Berkshire Hathaway Inc. - Chairman's Letter 1984: Briefing Document
Source: Excerpts from "Chairman's Letter - 1984" by Warren E. Buffett
Key Themes:
Mediocre Annual Performance, Long-Term Focus: While the net worth gain in 1984 was positive, Buffett deemed it "mediocre" when compared to the capital employed. He emphasizes the importance of long-term intrinsic business value growth over short-term book value gains.
The Challenge of Scale: Buffett acknowledges the increasing difficulty in achieving historically high growth rates due to Berkshire's expanding capital base. He states that maintaining a 15% annual return over the next decade will require "a few big ideas."
Sources of Earnings & Accounting Nuances: The letter provides a detailed breakdown of Berkshire's earnings by operating segment. It also delves into a disagreement with Peat Marwick's New York office regarding the accounting treatment of special stock repurchase transactions with GEICO and General Foods, highlighting the difference between accounting form and economic substance.
Rationale for Stock Repurchases: Buffett strongly advocates for stock repurchases when a company's shares are trading significantly below intrinsic value, outlining both the immediate arithmetic benefit and the less obvious signal of shareholder-oriented management. He contrasts this with "greenmail," which he finds "odious and repugnant."
Difficulty in Finding Attractive Investments: Buffett notes the increasing challenge in finding equity investments that meet both qualitative and quantitative standards, making "doing nothing" the most difficult task.
Exceptional Controlled Businesses: The letter highlights the outstanding performance and management of Nebraska Furniture Mart (led by the remarkable Mrs. B and her family), See's Candy Shops (under Chuck Huggins), and the Buffalo Evening News (managed by Stan Lipsey).
Troubles in Insurance Underwriting: Buffett candidly discusses the poor underwriting results of Berkshire's insurance operations in 1984 and the preceding years, acknowledging his own errors in loss reserving. He explains the inherent imprecision in insurance accounting and the potential for systemic bias.
Strategic Bond Investment in WPPSS: Buffett details Berkshire's significant investment in Washington Public Power Supply System (WPPSS) bonds, framing it as a business valuation exercise with attractive current returns but inherent risks. He contrasts this with the often-unintelligent bond investing behavior based purely on yield without considering fundamental business economics.
Dividend Policy Philosophy: Buffett provides a detailed explanation of Berkshire's long-standing policy of retaining earnings, arguing that dividends should only be paid when there is no reasonable prospect of the company generating at least one dollar of market value for every dollar retained. He criticizes managers who retain earnings for empire-building or personal comfort rather than shareholder benefit.
"Business Wanted" Advertisement: Buffett reiterates Berkshire's criteria for acquiring new businesses, emphasizing size, consistent earnings power, high returns on equity with low debt, existing management, simplicity, and a clear offering price.
Shareholder-Designated Contributions Program & Annual Meeting: Buffett highlights the success of the shareholder-designated contributions program and encourages new shareholders to register their shares properly for future participation. He also previews the annual meeting in Omaha, emphasizing its focus on substantive business discussion.
Subsequent Event - Investment in Capital Cities Communications/ABC: A postscript announces a significant agreement to purchase shares of Capital Cities Communications contingent upon their acquisition of American Broadcasting Companies, Inc., praising the management of Capital Cities.
Most Important Ideas and Facts:
Intrinsic Value Focus: Buffett reiterates that the primary measure of economic progress is the growth in per-share intrinsic business value, with book value serving as a useful but potentially understated proxy.
"As we discussed last year, the gain in per-share intrinsic business value is the economic measurement that really counts. But calculations of intrinsic business value are subjective. In our case, book value serves as a useful, although somewhat understated, proxy."
Challenge of Large Capital Base: Achieving past growth rates becomes increasingly difficult with a large capital base, requiring larger and more impactful investment ideas.
"Our historical 22% rate is just that - history. To earn even 15% annually over the next decade (assuming we continue to follow our present dividend policy... we would need profits aggregating about $3.9 billion. Accomplishing this will require a few big ideas - small ones just won�t do."
Economic Substance over Accounting Form: The dispute with Peat Marwick highlights Buffett's focus on the underlying economics of transactions rather than just their accounting treatment.
"None of this, however, has any effect on intrinsic business value: our ownership interests in GEICO and General Foods, our cash, our taxes, and the market value and tax basis of our holdings all remain the same."
Value of Stock Repurchases at Discount: Buffett sees repurchases as a powerful tool to enhance shareholder value when shares are undervalued and a clear sign of management prioritizing owners' interests.
"When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases."
Exceptional Management at Controlled Businesses: The detailed descriptions of Mrs. B at NFM and Chuck Huggins at See's emphasize the critical role of outstanding and ethical management in achieving business success.
(Regarding Mrs. B): "After another year of observing their remarkable talents and character, I can honestly say that I never have seen a managerial group that either functions or behaves better than the Blumkin family."
(Regarding Mrs. B's business philosophy): "(Mrs. B boils it down to �sell cheap and tell the truth�.)"
(Regarding Chuck Huggins): "The success of See�s reflects the combination of an exceptional product and an exceptional manager, Chuck Huggins."
Transparency and Accountability in Insurance: Buffett's candid discussion of loss reserving errors underscores his commitment to transparency and his personal accountability for mistakes.
"As you can see from reviewing the table, my errors in reporting to you have been substantial and recently have always presented a better underwriting picture than was truly the case. This is a source of particular chagrin to me..."
Unconventional Bond Investing: The WPPSS investment illustrates Buffett's business-like approach to bond investing, focusing on underlying economics and potential returns relative to risk, rather than simply chasing yields.
"Simply put, we feel that if we can buy small pieces of businesses with satisfactory underlying economics at a fraction of the per-share value of the entire business, something good is likely to happen to us - particularly if we own a group of such securities. We extend this business-valuation approach even to bond purchases such as WPPSS."
Rational Dividend Policy: Berkshire's retention of earnings is justified by the historical ability to generate above-market returns on reinvested capital, directly benefiting shareholders through increased intrinsic value.
"Unrestricted earnings should be retained only when there is a reasonable prospect... that for every dollar retained by the corporation, at least one dollar of market value will be created for owners."
Focus on Quality Acquisitions: The "business wanted" ad clearly outlines Berkshire's strict criteria for acquisitions, emphasizing quality, simplicity, and existing management.
Value of Thoughtful Shareholder Engagement: The structure and purpose of Berkshire's annual meeting highlight the importance of substantive dialogue between management and informed shareholders.
Quotes for Emphasis:
"Economic gains must be evaluated by comparison with the capital that produces them."
"To earn even 15% annually over the next decade... we would need profits aggregating about $3.9 billion. Accomplishing this will require a few big ideas - small ones just won�t do."
"When companies purchase their own stock, they often find it easy to get $2 of present value for $1."
"A manager who consistently turns his back on repurchases, when these clearly are in the interests of owners, reveals more than he knows of his motivations."
"Investment is most intelligent when it is most businesslike." - Quoting Ben Graham
"We behave with Berkshire�s money as we would with our own. That frequently leads us to unconventional behavior both in investments and general business management."
"Unrestricted earnings should be retained only when there is a reasonable prospect... that for every dollar retained by the corporation, at least one dollar of market value will be created for owners."
This letter provides valuable insights into Warren Buffett's investment philosophy, management principles, and his candid assessment of Berkshire Hathaway's performance and future prospects in 1984. It underscores the importance of long-term thinking, intrinsic value, shareholder-oriented management, and intellectual honesty in the world of business and investment.
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