Each year, Warren Buffett writes an open letter to Berkshire Hathaway shareholders which many value investors can’t wait to jump on reading. In this post, we have summarised the key learnings from the letter written in 1980, to save you the time from reading the whole letter (although still strongly recommended).
Berkshire Hathaway – 1980 Letter Learnings
Buffett: Our holdings in this third category of companies [which Berkshire owns <20% ownership] 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.
MoneyWiseSmart (MWS): Are there hidden values within your companies? How much investments in affiliates do they have, and how much of those iceberg are above the surface?
Buffett: 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.
MWS: Do your businesses’ cash come with any strings attached?
Buffett: 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…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.
MWS: When higher inflation comes back, would you take inflation for granted (assuming you still want to eat your hamburger)?
Buffett: Variations of this depressing sequence involve a smaller penalty to stated net worth [of insurance companies]. 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.
MWS: Are the management of your companies doing the right thing for short-term or long-term? Are they willing to take a hit on short-term for long-term?
Final Reflections from Berkshire Hathaway 1980 Letter
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Source: Berkshire Hathaway letter.
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