the richest man in atherstone

SOURCE: Berkshire Hathaway Shareholder Letter 1978

Business Advice
Buffett opens this letter by explaining the reasons for some of Berkshire Hathaway's figures that some shareholders may find puzzling, due to accounting and tax procedure. He is honest by stating that the figures do not represent the true picture and, in my view, goes out of his way to explain the reasons and provide extra figures for investors to evaluate the company's progress. He strikes me as a man with great integrity, high standards and fine attention to detail.

He goes on to say that 1978 was a good year, mainly for the insurance divisions but notes that the momentum is not sustainable in the short-term future due to a downward turn in the insurance industry.

Although the textile businesses have improved and are still profitable, they still perform poorly in comparison to other businesses. Buffett explains that this is due to being in an industry that offers little in terms of differentiated products and a supply that is bigger than demand. He ensures that management are investigating different ways to improve profits including differentiating the product, cutting manufacturing costs (both equipment and human resources) and moving into stronger material markets. Although profits aren't that big, Berkshire Hathaway will continue to support these businesses while they are making modest profits for the resons listed in last years letter.

Although insurance has been very profitable across the whole industry over the past year, most of Berkshire Hathaway's insurance companies have performed even better than their competitors.

"Although some segments were disappointing, overall our insurance operation had an excellent year."

Because of the strength of the insurance industry, Buffett makes it clear that Berkshire Hathaway are always looking for ways to expand its insurance division. He admits his own shortcomings in some of his efforts in expansion, pointing out that it is not easy to enter the insurance business.

"It is not easy to buy a good insurance business, but our experience has been that it is easier to buy one than to create one."

Buffett praises the managers of Berkshire Hathaway's banking and retail businesses, which have performed well over the past year. He advises that his best managers think like owners and enjoy coming into work plus they are always looking for new ways to cut costs.

"Our experience has been that the manager of an already high-cost operation frequently is uncommonly resourceful in finding new ways to add to overhead, while the manager of a tightly-run operation usually continues to find additional methods to curtail costs, even when his costs are already well below those of his competitors."

"It is a real pleasure to work with managers who enjoy coming to work each morning and, once there, instinctively and unerringly think like owners."

Investment Advice
Buffett makes a point that he doesn't think that anyone can predict short-term changes in stock price, including Berkshire Hathaway. That is why they only invest in securities for the long-term.

"We make no attempt to predict how security markets will behave; successfully forecasting short-term stock price movements is something we think neither we nor anyone else can do."

Buffett repeats his advice from last years letter that businesses must adhere to the following principle checkpoints before they are considered for purchase (either by buying stock or as a whole):

1. The business must be understood by the investor.
2. The business must have favourable long-term prospects.
3. The business must be operated by honest and competent management.
4. The business must be priced attractively.

I get the feeling that Buffett spends a good proportion of time locating businesses that fulfil checkpoints 1, 2 and 3 above and then waits until they achieve checkpoint 4 through market fluctuations.

"We continue to find for our insurance portfolios small portions of really outstanding businesses that are available, through the auction pricing mechanism of security markets, at prices dramatically cheaper than the valuations inferior businesses command on negotiated sales."

Buffett continues by saying that when a worthwhile business is found that meets the above checkpoints, Berkshire Hathaway will purchase a substantial amount of equity.

"When we are convinced as to the attractiveness, we believe in buying worthwhile amounts."

He goes on to say that it is sometimes better to buy shares in a company than it is to buy the firm outright. He explains that if a company is being run well by management, it is not worth purchasing control at an inflated price when nothing needs to be changed. Buying shares in a company can also be cheaper than starting a business from scratch.

Berkshire Hathaway, Buffett explains, is happy for businesses to retain earnings and plow them back into the company providing that it can be utilised at good rates. This can often be the most profitable employment of capital. However, in industries with low capital requirements or in businesses with management that have a past record of squandering money, earnings should either be paid to shareholders or used to repurchase shares.