Learning from Warren Buffett Shareholders Letters – Year 1980.

1st September 2024


Learning from Warren Buffett Shareholders Letters – Year 1980.


Dear Investors,

Namaste! With the passage of time the business empire of Berkshire started expanding and so the shareholders letters. In 1979 – master dealt with the letter with profitability / Equity performance / Insurance performance and Banking performance. We wrote two posts for 1979 – one for equity and other for bonds. 

Both are very educational. Now, we will deal with 1980. 

Master Says : - It’s the act that counts, not the actors.

If a tree grows in a forest partially owned by us, but we don’t record the growth in our financial statements, we still own part of the tree.

Our view, we warn you, is non-conventional. But we would rather have earnings for which we did not get accounting credit put to good use in a 10%-owned company by a management we did not personally hire, 

than have earnings for which we did get credit put into projects of more dubious potential by another management - even if we are that management.

Our explanation: - 

Accounting laws in 1980 demanded that when a company owns less than 20% of the other company – they can only account for the dividends they receive. They can’t take the accounting effect of profits – to the extent of their holding %. 

Thus, should we own 10% of Corporation X with earnings of $10 million in 1980, we would report in our earnings (ignoring relatively minor taxes on inter-corporate dividends) either (a) $1 million if X declared the full $10 million in dividends; (b) $500,000 if X paid out 50%, or $5 million, in dividends; or

(c) zero if X reinvested all earnings. So, the master gave the hint of the economic value of Berkshire rather than the accounting value. 

Master Talks of Retained Earnings: - ( Recently apple did the Buyback but this is what he said in 1980). 

One usage of retained earnings we often greet with special enthusiasm when practiced by companies in which we have an investment interest is repurchase of their own shares. The reasoning is simple: if a fine business is selling in the market place for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price? 

Why is it better to buy your own shares instead of taking over other companies? MASTER SAYS: - 

The competitive nature of corporate acquisition activity almost guarantees the payment of a full - frequently more than full price when a company buys the entire ownership of another enterprise. But the auction nature of security markets often allows finely-run companies the opportunity to purchase portions of their own businesses at a price under 50% of that needed to acquire the same earning power through the negotiated acquisition of another enterprise.

What is happening in India? 

Our corporates in India also do the BUY-BACKS but they are in PREMIUM

to the market price and also we have the tender system. This may be good for investors but bad for the corporates who are buying their shares. They should be allowed to buy when the market is down or when they feel that the market price is reasonably down. 

How retained earnings helped BERKSHIRE?

Master Says: - 

As we have noted, we evaluate single-year corporate performance by comparing operating earnings to shareholders’ equity with securities valued at cost. Our long-term yardstick of performance, however, includes all capital gains or losses, realized or unrealized. We continue to achieve a long-term return on equity that considerably exceeds the average of our yearly returns. The major factor causing this pleasant result is a simple one: the retained earnings of those non-controlled holdings we discussed earlier have been translated into gains in market value.

Of course, this translation of retained earnings into market price appreciation is highly uneven (it goes in reverse some years), unpredictable as to timing,  and unlikely to materialize on a precise dollar-for-dollar basis. And a silly purchase price for a block of stock in a corporation can negate the effects of a decade of earnings retention by that corporation. But when purchase prices are sensible, some long-term market recognition of the accumulation of retained earnings almost certainly will occur. Periodically you even will receive some frosting on the cake, with market appreciation far exceeding post-purchase retained earnings.

In the sixteen years since present management assumed responsibility for Berkshire, book value per share with insurance-held equities valued at market has increased from $19.46 to $400.80, or 20.5% compounded annually. (You’ve done better: the value of the mineral content in the human body compounded at 22% annually during the past decade.) It is encouraging, moreover, to realize that our record was achieved despite many mistakes. The list is too painful and lengthy to detail here. But it clearly shows that a reasonably competitive corporate batting average can be achieved in spite of a lot of managerial strikeouts.

Our insurance companies will continue to make large Investments in well-run, favorably-situated, non-controlled companies that very often will pay out in dividends only small proportions of their earnings. Following this policy, we would expect our long-term returns to continue to exceed the returns 

derived annually from reported operating earnings. Our confidence in this belief can easily be quantified: if we were to sell the equities that we hold and replace them with long-term tax-free bonds, our reported operating earnings would rise immediately by over $30 million annually. Such a shift tempts us not at all. 

Our explanations: - 

Say a company X is not giving dividend or giving very less dividends and invest the retained earnings in their own business which is growing at say 20% or more. 

The effect of the same in the share prices of company X will come and the growth in prices will be more than 20% for sure. However, it will not be linear as the master explains above. 

Self - Study: - 

Look at the price performance of the well managed HIGH DIVIDEND paying companies and LOW DIVIDEND paying companies. 

You will agree with the master. 

We will share more in the next post. 

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

Hitesh Parikh.