the richest man in atherstone

Much like the compilation episodes that are strung together by television series producers when they haven't got any new material this post will take a look back over the previous 12 months and summarise my achievements for 2006.

January
In the first month of the year, I had a very unsettling experience with the ICICI bank, which resulted in them losing a customer for life. Conversely, I had a very pleasant experience with the Alliance + Leicester when they gave me £150 and my mum £50 simply for opening a Premier Direct Account.

February
The only month of 2006 in which I didn't make a journal entry.

March
I learned a very valuable lesson - that I shouldn't forsake my family and friends for money. Thirty pound spent on a nice meal in the company of loved ones is a fantastic investment.

April
April saw the launch of this website into the public domain. Previously, I had been updating my journal privately but I decided to publish it to the masses in the hope it would provide useful information and an entertaining read. Additionally, in April, I realised that I had not been following Clason's advice properly which resulted in me rearranging my finances.

May
May was quite a busy month for me. The money I had saved over the previous year or so was now available for worthwhile investments, so I set about finding some. I bought Premium Bonds and dabbled in the stock market for the first time by buying shares in my ISP, Plusnet. A week or so later, I increased my stake in Plusnet. I also opened a Monthly Saver account with Lloyds TSB, as well as writing a book review of 'The Richest Man in Babylon' by George S. Clason, writing an article entitled Top Ten Tips to Increase you Wealth and talking about my money box.

June
In June, I got a GE Money Credit Card, which gives me 3% cashback when I use it to buy petrol or groceries. I also tested a gambling strategy during the FIFA World Cup.

July
My biggest achievement of the year occurred in July - I stopped smoking. And the best part was it was much easier than I thought it would be (having failed many times before). I also updated the progress of my Plusnet shares and wrote a book review of Robert Kiyosaki's 'Rich Dad, Poor Dad'.

August
I decided to analyse Warren Buffet's letters to Berkshire Hathaway shareholders, which contain some great investment advice from arguably the world's best. The first letter I analysed was from 1977. I also decided what I would do with all the extra money I would have due to quitting smoking.

September
I analysed Warren Buffet's 1978 letter to shareholders.

October
A very busy month. I analysed Warren Buffet's 1979 letter to shareholders as well as releasing the prototypes of my Mortgage Calculator and Regular Savings Calculator to the world. I reduced my expenditures by changing my telephone provider and updated the progress of my Plusnet stock. I collected the cashback from my Morgan Stanley Credit Card and closed my A+L Premier Direct account. Finally, I began to cut down our grocery shopping bill and wrote an in-depth article on earning over £100 using Quidco.

November
In November, I continued to reduce our grocery bill as well as writing an article describing my Top Ten Tips. I had a bit of a moan about feeling constrained as I couldn't invest my money due to our house being on the market, however I did find a cracking savings account (IceSave) that I transferred my money to. November also saw me begin my 'doubling to a million' project and making my way to step 7. I also gave honourary mentions to other doublers I'd found. Click here to see all doubling posts.

December
December saw the first issue of my newsletter, I sold my Plusnet shares to BT and completed step 7 and step 8 of my 'doubling to a million' project as well as making some progress towards step 9. I described my experiment for super-unleaded petrol economics and published my financial report for 2006.

In summary, I feel I've achieved a lot over the last 12 months. It's certainly more than I achieved in 2005 and quitting smoking is one of the biggest achievements in my life.

Another year has begun and I wish you all a healthy, wealthy and happy 2007.

SOURCE: Berkshire Hathaway Shareholder Letter 1979

Business Advice
Buffett begins with a few words about changes to accounting procedure. Equities owned by insurance companies are now required to be listed on the balance sheet at market value whereas previously they were recorded as either the purchase price or the aggregate market value (whichever was lower). This has resulted in the net worth of the insurance division increasing substantially. It also means that should an insurance company and a non-insurance company purchase the same equity, they would be recorded differently on each balance sheet. Again, Buffett's inegrity and his ability to explain difficult concepts in layman's terms is highlighted. A less scrupulous chairman might use this change in procedure to make it appear as though the company has done better than it has.

Buffett explains that the previous year has bought good results, however the increased amount of capital that was available at the start of the year has not been utilised as efficiently as in previous years. This is further explained in the 'Investment Advice' section below.

Berkshire Hathaway has bought 13 new companies for cash and have started 6 others, however the outlook for equities looks less desirable than in previous years due to the current economic climate. Increases to inflation rates and taxes could wipe out any real profits.

"When this index exceeds the rate of return earned on equity by the business, the investor’s purchasing power (real capital) shrinks even though he consumes nothing at all."

Buffett is forthright enough to say that he has no solution to this problem.

Associated Retail Stores has produced fantastic results in an unpredictable sector. Berkshire Hathaway's textile businesses however, have performed poorly in comparison to capital employed despite being profitable. As in previous letters, Buffett explains that the problem is not so much the specific businesses but the industry that they're in. This is because the capital employed in property, machinery etc is high and the relative profits are low.

Berkshire Hathaway's Insurance businesses have been a mixed bag this year. Competition from other companies in the insurance sector has increased as they are prepared to sacrifice profitable underwriting for volume of premiums. Despite the tough market, some of Berkshire Hathaway's businesses have performed extraordinarily well, most notably National Indemnity and Workers Compensation. These businesses have continued to only underwrite at a profit without worrying about the volume of premiums. The managers have been singled out for praise by Buffett for their strong-mindedness. I have noticed that when he is handing out praise, Buffett is eager to name the managers, however if results are poor he only mentions the company name.

Analysts at the time have predicted the insurance industry will do poorly for a year or so before getting back on track. Buffett disagrees with this, citing that he doesn't think that insurance companies will stop issuing policies at an underwriting loss and forecasts around a five year dip. As Berkshire Hathaway's companies will not be underwriting at a loss, he predicts this time will be difficult for them and warns that performance will not be as lucrative as previous years. Buffett demonstrates that he is single-minded and will go against conventional wisdom if he believes it to be incorrect. He also shows a high level of honesty towards his shareholders again.

The Illinois National Bank has beaten its own records and outperformed its competitors again, however due to legislation (the Bank Holding Company Act 1969), Berkshire Hathaway are being forced to sell most or all of the business. Buffett hopes to find a buyer next year but highlights that price is not the only factor. He wants to ensure the staff will be treated well after providing Berkshire Hathaway with a fantastic service over the years. Buffett does not expect to be able to employ the proceeds from the sale in as profitable a business.

"You simply can’t buy high quality businesses at the sort of price/earnings multiple likely to prevail on our bank sale."

Berkshire Hathaway are listed for trading on the NASDAQ, meaning that its earnings are now quoted in the Wall Street Journal and the Dow Jones ticker solving previous issues of information dissemination.

Buffett displays a great amount of respect for Berkshire Hathaway shareholders and takes the time to discuss the format of the companies annual reporting principles. As most shareholders are long-term investors and have a significant proportion of their wealth in Berkshire Hathaway stock, Buffett does not tend to restate things he has said in previous annual reports and aims to keep them informed of all the important issues in the companies operations.

"Many of these owners are willing to spend a significant amount of time with the annual report, and we attempt to provide them with the same information we would find useful if the roles were reversed."

Due to the long-term view, explanations are kept to a minimum in quarterly reports and saved for the annual reports, which are written by Buffett himself.

He goes on to explain that Berkshire Hathaway is not all things to all people and he intends for it to stay that way so that shareholders and potential shareholders know exactly where they stand. Buffett is happy with his current shareholders as they have the same views as the management and he does not want to lose them, in favour of new ones, as a consequence of becoming more universal.

"We much prefer owners who like our service and menu and who return year after year. It would be hard to find a better group to sit in the Berkshire Hathaway shareholder “seats” than those already occupying them."

Buffet expects next year to provide increased operating earnings but decreased return on equity. He states three reasons that could reduce operating earnings:

"the outcome depends partly upon the date of disposition of the bank, partly upon the degree of slippage in insurance underwriting profitability, and partly upon the severity of earnings problems in the savings and loan industry."

Berkshire Hathaway's financial decisions are made at the very top by Buffett's own very small team with operations delegated to a small number of key managers in each company. Buffett explains that this structure both reduces costs and speeds up the decision-making process as well as attracting and retaining some very talented individuals. Buffett believes that this is one of the reasons that Berkshire Hathaway continues to produce outstanding results year after year.

Investment Advice
Buffett describes what Berkshire Hathaway considers to be the best way to measure a companies performance over a year:

"We continue to feel that the ratio of operating earnings (before securities gains or losses) to shareholders’ equity with all securities valued at cost is the most appropriate way to measure any single year’s operating performance."

He goes on to explain that if securities were recorded at their current market value, it would create wild fluctuations from one year to the next due to the nature of the market. This would not show the true picture of how a company itself is performing.

Earnings per Share for Berkshire Hathaway has increased by 20%, however Buffett does not think this represents a sound figure on which to focus as capital has been somewhat under-utilised over the previous 12 months despite the fact that more had been available than in previous years. He goes on to provide further explanation of this:

“'Earnings per share' will rise constantly on a dormant savings account or on a U.S. Savings Bond bearing a fixed rate of return simply because 'earnings' (the stated interest rate) are continuously plowed back and added to the capital base."

"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share."

In contrast, when measuring performance over the long term, Buffett believes that equities should be represented at market value and all realised capital gains and losses should be recorded as well as any extraordinary items. In the short term however, they are not good performance indicators.

"...it is just that their impact is often extremely capricious in the short run, a characteristic that makes them inappropriate as an indicator of single year managerial performance."

Investments by Berkshire Hathaway's insurance companies has produced good performance over the last year. Buffett forecasts that over the next year, equity markets will be less profitable but he doesn't intend to adjust any of the stock portfolios to match the market for one specific year, preferring to hold with a view to the long term.

Insurance companies are required to invest a percentage of their money in fixed income bonds, however Buffett explains that due to high inflation, long-term bonds are a risky as the value of the dollar is constantly being eroded. He goes on to explain that it is ironic that some insurance companies are only offering 6 month car policies as it is difficult to forecast the future in the current economic climate yet they are still investing in 30 and 40 year bonds!

"We have severe doubts as to whether a very long-term fixed-interest bond, denominated in dollars, remains an appropriate business contract in a world where the value of dollars seems almost certain to shrink by the day."

One of the reasons for Berkshire Hathaway's outperforming competitors is that they have favoured convertible bonds (the bonds can be converted to shares) over normal bonds. Additionally, they have favoured equities over bonds.

Despite this, Buffett admits that mistakes have been made with the purchase of shorter term bonds (15 years). These were purchased knowing that bonds would probably underperform other investments and erred on the side of caution (15yr bonds instead of 40yr bonds).

"You do not adequately protect yourself by being half awake while others are sleeping."

Buffett concludes his discussion of bonds by saying that, on the positive side, new government legislation or higher interest rates could still protect bond buyers.

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.

SOURCE: Berkshire Hathaway Shareholder Letter 1977

Business Advice
Buffett begins this letter by giving a general overview of Berkshire Hathaway's annual results highlighting that the insurance companies have had outstanding performance whereas the textile companies came in well below forecast.

Shareholders have raised their concerns about keeping the textile companies when bigger profits could be made in other industries. Buffett explains that Berkshire intends to continue supporting them as they employ a large number of people with non-transferrable skills and both employees and management have worked hard together to keep the business as a viable operation. Buffett believes that it is realistic to expect modest returns from this division.

In contrast, the insurance division of Berkshire has performed exceedingly well despite a number of small mistakes. Buffett highlights the importance of being in businesses that can absorb some of the damage when mistakes are made.

"One of the lessons your management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds."

Buffett continues by stating that there is very little product differentiation within the insurance sector, therefore the fantastic results obtained must be credited to the management of those companies.

Investment Advice
Something that I found particularly interesting was that Buffett uses the same criteria to select the shares he invests in as he would use if he were to buy the entire company. He recommends that a business should:

1. Be easy to understand.
2. Have favourable long-term prospects.
3. Be operated by honest and compentent people.
4. Be available at a very attractive price.

Having found a favourable business to invest in, the purchase price should represent good value for money. Stock market fluctuations should be used to the investors advantage and shares should only be bought at a discount. Buffett actually welcomes low share prices in his portfolio because it gives him the chance to purchase more stock at discount.

"If [a company's] business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price."

Buffett understands that an outstanding company bought at a discount due to market fluctuations will eventually realise the value it deserves.

He also notes that by buying stock through the markets, discounts can be attained that would not be possible if the company was bought as a whole. If a business and its management are performing well, it would cost more to purchase the company rather than a large holding of stock, while there would be no advantage in taking control.

"To purchase, directly, properties such as Capital Cities owns would cost in the area of twice our cost of purchase via the stock market, and direct ownership would offer no important advantages to us."

---

Buffett warns readers to be careful of the figures when companies report "record earnings". His grievance is that this phrase is often used when earnings per share (EPS) hits a new high. He explains that it is usual for a company to increase their equity base each year, so higher EPS should be expected.

"Even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding."

Buffett continues by explaining that a better performance indicator is Return on Equity (ROE). Not only is ROE more accurate, it also takes into account the company's debt levels.