio of
109.5 represents a “best case” estimate. In a given year, it is
possible for an insurer to show almost any profit number it
wishes, particularly if it (1) writes “long-tail” business
(coverage where current costs can be only estimated, because
claim payments are long delayed), (2) has been adequately
reserved in the past, or (3) is growing very rapidly. There are
indications that several large insurers opted in 1982 for obscure
accounting and reserving maneuvers that masked significant
deterioration in their underlying businesses. In insurance, as
elsewhere, the reaction of weak managements to weak operations is
often weak accounting. (“It’s difficult for an empty sack to
stand upright.”)

The great majority of managements, however, try to play it
straight. But even managements of integrity may subconsciously
be less willing in poor profit years to fully recognize adverse
loss trends. Industry statistics indicate some deterioration in
loss reserving practices during 1982 and the true combined ratio
is likely to be modestly worse than indicated by our table.

The conventional wisdom is that 1983 or 1984 will see the
worst of underwriting experience and then, as in the past, the
“cycle” will move, significantly and steadily, toward better
results. We disagree because of a pronounced change in the
competitive environment, hard to see for many years but now quite
visible.

To understand the change, we need to look at some major
factors that affect levels of corporate profitability generally.
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) “extra-
legally” through OPEC-style foreign cartelization (with tag-along
benefits for domestic non-cartel operators).

If, however, 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”).

In many industries, differentiation simply can’t be made
meaningful. A few producers in such industries may consistently
do well if they have a cost advantage that is both wide and
sustainable. By definition such exceptions are few, and, in many
industries, are non-existent. For the great majority of
companies selling “commodity”products, a depressing equation of
business economics prevails: persistent over-capacity without
administered prices (or costs) equals poor profitability.

Of course, over-capacity may eventually self-correct, either
as capacity shrinks or demand expands. Unfortunately for the
participants, such corrections often are long delayed. When they
finally occur, the rebound to prosperity frequently produces a
pervasive enthusiasm for expansion that, within a few years,
again creates over-capacity and a new profitless environment. In
other words, nothing fails like success.

What finally determines levels of long-term profitability in
such industries is the ratio of supply-tight to supply-ample
years. Frequently that ratio is dismal. (It seems as if the most
recent supply-tight period in our textile business - it occurred
some years back - lasted the better part of a morning.)

In some industries, however, capacity-tight conditions can
last a long time. Sometimes actual growth in demand will outrun
forecasted growth for an extended period. In other cases, adding
capacity requires very long lead times because complicated
manufacturing facilities must be planned and built.

But in the insurance business, to return to that subject,
capacity can be instantly created by capital plus an
underwriter’s willingness to sign his name. (Even capital is less
important in a world in which state-sponsored guaranty funds
protect many policyholders against insurer insolvency.) Under
almost all conditions except that of fear for survival -
produced, perhaps, by a stock market debacle or a truly major
natural disaster - the insurance industry operates under the
competitive sword of substantial overcapacity. Generally, also,
despite heroic attempts to do otherwise, the industry sells a
relatively undifferentiated commodity-type product. (Many
insureds, including the managers of large businesses, do not even
know the names of their insurers.) Insurance, therefore, would
seem to be a textbook case of an industry usually faced with the
deadly combination of excess capacity and a “commodity” product.

Why, then, was underwriting, despite the existence of
cycles, generally profitable over many decades? (From 1950
through 1970, the industry combined ratio averaged 99.0.
allowing all investment income plus 1% of premiums to flow
through to profits.) The answer lies primarily in the historic
methods of regulation and distribution. For much of this
century, a large portion of the industry worked, in effect,
within a legal quasi-administered pricing system fostered by
insurance regulators. While price competition existed, it was
not pervasive among the larger companies. The main competition
was for agents, who were courted via various non-price-related
strategies.

For the giants of the industry, most rates were set through
negotiations between industry “bureaus” (or through companies
acting in accord with their recommendations) and state
regulators. Dignified haggling occurred, but it was between
company and regulator rather than between company and customer.
When the dust settled, Giant A charged the same price as Giant B
- and both companies and agents were prohibited by law from
cutting such filed rates.

The company-state negotiated prices included specific profit
allowances and, when loss data indicated that current prices were
unprofitable, both company managements and state regulators
expected that they would act together to correct the situation.
Thus, most of the pricing actions of the giants of the industry
were “gentlemanly”, predictable, and profit-producing. Of prime
importance - and in contrast to the way most of the business
world operated - insurance companies could legally price their
way to profitability even in the face of substantial over-
capacity.

That day is gone. Although parts of the old structure
remain, far more than enough new capacity exists outside of that
structure to force all parties, old and new, to respond. The new
capacity uses various methods of distribution and is not
reluctant to use price as a prime competitive weapon. Indeed, it
relishes that use. In the process, customers have learned that
insurance is no longer a one-price business. They won’t forget.

Future profitability of the industry will be determined by
current competitive characteristics, not past ones. Many
managers have been slow to recognize this. It’s not only
generals that prefer to fight the last war. Most business and
investment analysis also comes from the rear-view mirror. It
seems clear to us, however, that only one condition will allow
the insurance industry to achieve significantly improved
underwriting results. That is the same condition that will allow
better results for the aluminum, copper, or corn producer - a
major narrowing of the gap between demand and supply.

Unfortunately, there can be no surge in demand for insurance
policies comparable to one that might produce a market tightness
in copper or aluminum. Rather, the supply of available insurance
coverage must be curtailed. “Supply”, in this context, is mental
rather than physical: plants or companies need not be shut; only
the willingness of underwriters to sign their names need be
curtailed.

This contraction will not happen because of generally poor
profit levels. Bad profits produce much hand-wringing and
finger-pointing. But they do not lead major sources of insurance
capacity to turn their backs on very large chunks of business,
thereby sacrificing market share and industry significance.

Instead, major capacity withdrawals require a shock factor
such as a natural or financial “megadisaster”. One might occur
tomorrow - or many years from now. The insurance business - even
taking investment income into account - will not be particularly
profitable in the meantime.

When supply ultimately contracts, large amounts of business
will be available for the few with large capital capacity, a
willingness to commit it, and an in-place distribution system.
We would expect great opportunities for our insurance
subsidiaries at such a time.

During 1982, our insurance underwriting deteriorated far
more than did the industry’s. From a profit position well above
average, we, slipped to a performance modestly below average.
The biggest swing was in National Indemnity’s traditional
coverages. Lines that have been highly profitable for us in the
past are now priced at levels that guarantee underwriting losses.
In 1983 we expect our insurance group to record an average
performance in an industry in which average is very poor.

Two of our stars, Milt Thornton at Cypress and Floyd Taylor
at Kansas Fire and Casualty, continued their outstanding records
of producing an underwriting profit every year since joining us.
Both Milt and Floyd simply are incapable of being average. They
maintain a passionately proprietary attitude toward their
operations and have developed a business culture centered upon
unusual cost-consciousness and customer service. It shows on
their scorecards.

During 1982, parent company responsibility for most of our
insurance operations was given to Mike Goldberg. Planning,
recruitment, and monitoring all have shown significant
improvement since Mike replaced me in this role.

GEICO continues to be managed with a zeal for efficiency and
value to the customer that virtually guarantees unusual success.
Jack Byrne and Bill Snyder are achieving the most elusive of
human goals - keeping things simple and remembering what you set
out to do. In Lou Simpson, additionally, GEICO has the best
investment manager in the property-casualty business. We are
happy with every aspect of this operation. GEICO is a
magnificent illustration of the high-profit exception we
described earlier in discussing commodity industries with over-
capacity - a company with a wide and sustainable cost advantage.
Our 35% interest in GEICO represents about $250 million of
premium volume, an amount considerably greater than all of the
direct volume we produce.
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:46 par mihou
Issuance of Equity

Berkshire and Blue Chip are considering merger in 1983. If
it takes place, it will involve an exchange of stock based upon
an identical valuation method applied to both companies. The one
other significant issuance of shares by Berkshire or its
affiliated companies that occurred during present management’s
tenure was in the 1978 merger of Berkshire with Diversified
Retailing Company.

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.

The first choice of these managers in making acquisitions
may be to use cash or debt. But frequently the CEO’s cravings
outpace cash and credit resources (certainly mine always have).
Frequently, also, these cravings occur when his own stock is
selling far below intrinsic business value. This state of
affairs produces a moment of truth. At that point, as Yogi Berra
has said, “You can observe a lot just by watching.” For
shareholders then will find which objective the management truly
prefers - expansion of domain or maintenance of owners’ wealth.

The need to choose between these objectives occurs for some
simple reasons. Companies often sell in the stock market below
their intrinsic business value. But when a company wishes to
sell out completely, in a negotiated transaction, it inevitably
wants to - and usually can - receive full business value in
whatever kind of currency the value is to be delivered. If cash
is to be used in payment, the seller’s calculation of value
received couldn’t be easier. If stock of the buyer is to be the
currency, the seller’s calculation is still relatively easy: just
figure the market value in cash of what is to be received in
stock.

Meanwhile, the buyer wishing to use his own stock as
currency for the purchase has no problems if the stock is selling
in the market at full intrinsic value.

But suppose it is selling at only half intrinsic value. In
that case, the buyer is faced with the unhappy prospect of using
a substantially undervalued currency to make its purchase.

Ironically, were the buyer to instead be a seller of its
entire business, it too could negotiate for, and probably get,
full intrinsic business value. But when the buyer makes a
partial sale of itself - and that is what the issuance of shares
to make an acquisition amounts to - it can customarily get no
higher value set on its shares than the market chooses to grant
it.

The acquirer who nevertheless barges ahead ends up using an
undervalued (market value) currency to pay for a fully valued
(negotiated value) property. In effect, the acquirer must give
up $2 of value to receive $1 of value. Under such circumstances,
a marvelous business purchased at a fair sales price becomes a
terrible buy. For gold valued as gold cannot be purchased
intelligently through the utilization of gold - or even silver -
valued as lead.

If, however, the thirst for size and action is strong
enough, the acquirer’s manager will find ample rationalizations
for such a value-destroying issuance of stock. Friendly
investment bankers will reassure him as to the soundness of his
actions. (Don’t ask the barber whether you need a haircut.)

A few favorite rationalizations employed by stock-issuing
managements follow:

(a) “The company we’re buying is going to be worth a lot
more in the future.” (Presumably so is the interest in
the old business that is being traded away; future
prospects are implicit in the business valuation
process. If 2X is issued for X, the imbalance still
exists when both parts double in business value.)

(b) “We have to grow.” (Who, it might be asked, is the “we”?
For present shareholders, the reality is that all
existing businesses shrink when shares are issued. Were
Berkshire to issue shares tomorrow for an acquisition,
Berkshire would own everything that it now owns plus the
new business, but your interest in such hard-to-match
businesses as See’s Candy Shops, National Indemnity,
etc. would automatically be reduced. If (1) your family
owns a 120-acre farm and (2) you invite a neighbor with
60 acres of comparable land to merge his farm into an
equal partnership - with you to be managing partner,
then (3) your managerial domain will have grown to 180
acres but you will have permanently shrunk by 25% your
family’s ownership interest in both acreage and crops.
Managers who want to expand their domain at the expense
of owners might better consider a career in government.)

(c) “Our stock is undervalued and we’ve minimized its use in
this deal - but we need to give the selling shareholders
51% in stock and 49% in cash so that certain of those
shareholders can get the tax-free exchange they want.”
(This argument acknowledges that it is beneficial to the
acquirer to hold down the issuance of shares, and we like
that. But if it hurts the old owners to utilize shares
on a 100% basis, it very likely hurts on a 51% basis.
After all, a man is not charmed if a spaniel defaces his
lawn, just because it’s a spaniel and not a St. Bernard.
And the wishes of sellers can’t be the determinant of the
best interests of the buyer - what would happen if,
heaven forbid, the seller insisted that as a condition of
merger the CEO of the acquirer be replaced?)

There are three ways to avoid destruction of value for old
owners when shares are issued for acquisitions. One is to have a
true business-value-for-business-value merger, such as the
Berkshire-Blue Chip combination is intended to be. Such a merger
attempts to be fair to shareholders of both parties, with each
receiving just as much as it gives in terms of intrinsic business
value. The Dart Industries-Kraft and Nabisco Standard Brands
mergers appeared to be of this type, but they are the exceptions.
It’s not that acquirers wish to avoid such deals; it’s just that
they are very hard to do.

The second route presents itself when the acquirer’s stock
sells at or above its intrinsic business value. In that
situation, the use of stock as currency actually may enhance the
wealth of the acquiring company’s owners. Many mergers were
accomplished on this basis in the 1965-69 period. The results
were the converse of most of the activity since 1970: the
shareholders of the acquired company received very inflated
currency (frequently pumped up by dubious accounting and
promotional techniques) and were the losers of wealth through
such transactions.

During recent years the second solution has been available
to very few large companies. The exceptions have primarily been
those companies in glamorous or promotional businesses to which
the market temporarily attaches valuations at or above intrinsic
business valuation.

The third solution is for the acquirer to go ahead with the
acquisition, but then subsequently repurchase a quantity of
shares equal to the number issued in the merger. In this manner,
what originally was a stock-for-stock merger can be converted,
effectively, into a cash-for-stock acquisition. Repurchases of
this kind are damage-repair moves. Regular readers will
correctly guess that we much prefer repurchases that directly
enhance the wealth of owners instead of repurchases that merely
repair previous damage. Scoring touchdowns is more exhilarating
than recovering one’s fumbles. But, when a fumble has occurred,
recovery is important and we heartily recommend damage-repair
repurchases that turn a bad stock deal into a fair cash deal.

The language utilized in mergers tends to confuse the issues
and encourage irrational actions by managers. For example,
“dilution” is usually carefully calculated on a pro forma basis
for both book value and current earnings per share. Particular
emphasis is given to the latter item. When that calculation is
negative (dilutive) from the acquiring company’s standpoint, a
justifying explanation will be made (internally, if not
elsewhere) that the lines will cross favorably at some point in
the future. (While deals often fail in practice, they never fail
in projections - if the CEO is visibly panting over a prospective
acquisition, subordinates and consultants will supply the
requisite projections to rationalize any price.) Should the
calculation produce numbers that are immediately positive - that
is, anti-dilutive - for the acquirer, no comment is thought to be
necessary.

The attention given this form of dilution is overdone:
current earnings per share (or even earnings per share of the
next few years) are an important variable in most business
valuations, but far from all powerful.

There have been plenty of mergers, non-dilutive in this
limited sense, that were instantly value destroying for the
acquirer. And some mergers that have diluted current and near-
term earnings per share have in fact been value-enhancing. What
really counts is whether a merger is dilutive or anti-dilutive in
terms of intrinsic business value (a judgment involving
consideration of many variables). We believe calculation of
dilution from this viewpoint to be all-important (and too seldom
made).
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:47 par mihou
A second language problem relates to the equation of
exchange. If Company A announces that it will issue shares to
merge with Company B, the process is customarily described as
“Company A to Acquire Company B”, or “B Sells to A”. Clearer
thinking about the matter would result if a more awkward but more
accurate description were used: “Part of A sold to acquire B”, or
“Owners of B to receive part of A in exchange for their
properties”. In a trade, what you are giving is just as
important as what you are getting. This remains true even when
the final tally on what is being given is delayed. Subsequent
sales of common stock or convertible issues, either to complete
the financing for a deal or to restore balance sheet strength,
must be fully counted in evaluating the fundamental mathematics
of the original acquisition. (If corporate pregnancy is going to
be the consequence of corporate mating, the time to face that
fact is before the moment of ecstasy.)

Managers and directors might sharpen their thinking by
asking themselves if they would sell 100% of their business on
the same basis they are being asked to sell part of it. And if
it isn’t smart to sell all on such a basis, they should ask
themselves why it is smart to sell a portion. A cumulation of
small managerial stupidities will produce a major stupidity - not
a major triumph. (Las Vegas has been built upon the wealth
transfers that occur when people engage in seemingly-small
disadvantageous capital transactions.)

The “giving versus getting” factor can most easily be
calculated in the case of registered investment companies.
Assume Investment Company X, selling at 50% of asset value,
wishes to merge with Investment Company Y. Assume, also, that
Company X therefore decides to issue shares equal in market value
to 100% of Y’s asset value.

Such a share exchange would leave X trading $2 of its
previous intrinsic value for $1 of Y’s intrinsic value. Protests
would promptly come forth from both X’s shareholders and the SEC,
which rules on the fairness of registered investment company
mergers. Such a transaction simply would not be allowed.

In the case of manufacturing, service, financial companies,
etc., values are not normally as precisely calculable as in the
case of investment companies. But we have seen mergers in these
industries that just as dramatically destroyed value for the
owners of the acquiring company as was the case in the
hypothetical illustration above. This destruction could not
happen if management and directors would assess the fairness of
any transaction by using the same yardstick in the measurement of
both businesses.

Finally, a word should be said about the “double whammy”
effect upon owners of the acquiring company when value-diluting
stock issuances occur. Under such circumstances, the first blow
is the loss of intrinsic business value that occurs through the
merger itself. The second is the downward revision in market
valuation that, quite rationally, is given to that now-diluted
business value. For current and prospective owners
understandably will not pay as much for assets lodged in the
hands of a management that has a record of wealth-destruction
through unintelligent share issuances as they will pay for assets
entrusted to a management with precisely equal operating talents,
but a known distaste for anti-owner actions. Once management
shows itself insensitive to the interests of owners, shareholders
will suffer a long time from the price/value ratio afforded their
stock (relative to other stocks), no matter what assurances
management gives that the value-diluting action taken was a one-
of-a-kind event.

Those assurances are treated by the market much as one-bug-
in-the-salad explanations are treated at restaurants. Such
explanations, even when accompanied by a new waiter, do not
eliminate a drop in the demand (and hence market value) for
salads, both on the part of the offended customer and his
neighbors pondering what to order. Other things being equal, the
highest stock market prices relative to intrinsic business value
are given to companies whose managers have demonstrated their
unwillingness to issue shares at any time on terms unfavorable to
the owners of the business.

At Berkshire, or any company whose policies we determine
(including Blue Chip and Wesco), we will issue shares only if our
owners receive in business value as much as we give. We will not
equate activity with progress or corporate size with owner-
wealth.


Miscellaneous

This annual report is read by a varied audience, and it is
possible that some members of that audience may be helpful to us
in our acquisition program.

We prefer:

(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).

We will not engage in unfriendly transactions. We can
promise complete confidentiality and a very fast answer as to
possible interest - customarily within five minutes. Cash
purchases are preferred, but we will consider the use of stock
when it can be done on the basis described in the previous
section.

* * * * *

Our shareholder-designated contributions program met with
enthusiasm again this year; 95.8% of eligible shares
participated. This response was particularly encouraging since
only $1 per share was made available for designation, down from
$2 in 1981. If the merger with Blue Chip takes place, a probable
by-product will be the attainment of a consolidated tax position
that will significantly enlarge our contribution base and give us
a potential for designating bigger per-share amounts in the
future.

If you wish to participate in future programs, we strongly
urge that you immediately make sure that your shares are
registered in the actual owner’s name, not a “street” or nominee
name. For new shareholders, a more complete description of the
program is on pages 62-63.

* * * * *

In a characteristically rash move, we have expanded World
Headquarters by 252 square feet (17%), coincidental with the
signing of a new five-year lease at 1440 Kiewit Plaza. The five
people who work here with me - Joan Atherton, Mike Goldberg,
Gladys Kaiser, Verne McKenzie and Bill Scott - outproduce
corporate groups many times their number. A compact organization
lets all of us spend our time managing the business rather than
managing each other.

Charlie Munger, my partner in management, will continue to
operate from Los Angeles whether or not the Blue Chip merger
occurs. Charlie and I are interchangeable in business decisions.
Distance impedes us not at all: we’ve always found a telephone
call to be more productive than a half-day committee meeting.

* * * * *

Two of our managerial stars retired this year: Phil Liesche
at 65 from National Indemnity Company, and Ben Rosner at 79 from
Associated Retail Stores. Both of these men made you, as
shareholders of Berkshire, a good bit wealthier than you
otherwise would have been. National Indemnity has been the most
important operation in Berkshire’s growth. Phil and Jack
Ringwalt, his predecessor, were the two prime movers in National
Indemnity’s success. Ben Rosner sold Associated Retail Stores to
Diversified Retailing Company for cash in 1967, promised to stay
on only until the end of the year, and then hit business home
runs for us for the next fifteen years.

Both Ben and Phil ran their businesses for Berkshire with
every bit of the care and drive that they would have exhibited
had they personally owned 100% of these businesses. No rules
were necessary to enforce or even encourage this attitude; it was
embedded in the character of these men long before we came on the
scene. Their good character became our good fortune. If we can
continue to attract managers with the qualities of Ben and Phil,
you need not worry about Berkshire’s future.


Warren E. Buffett
Chairman of the Board
mihou
Re: Warren E. Buffett letters
Message Mer 5 Juil - 0:49 par mihou
To the Shareholders of Berkshire Hathaway Inc.:

This past year our registered shareholders increased from
about 1900 to about 2900. Most of this growth resulted from our
merger with Blue Chip Stamps, but there also was an acceleration
in the pace of “natural” increase that has raised us from the
1000 level a few years ago.

With so many new shareholders, it’s appropriate to summarize
the major business principles we follow that pertain to the
manager-owner relationship:

o Although our form is corporate, our attitude is
partnership. Charlie Munger and I think of our shareholders as
owner-partners, and of ourselves as managing partners. (Because
of the size of our shareholdings we also are, for better or
worse, controlling partners.) We do not view the company itself
as the ultimate owner of our business assets but, instead, view
the company as a conduit through which our shareholders own the
assets.

o In line with this owner-orientation, our directors are all
major shareholders of Berkshire Hathaway. In the case of at
least four of the five, over 50% of family net worth is
represented by holdings of Berkshire. We eat our own cooking.

o Our long-term economic goal (subject to some qualifications
mentioned later) is to maximize the average annual rate of gain
in intrinsic business value on a per-share basis. We do not
measure the economic significance or performance of Berkshire by
its size; we measure by per-share progress. We are certain that
the rate of per-share progress will diminish in the future - a
greatly enlarged capital base will see to that. But we will be
disappointed if our rate does not exceed that of the average
large American corporation.

o Our preference would be to reach this goal by directly
owning a diversified group of businesses that generate cash and
consistently earn above-average returns on capital. Our second
choice is to own parts of similar businesses, attained primarily
through purchases of marketable common stocks by our insurance
subsidiaries. The price and availability of businesses and the
need for insurance capital determine any given year’s capital
allocation.

o Because of this two-pronged approach to business ownership
and because of the limitations of conventional accounting,
consolidated reported earnings may reveal relatively little about
our true economic performance. Charlie and I, both as owners and
managers, virtually ignore such consolidated numbers. However,
we will also report to you the earnings of each major business we
control, numbers we consider of great importance. These figures,
along with other information we will supply about the individual
businesses, should generally aid you in making judgments about
them.

o Accounting consequences do not influence our operating or
capital-allocation decisions. When acquisition costs are
similar, we much prefer to purchase $2 of earnings that is not
reportable by us under standard accounting principles than to
purchase $1 of earnings that is reportable. This is precisely
the choice that often faces us since entire businesses (whose
earnings will be fully reportable) frequently sell for double the
pro-rata price of small portions (whose earnings will be largely
unreportable). In aggregate and over time, we expect the
unreported earnings to be fully reflected in our intrinsic
business value through capital gains.

o We rarely use much debt and, when we do, we attempt to
structure it on a long-term fixed rate basis. We will reject
interesting opportunities rather than over-leverage our balance
sheet. This conservatism has penalized our results but it is the
only behavior that leaves us comfortable, considering our
fiduciary obligations to policyholders, depositors, lenders and
the many equity holders who have committed unusually large
portions of their net worth to our care.

o A managerial “wish list” will not be filled at shareholder
expense. We will not diversify by purchasing entire businesses
at control prices that ignore long-term economic consequences to
our shareholders. We will only do with your money what we would
do with our own, weighing fully the values you can obtain by
diversifying your own portfolios through direct purchases in the
stock market.

o We feel noble intentions should be checked periodically
against results. We test the wisdom of retaining earnings by
assessing whether retention, over time, delivers shareholders at
least $1 of market value for each $1 retained. To date, this
test has been met. We will continue to apply it on a five-year
rolling basis. As our net worth grows, it is more difficult to
use retained earnings wisely.

o We will issue common stock only when we receive as much in
business value as we give. This rule applies to all forms of
issuance - not only mergers or public stock offerings, but stock
for-debt swaps, stock options, and convertible securities as
well. We will not sell small portions of your company - and that
is what the issuance of shares amounts to - on a basis
inconsistent with the value of the entire enterprise.

o You should be fully aware of one attitude Charlie and I
share that hurts our financial performance: regardless of price,
we have no interest at all in selling any good businesses that
Berkshire owns, and are very reluctant to sell sub-par businesses
as long as we expect them to generate at least some cash and as
long as we feel good about their managers and labor relations.
We hope not to repeat the capital-allocation mistakes that led us
into such sub-par businesses. And we react with great caution to
suggestions that our poor businesses can be restored to
satisfactory profitability by major capital expenditures. (The
projections will be dazzling - the advocates will be sincere -
but, in the end, major additional investment in a terrible
industry usually is about as rewarding as struggling in
quicksand.) Nevertheless, gin rummy managerial behavior (discard
your least promising business at each turn) is not our style. We
would rather have our overall results penalized a bit than engage
in it.

o We will be candid in our reporting to you, emphasizing the
pluses and minuses important in appraising business value. Our
guideline is to tell you the business facts that we would want to
know if our positions were reversed. We owe you no less.
Moreover, as a company with a major communications business, it
would be inexcusable for us to apply lesser standards of
accuracy, balance and incisiveness when reporting on ourselves
than we would expect our news people to apply when reporting on
others. We also believe candor benefits us as managers: the CEO
who misleads others in public may eventually mislead himself in
private.

o Despite our policy of candor, we will discuss our
activities in marketable securities only to the extent legally
required. Good investment ideas are rare, valuable and subject
to competitive appropriation just as good product or business
acquisition ideas are. Therefore, we normally will not talk
about our investment ideas. This ban extends even to securities
we have sold (because we may purchase them again) and to stocks
we are incorrectly rumored to be buying. If we deny those
reports but say “no comment” on other occasions, the no-comments
become confirmation.

That completes the catechism, and we can now move on to the
high point of 1983 - the acquisition of a majority interest in
Nebraska Furniture Mart and our association with Rose Blumkin and
her family.

Nebraska Furniture Mart

Last year, in discussing how managers with bright, but
adrenalin-soaked minds scramble after foolish acquisitions, I
quoted Pascal: “It has struck me that all the misfortunes of men
spring from the single cause that they are unable to stay quietly
in one room.”

Even Pascal would have left the room for Mrs. Blumkin.

About 67 years ago Mrs. Blumkin, then 23, talked her way
past a border guard to leave Russia for America. She had no
formal education, not even at the grammar school level, and knew
no English. After some years in this country, she learned the
language when her older daughter taught her, every evening, the
words she had learned in school during the day.

In 1937, after many years of selling used clothing, Mrs.
Blumkin had saved $500 with which to realize her dream of opening
a furniture store. Upon seeing the American Furniture Mart in
Chicago - then the center of the nation’s wholesale furniture
activity - she decided to christen her dream Nebraska Furniture
Mart.

She met every obstacle you would expect (and a few you
wouldn’t) when a business endowed with only $500 and no
locational or product advantage goes up against rich, long-
entrenched competition. At one early point, when her tiny
resources ran out, “Mrs. B” (a personal trademark now as well
recognized in Greater Omaha as Coca-Cola or Sanka) coped in a way
not taught at business schools: she simply sold the furniture and
appliances from her home in order to pay creditors precisely as
promised.

Omaha retailers began to recognize that Mrs. B would offer
customers far better deals than they had been giving, and they
pressured furniture and carpet manufacturers not to sell to her.
But by various strategies she obtained merchandise and cut prices
sharply. Mrs. B was then hauled into court for violation of Fair
Trade laws. She not only won all the cases, but received
invaluable publicity. At the end of one case, after
demonstrating to the court that she could profitably sell carpet
at a huge discount from the prevailing price, she sold the judge
$1400 worth of carpet.

Today Nebraska Furniture Mart generates over $100 million of
sales annually out of one 200,000 square-foot store. No other
home furnishings store in the country comes close to that volume.
That single store also sells more furniture, carpets, and
appliances than do all Omaha competitors combined.

One question I always ask myself in appraising a business is
how I would like, assuming I had ample capital and skilled
personnel, to compete with it. I’d rather wrestle grizzlies than
compete with Mrs. B and her progeny. They buy brilliantly, they
operate at expense ratios competitors don’t even dream about, and
they then pass on to their customers much of the savings. It’s
the ideal business - one built upon exceptional value to the
customer that in turn translates into exceptional economics for
its owners.

Mrs. B is wise as well as smart and, for far-sighted family
reasons, was willing to sell the business last year. I had
admired both the family and the business for decades, and a deal
was quickly made. But Mrs. B, now 90, is not one to go home and
risk, as she puts it, “losing her marbles”. She remains Chairman
and is on the sales floor seven days a week. Carpet sales are
her specialty. She personally sells quantities that would be a
good departmental total for other carpet retailers.

We purchased 90% of the business - leaving 10% with members
of the family who are involved in management - and have optioned
10% to certain key young family managers.

And what managers they are. Geneticists should do
handsprings over the Blumkin family. Louie Blumkin, Mrs. B’s
son, has been President of Nebraska Furniture Mart for many years
and is widely regarded as the shrewdest buyer of furniture and
appliances in the country. Louie says he had the best teacher,
and Mrs. B says she had the best student. They’re both right.
Louie and his three sons all have the Blumkin business ability,
work ethic, and, most important, character. On top of that, they
are really nice people. We are delighted to be in partnership
with them.
Re: Warren E. Buffett letters
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Warren E. Buffett letters

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