Buffett to Shareholders – 1977

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.

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