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 1982, to save you the time from reading the whole letter (although still strongly recommended).
Berkshire Hathaway – 1982 Letter Learnings
Buffett: 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.
MoneyWiseSmart (MWS): As a long term investor, assuming you are a net saver and not a net consumer (of your savings/ cash), do you rejoice when the stock prices of your companies go up or go down? Should you rejoice when the stock prices of your companies go up or go down?
Buffett: 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… 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.
MWS: Do your companies provide differentiated or undifferentiated solutions? If the latter, do they have specific advantages to prevail a depressing equation of business economics?
Buffett: 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.
… 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… 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.
… 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.
MWS: In issuing new shares, do your companies follow the simple basic rule used by Berkshire Hathaway? And do they use one of the three ways to avoid destruction of value in issuing new shares?
Top Insights from Berkshire Hathaway’s 1982 Shareholder Letter
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Source: Berkshire Hathaway letter.
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