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.
Accueil 
