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 1988, to save you the time from reading the whole letter (although still strongly recommended).
Berkshire Hathaway – 1988 Letter Learnings
Buffett: As a partial offset to the drag that our growing capital base exerts upon returns, we have a very important advantage now that we lacked 24 years ago. Then, all our capital was tied up in a textile business with inescapably poor economic characteristics. Today part of our capital is invested in some really exceptional businesses.
Last year we dubbed these operations the Sainted Seven: Buffalo News, Fechheimer, Kirby, Nebraska Furniture Mart, Scott Fetzer Manufacturing Group, See’s, and World Book. In 1988 the Saints came marching in. You can see just how extraordinary their returns on capital were by examining the historical-cost financial statements on page 45, which combine the figures of the Sainted Seven with those of several smaller units. With no benefit from financial leverage, this group earned about 67% on average equity capital.
In most cases the remarkable performance of these units arises partially from an exceptional business franchise; in all cases an exceptional management is a vital factor. The contribution Charlie and I make is to leave these managers alone.
MoneyWiseSmart (MWS): What type of return on capital are your businesses earning, and do they all have exceptional management?
Buffett: The [Nebraska Furniture] Mart, long the largest home furnishings store in the
country, continues to grow. In the fall, the store opened a detached 20,000 square foot Clearance Center, which expands our ability to offer bargains in all price ranges.
Recently Dillard’s, one of the most successful department store operations in the country, entered the Omaha market. In many of its stores, Dillard’s runs a full furniture department, undoubtedly doing well in this line. Shortly before opening in Omaha, however, William Dillard, chairman of the company, announced that his new store would not sell furniture.
Said he, referring to NFM: “We don’t want to compete with them. We think they are about the best there is.”
MoneyWiseSmart (MWS): Do you own businesses where their competitors don’t even want to compete with them, and choose to retreat straight?
Buffett: In 1948 Mr. Friedman purchased Borsheim’s, a small Omaha jewelry store. He was joined in the business by his son, Ike, in 1950 and, as the years went by, Ike’s son, Alan, and his sons-in-law, Marvin Cohn and Donald Yale, came in also.
You won’t be surprised to learn that this family brings to the jewelry business precisely the same approach that the Blumkins bring to the furniture business. The cornerstone for both enterprises is Mrs. B’s creed: “Sell cheap and tell the truth.” Other fundamentals at both businesses are: (1) single store operations featuring huge inventories that provide customers with an enormous selection across all price ranges, (2) daily attention to detail by top management, (3) rapid turnover, (4) shrewd buying, and (5) incredibly low expenses. The combination of the last three factors lets both stores offer everyday prices that no one in the country comes close to matching.
MoneyWiseSmart (MWS): If you own any retail businesses, do they share similar traits of good working capital management and focus on cost efficiencies?
Buffett: [On arbitrage opportunities that Warren Buffett was involved in in his time at Graham-Newman Corp], For several weeks I busily bought shares, sold [cocoa] beans, and made periodic stops at Schroeder Trust to exchange stock certificates for warehouse receipts. The profits were good and my only expense was subway tokens.
… To evaluate arbitrage situations you must answer four questions: (1) How likely is it that the promised event will indeed occur? (2) How long will your money be tied up? (3) What chance is there that something still better will transpire – a competing takeover bid, for example? and (4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?
… Berkshire’s arbitrage activities differ from those of many arbitrageurs. First, we participate in only a few, and usually very large, transactions each year. Most practitioners buy into a great many deals perhaps 50 or more per year. With that many irons in the fire, they must spend most of their time monitoring both the progress of deals and the market movements of the related stocks. This is not how Cheeeeefadfafasarlie nor I wish to spend our lives. (What’s the sense in getting rich just to stare at a ticker tape all day?)
… The other way we differ from some arbitrage operations is that we participate only in transactions that have been publicly announced. We do not trade on rumors or try to guess takeover candidates. We just read the newspapers, think about a few of the big propositions, and go by our own sense of probabilities.
MoneyWiseSmart (MWS): Do you engage in arbitrage opportunities, just like Buffett did?
Buffett: The preceding discussion about arbitrage makes a small discussion of “efficient market theory” (EMT) also seem relevant. This doctrine became highly fashionable – indeed, almost holy scripture in academic circles during the 1970s. Essentially, it said that analyzing stocks was useless because all public information about them was appropriately reflected in their prices. In other words, the market always knew everything. As a corollary, the professors who taught EMT said that someone throwing darts at the stock tables could select a stock portfolio having prospects just as good as one selected by the brightest, most hard-working security analyst. Amazingly, EMT was embraced not only by academics, but by many investment professionals and corporate managers as well. Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.
… Naturally the disservice done students and gullible investment professionals who have swallowed EMT has been an extraordinary service to us and other followers of Graham. In any sort of a contest – financial, mental, or physical – it’s an enormous advantage to have opponents who have been taught that it’s useless to even try. From a selfish point of view, Grahamites should probably endow chairs to ensure the perpetual teaching of EMT.
MoneyWiseSmart (MWS): What’s your take on the efficient market theory? Do you try to beat it?
Summary: Key Takeaways from Berkshire Hathaway’s 1988 Shareholder Letter
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Source: Berkshire Hathaway letter.
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