Learning from Warren Buffett Shareholders Letters - Year 1979.

13th May 2024


Learning from Warren Buffett Shareholders Letters – Year 1979.

Dear Investors,

Namaste! The journey has reached the most interesting topic. Today, the master is sharing how to see the investment returns. As an investor – we all are interested in the RETURN. But do we really earn the returns? Let us learn the finer secrets which take away our returns.

The ultimate guidance for RETURNS on Investments:-

We had substantially more capital to work with in 1979 than in 1978, and our
performance in utilizing that capital fell short of the earlier year, even though
per-share earnings rose. “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 ploughed back and
added to the capital base. Thus, even a “stopped clock” can look like a growth
stock if the dividend payout ratio is low.

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 our view, many businesses would be better understood
by their shareholder owners, as well as the general public, if managements and
financial analysts modified the primary emphasis they place upon earnings per
share, and upon yearly changes in that figure.


(The Emphasis on return on capital and not on EPS).

A few years ago, a business whose per-share net worth compounded at 20%
annually would have guaranteed its owners a highly successful real investment
return. Now such an outcome seems less certain.

For the inflation rate, coupled with individual tax rates, will be the ultimate
determinant as to whether our internal operating performance produces
successful investment results - i.e., a reasonable gain in purchasing power from
funds committed - for you as shareholders.

If we should continue to achieve a 20% compounded gain - not an easy or
certain result by any means - and this gain is translated into a corresponding
increase in the market value of Berkshire Hathaway stock as it has been over
the last fifteen years, your after-tax purchasing power gain is likely to be very
close to zero at a 14% inflation rate. Most of the remaining six percentage
points will go for income tax any time you wish to convert your twenty
percentage points of nominal annual gain into cash.

Interesting Learning from Current Indian Laws: -


Say you have made 20% gain on your investments. Now you booked the profit.
So, you have to pay the capital gains tax at 15% or 10% depending on the short
term gain or long term gain. So, deduct 20%- 3% or 2% from your return. You
have got the return of 17% or 18%. Now deduct the inflation at 10% which is
normal in India. So, your net return is 7% or 8%.

Effective return will be very low as we also have to earn for GST / ST and
other taxes while buying and selling shares.

Those who are earning 12%-15% return on their mutual funds must study
the above calculations.

Let us see another scenario where you have taken a loan to buy shares: -

Now, say you have taken a loan to buy shares. You will be paying 12% interest
on the same. Plus inflation is 10% and you have earned 20%. Say you made
Rs.2 lakhs gain on Rs.10 lakhs loan.

Your interest payment is Rs.1 lakh. Your tax out go (say you have shown as
business income) will be Rs.30000/- on 1 lakh gains (assuming you are in 20%
slab). You are left with Rs.70000/- net gain. Now, deduct Rs.1 lakh of inflation
and you are in minus Rs.30000/-.

You earned 20% but still you are in loss of Rs.30000/- thanks to taxation –
interest and inflation.

Master Says: -

That combination - the inflation rate plus the percentage of capital that
must be paid by the owner to transfer into his own pocket the annual
earnings achieved by the business (i.e., ordinary income tax on dividends
and capital gains tax on retained earnings) - can be thought of as an
“investor’s misery index”. 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.

(In our example our misery index is 13% when loan is not taken. Since we are
making 20%, we are making some money. In the case where we have taken loan
– our misery index is 23% and we are making 20%. So, we are making loss of
3%.)

Alternative Way to see the RETURN: -

Master says: -

One friendly but sharp-eyed commentator on Berkshire has pointed out that our
book value at the end of 1964 would have bought about one-half ounce of gold
and, fifteen years later, after we have ploughed back all earnings along with
much blood, sweat and tears, the book value produced will buy about the same
half ounce. A similar comparison could be drawn with Middle Eastern oil.
The rub has been that government has been exceptionally able in printing
money and creating promises, but is unable to print gold or create oil.

Our Explanation:- 



When I got married gold was available at Rs.4000 per 10 grams. Current price is Rs.73000 per 10 grams. Say my monthly income was Rs.20000 at that time. So, I could buy 50 grams of gold with my monthly income. Now, to buy the same amount of Gold – I need my monthly income to be Rs.3.65 lakhs (Rs.73000X5).


· If my income has not crossed this amount – I have become poor.

· If my income is the same as this amount – I am still at the same level.

· But if my income has gone well above Rs.3.65 lakhs – Say Rs.10 lakh – then I have not only beaten the inflation – but I am much better off in real sense.

What Next?

The year 1979 letter is unique in many respects. We will deal with the second part of the same tomorrow. Master talks about BONDS in the same. Last year a lot of AMERICAN BANKS lost their depositors money due to bond interest rates only. In the year 1979, this happened with the insurance companies. We will understand the same tomorrow.

Share your feed-back on the email given and share with like-minded investors.

Follow me on Twitter @hiteshmparikh Or on Whatsapp - +91-9869425399.

Learn a Lesson. Live with Passion & Invest with Reason.



Hitesh Parikh.