Price is what you pay, value is what you get
– Warren Buffett, Letter to shareholders 2008
Regardless of the seemingly endless supply of business & investing literature and online material, Warren Buffett’s letters to shareholders is the ideal starting point for anyone concerned with business valuation. In fact, it should be a mandatory reading material in any kind of business related education. In terms of the above quote, in value the letters are priceless and in price they are free of charge.
What makes them so valuable is the fact that they offer (1) Buffett’s no nonsense insight on financial management practices, (2) methods of valuating a business and most importantly (3) as the letters are written annually you read Buffett’s thoughts at a given point in time, making them free of hindsight biases (a feature present in most of the Buffett literature, as writers make causal links by linking causes to events after they occur). Last but not least Buffett’s humor and wit makes the reading very entertaining.
These are excerpts from Buffett’s letters that I have made for myself as a sort of a glossary and that I’d like to share on Sportgamma.net.
Warren Buffets 1977 Letter to Shareholders
Most companies define “record” earnings as a new high in
earnings per share. Since businesses customarily add from year
to year to their equity base, we find nothing particularly
noteworthy in a management performance combining, say, a 10%
increase in equity capital and a 5% increase in earnings per
share. After all, even a totally dormant savings account will
produce steadily rising interest earnings each year because of
Except for special cases (for example, companies with
unusual debt-equity ratios or those with important assets carried
at unrealistic balance sheet values), we believe a more
appropriate measure of managerial economic performance to be
return on equity capital.
It is comforting to be in a
business where some mistakes can be made and yet a quite
satisfactory overall performance can be achieved. In a sense,
this is the opposite case from our textile business where even
very good management probably can average only modest results.
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.
Insurance companies offer standardized policies which can be
copied by anyone. Their only products are promises. It is not
difficult to be licensed, and rates are an open book. There are
no important advantages from trademarks, patents, location,
corporate longevity, raw material sources, etc., and very little
consumer differentiation to produce insulation from competition.
It is commonplace, in corporate annual reports, to stress the
difference that people make. Sometimes this is true and
sometimes it isn’t. But there is no question that the nature of
the insurance business magnifies the effect which individual
managers have on company performance. We are very fortunate to
have the group of managers that are associated with us.
Most of our large stock positions are going
to be held for many years and the scorecard on our investment
decisions will be provided by business results over that period,
and not by prices on any given day. Just as it would be foolish
to focus unduly on short-term prospects when acquiring an entire
company, we think it equally unsound to become mesmerized by
prospective near term earnings or recent trends in earnings when
purchasing small pieces of a company; i.e., marketable common
We select our marketable equity securities in much the same
way we would evaluate a business for acquisition in its entirety.
We want the business to be (1) one that we can understand, (2)
with favorable long-term prospects, (3) operated by honest and
competent people, and (4) available at a very attractive price.
We ordinarily make no attempt to buy equities for anticipated
favorable stock price behavior in the short term. In fact, if
their 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.
Capital Cities possesses both extraordinary properties and
extraordinary management. And these management skills extend
equally to operations and employment of corporate capital. 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. While control would give us the opportunity – and the
responsibility – to manage operations and corporate resources, we
would not be able to provide management in either of those
respects equal to that now in place. In effect, we can obtain a
better management result through non-control than control. This
is an unorthodox view, but one we believe to be sound.