Last year we made a prediction: "A reduction [in Berkshire's
is almost certain in at least one of the next three years."
of 1990's second half, we were on the road to quickly proving
forecast accurate. But some strengthening in stock prices
late in the
year enabled us to close 1990 with net worth up by $362
7.3%. Over the last 26 years (that is, since present management
over) our per-share book value has grown from $19.46 to
or at a rate of 23.2% compounded annually.
Our growth rate was lackluster in 1990 because our
common stock holdings, in aggregate, showed little change
value. Last year I told you that though these companies
Cities/ABC, Coca-Cola, GEICO, and Washington Post - had
businesses and superb managements, widespread recognition
attributes had pushed the stock prices of the four to lofty
market prices of the two media companies have since fallen
significantly - for good reasons relating to evolutionary
developments that I will discuss later - and the price of
stock has increased significantly for what I also believe
reasons. Overall, yearend 1990 prices of our "permanent
far from enticing, were a bit more appealing than they were
Berkshire's 26-year record is meaningless in forecasting
results; so also, we hope, is the one-year record. We continue
for a 15% average annual gain in intrinsic value. But, as
we never tire
of telling you, this goal becomes ever more difficult to
reach as our
equity base, now $5.3 billion, increases.
If we do attain that 15% average, our shareholders
should fare well.
However, Berkshire's corporate gains will produce an identical
a specific shareholder only if he eventually sells his shares
at the same
relationship to intrinsic value that existed when he bought
example, if you buy at a 10% premium to intrinsic value;
value subsequently grows at 15% a year; and if you then
sell at a 10%
premium, your own return will correspondingly be 15% compounded.
(The calculation assumes that no dividends are paid.) If,
buy at a premium and sell at a smaller premium, your results
somewhat inferior to those achieved by the company.
Ideally, the results of every Berkshire shareholder
mirror those of the company during his period of ownership.
why Charlie Munger, Berkshire's Vice Chairman and my partner,
hope for Berkshire to sell consistently at about intrinsic
prefer such steadiness to the value-ignoring volatility
of the past two
years: In 1989 intrinsic value grew less than did book value,
up 44%, while the market price rose 85%; in 1990 book value
intrinsic value increased by a small amount, while the market
Berkshire's intrinsic value continues to exceed book
value by a
substantial margin. We can't tell you the exact differential
intrinsic value is necessarily an estimate; Charlie and
I might, in fact,
differ by 10% in our appraisals. We do know, however, that
some exceptional businesses that are worth considerably
the values at which they are carried on our books.
Much of the extra value that exists in our businesses
created by the managers now running them. Charlie and I
feel free to
brag about this group because we had nothing to do with
the skills they possess: These superstars just came that
way. Our job is
merely to identify talented managers and provide an environment
which they can do their stuff. Having done it, they send
their cash to
headquarters and we face our only other task: the intelligent
deployment of these funds.
My own role in operations may best be illustrated
by a small tale
concerning my granddaughter, Emily, and her fourth birthday
last fall. Attending were other children, adoring relatives,
the Clown, a local entertainer who includes magic tricks
in his act.
Beginning these, Beemer asked Emily to help him by
"magic wand" over "the box of wonders."
Green handkerchiefs went
into the box, Emily waved the wand, and Beemer removed blue
Loose handkerchiefs went in and, upon a magisterial wave
emerged knotted. After four such transformations, each more
than its predecessor, Emily was unable to contain herself.
aglow, she exulted: "Gee, I'm really good at this."
And that sums up my contribution to the performance
Berkshire's business magicians - the Blumkins, the Friedman
Mike Goldberg, the Heldmans, Chuck Huggins, Stan Lipsey
Schey. They deserve your applause.
族、Friedman 家族、Mike Goldberg、the Heldmans、Chuck Huggins、
Stan Lipsey与Ralph Schey等人，请为这些人精彩的演出给予热烈的掌声。
Sources of Reported Earnings
The table below shows the major sources of Berkshire's
earnings. In this presentation, amortization of Goodwill
major purchase-price accounting adjustments are not charged
the specific businesses to which they apply, but are instead
aggregated and shown separately. This procedure lets you
earnings of our businesses as they would have been reported
not purchased them. I've explained in past reports why this
presentation seems to us to be more useful to investors
than one utilizing generally accepted accounting principles
which require purchase-price adjustments to be made on a
business-by-business basis. The total net earnings we show
table are, of course, identical to the GAAP total in our
Much additional information about these businesses
is given on
pages 39-46, where you also will find our segment earnings
on a GAAP basis. For information on Wesco's businesses,
I urge you to
read Charlie Munger's letter, which starts on page 56. His
contains the clearest and most insightful discussion of
industry that I have seen.
Sales of Securities ............. 33,989 223,810 23,348
-------- -------- -------- --------
Total Earnings - All Entities $516,466 $617,224 $394,093
====== ====== ===== =======
*Excludes interest expense of Scott Fetzer Financial Group
and Mutual Savings & Loan.
We refer you also to pages 47-53, where we have rearranged
Berkshire's financial data into four segments. These correspond
way Charlie and I think about the business and should help
in estimating Berkshire's intrinsic value than consolidated
would do. Shown on these pages are balance sheets and earnings
statements for: (1) our insurance operations, with their
investment positions itemized; (2) our manufacturing, publishing
retailing businesses, leaving aside certain non- operating
purchase-price accounting adjustments; (3) our subsidiaries
in finance-type operations, which are Mutual Savings and
Financial; and (4) an all-other category that includes the
non-operating assets (primarily marketable securities) held
companies in segment (2), all purchase- price accounting
and various assets and debts of the Wesco and Berkshire
If you combine the earnings and net worths of these
segments, you will derive totals matching those shown on
statements. However, I want to emphasize that this four-category
presentation does not fall within the purview of our auditors,
no way bless it.
The term "earnings" has a precise ring
to it. And when an earnings
figure is accompanied by an unqualified auditor's certificate,
reader might think it comparable in certitude to pi, calculated
dozens of decimal places.
In reality, however, earnings can be as pliable as
putty when a
charlatan heads the company reporting them. Eventually truth
surface, but in the meantime a lot of money can change hands.
some important American fortunes have been created by the
monetization of accounting mirages.
Funny business in accounting is not new. For connoisseurs
chicanery, I have attached as Appendix A on page 22 a previously
unpublished satire on accounting practices written by Ben
1936. Alas, excesses similar to those he then lampooned
times since found their way into the financial statements
American corporations and been duly certified by big-name
Clearly, investors must always keep their guard up and use
numbers as a beginning, not an end, in their attempts to
"economic earnings" accruing to them.
Berkshire's own reported earnings are misleading
in a different,
but important, way: We have huge investments in companies
("investees") whose earnings far exceed their
dividends and in which
we record our share of earnings only to the extent of the
receive. The extreme case is Capital Cities/ABC, Inc. Our
17% share of
the company's earnings amounted to more than $83 million
Yet only about $530,000 ($600,000 of dividends it paid us
$70,000 of tax) is counted in Berkshire's GAAP earnings.
$82 million-plus stayed with Cap Cities as retained earnings,
work for our benefit but go unrecorded on our books.
Our perspective on such "forgotten-but-not-gone"
simple: The way they are accounted for is of no importance,
ownership and subsequent utilization is all-important. We
whether the auditors hear a tree fall in the forest; we
do care who
owns the tree and what's next done with it.
When Coca-Cola uses retained earnings to repurchase
the company increases our percentage ownership in what I
be the most valuable franchise in the world. (Coke also,
uses retained earnings in many other value-enhancing ways.)
of repurchasing stock, Coca-Cola could pay those funds to
dividends, which we could then use to purchase more Coke
That would be a less efficient scenario: Because of taxes
we would pay
on dividend income, we would not be able to increase our
proportionate ownership to the degree that Coke can, acting
for us. If
this less efficient procedure were followed, however, Berkshire
report far greater "earnings."
I believe the best way to think about our earnings
is in terms of
"look-through" results, calculated as follows:
Take $250 million, which
is roughly our share of the 1990 operating earnings retained
investees; subtract $30 million, for the incremental taxes
have owed had that $250 million been paid to us in dividends;
the remainder, $220 million, to our reported operating earnings
$371 million. Thus our 1990 "look-through earnings"
As I mentioned last year, we hope to have look-through
grow about 15% annually. In 1990 we substantially exceeded
but in 1991 we will fall far short of it. Our Gillette preferred
called and we will convert it into common stock on April
1. This will
reduce reported earnings by about $35 million annually and
look-through earnings by a much smaller, but still significant,
Additionally, our media earnings - both direct and look-through
appear sure to decline. Whatever the results, we will post
on how we are doing on a look-through basis.
Take another look at the figures on page 51, which
earnings and balance sheets of our non-insurance operations.
After-tax earnings on average equity in 1990 were 51%, a
would have placed the group about 20th on the 1989 Fortune
Two factors make this return even more remarkable.
leverage did not produce it: Almost all our major facilities
not leased, and such small debt as these operations have
offset by cash they hold. In fact, if the measurement was
assets - a calculation that eliminates the effect of debt
upon returns -
our group would rank in Fortune's top ten.
Equally important, our return was not earned from
as cigarettes or network television stations, possessing
economics for all participating in them. Instead it came
from a group
of businesses operating in such prosaic fields as furniture
candy, vacuum cleaners, and even steel warehousing. The
is clear: Our extraordinary returns flow from outstanding
managers, not fortuitous industry economics.
o It was a poor year for retailing - particularly
for big-ticket items
- but someone forgot to tell Ike Friedman at Borsheim's.
Sales were up
18%. That's both a same-stores and all-stores percentage,
Borsheim's operates but one establishment.
But, oh, what an establishment! We can't be sure
about the fact
(because most fine-jewelry retailers are privately owned)
believe that this jewelry store does more volume than any
other in the
U.S., except for Tiffany's New York store.
Borsheim's could not do nearly that well if our customers
only from the Omaha metropolitan area, whose population
600,000. We have long had a huge percentage of greater Omaha's
jewelry business, so growth in that market is necessarily
every year business from non-Midwest customers grows dramatically.
Many visit the store in person. A large number of others,
through the mail in a manner you will find interesting.
These customers request a jewelry selection of a
certain type and
value - say, emeralds in the $10,000 -$20,000 range - and
send them five to ten items meeting their specifications
which they can pick. Last year we mailed about 1,500 assortments
all kinds, carrying values ranging from under $1,000 to
thousands of dollars.
The selections are sent all over the country, some
to people no
one at Borsheim's has ever met. (They must always have been
recommended, however.) While the number of mailings in 1990
record, Ike has been sending merchandise far and wide for
Misanthropes will be crushed to learn how well our "honor-system"
works: We have yet to experience a loss from customer dishonesty.
We attract business nationwide because we have several
advantages that competitors can't match. The most important
the equation is our operating costs, which run about 18%
compared to 40% or so at the typical competitor. (Included
in the 18%
are occupancy and buying costs, which some public companies
in "cost of goods sold.") Just as Wal-Mart, with
its 15% operating costs,
sells at prices that high-cost competitors can't touch and
constantly increases its market share, so does Borsheim's.
with diapers works with diamonds.
Our low prices create huge volume that in turn allows
us to carry
an extraordinarily broad inventory of goods, running ten
times the size of that at the typical fine-jewelry store.
breadth of selection and low prices with superb service
and you can
understand how Ike and his family have built a national
phenomenon from an Omaha location.
And family it is. Ike's crew always includes son
sons-in-law Marvin Cohn and Donald Yale. And when things
- that's often - they are joined by Ike's wife, Roz, and
Janis and Susie. In addition, Fran Blumkin, wife of Louie
Nebraska Furniture Mart and Ike's cousin), regularly pitches
you'll find Ike's 89-year-old mother, Rebecca, in the store
afternoons, Wall Street Journal in hand. Given a family
like this, is it any surprise that Borsheim's runs rings
competitors whose managers are thinking about how soon 5
o While Fran Blumkin was helping the Friedman family
at Borsheim's, her sons, Irv and Ron, along with husband
setting records at The Nebraska Furniture Mart. Sales at
one-and-only location were $159 million, up 4% from 1989.
again the fact can't be conclusively proved, we believe
NFM does close
to double the volume of any other home furnishings store
The NFM formula for success parallels that of Borsheim's.
operating costs are rock-bottom - 15% in 1990 against about
Levitz, the country's largest furniture retailer, and 25%
for Circuit City
Stores, the leading discount retailer of electronics and
Second, NFM's low costs allow the business to price well
competitors. Indeed, major chains, knowing what they will
clear of Omaha. Third, the huge volume generated by our
prices allows us to carry the broadest selection of merchandise
Some idea of NFM's merchandising power can be gleaned
recent report of consumer behavior in Des Moines, which
NFM was Number 3 in popularity among 20 furniture retailers
that city. That may sound like no big deal until you consider
that 19 of
those retailers are located in Des Moines, whereas our store
miles away. This leaves customers driving a distance equal
between Washington and Philadelphia in order to shop with
though they have a multitude of alternatives next door.
In effect, NFM,
like Borsheim's, has dramatically expanded the territory
it serves - not
by the traditional method of opening new stores but rather
an irresistible magnet that employs price and selection
to pull in the
Last year at the Mart there occurred an historic
experienced a counterrevelation. Regular readers of this
that I have long scorned the boasts of corporate executives
synergy, deriding such claims as the last refuge of scoundrels
defending foolish acquisitions. But now I know better: In
first synergistic explosion, NFM put a See's candy cart
in the store late
last year and sold more candy than that moved by some of
full-fledged stores See's operates in California. This success
contradicts all tenets of retailing. With the Blumkins,
impossible is routine.
o At See's, physical volume set a record in 1990 -
but only barely
and only because of good sales early in the year. After
the invasion of
Kuwait, mall traffic in the West fell. Our poundage volume
dropped slightly, though our dollar sales were up because
of a 5%
That increase, and better control of expenses, improved
margins. Against the backdrop of a weak retailing environment,
Huggins delivered outstanding results, as he has in each
nineteen years we have owned See's. Chuck's imprint on the
- a virtual fanaticism about quality and service - is visible
at all of our
One happening in 1990 illustrates the close bond
and its customers. After 15 years of operation, our store
Albuquerque was endangered: The landlord would not renew
wanting us instead to move to an inferior location in the
mall and even
so to pay a much higher rent. These changes would have wiped
the store's profit. After extended negotiations got us nowhere,
a date for closing the store.
On her own, the store's manager, Ann Filkins, then
urging customers to protest the closing. Some 263 responded
sending letters and making phone calls to See's headquarters
Francisco, in some cases threatening to boycott the mall.
reporter at the Albuquerque paper picked up the story. Supplied
this evidence of a consumer uprising, our landlord offered
satisfactory deal. (He, too, proved susceptible to a counterrevelation.)
Chuck subsequently wrote personal letters of thanks
loyalist and sent each a gift certificate. He repeated his
thanks in a
newspaper ad that listed the names of all 263. The sequel:
sales in Albuquerque were up substantially.
o Charlie and I were surprised at developments this
past year in the
media industry, including newspapers such as our Buffalo
business showed far more vulnerability to the early stages
recession than has been the case in the past. The question
this erosion is just part of an aberrational cycle - to
be fully made up
in the next upturn - or whether the business has slipped
in a way that
permanently reduces intrinsic business values.
Since I didn't predict what has happened, you may
value of my prediction about what will happen. Nevertheless,
proffer a judgment: While many media businesses will remain
economic marvels in comparison with American industry generally,
they will prove considerably less marvelous than I, the
lenders thought would be the case only a few years ago.
The reason media businesses have been so outstanding
past was not physical growth, but rather the unusual pricing
that most participants wielded. Now, however, advertising
growing slowly. In addition, retailers that do little or
advertising (though they sometimes use the Postal Service)
gradually taken market share in certain merchandise categories.
important of all, the number of both print and electronic
channels has substantially increased. As a consequence,
dollars are more widely dispersed and the pricing power
of ad vendors
has diminished. These circumstances materially reduce the
value of our major media investments and also the value
operating unit, Buffalo News - though all remain fine businesses.
Notwithstanding the problems, Stan Lipsey's management
News continues to be superb. During 1990, our earnings held
much better than those of most metropolitan papers, falling
In the last few months of the year, however, the rate of
I can safely make two promises about the News in
1991: (1) Stan
will again rank at the top among newspaper publishers; and
earnings will fall substantially. Despite a slowdown in
the demand for
newsprint, the price per ton will average significantly
more in 1991
and the paper's labor costs will also be considerably higher.
revenues may meanwhile be down, we face a real squeeze.
Profits may be off but our pride in the product remains.
continue to have a larger "news hole" - the portion
of the paper
devoted to news - than any comparable paper. In 1990, the
rose to 52.3% against 50.1% in 1989. Alas, the increase
a decline in advertising pages rather than from a gain in
Regardless of earnings pressures, we will maintain at least
a 50% news
hole. Cutting product quality is not a proper response to
o The news at Fechheimer, our manufacturer and retailer
uniforms, is all good with one exception: George Heldman,
at 69, has
decided to retire. I tried to talk him out of it but he
had one irrefutable
argument: With four other Heldmans - Bob, Fred, Gary and
Roger - to
carry on, he was leaving us with an abundance of managerial
Fechheimer's operating performance improved considerably
1990, as many of the problems we encountered in integrating
large acquisition we made in 1988 were moderated or solved.
several unusual items caused the earnings reported in the
table to be flat. In the retail operation, we continue to
add stores and
now have 42 in 22 states. Overall, prospects appear excellent
o At Scott Fetzer, Ralph Schey runs 19 businesses with
few bring to running one. In addition to overseeing three
on page 6 - World Book, Kirby, and Scott Fetzer Manufacturing
directs a finance operation that earned a record $12.2 million
Were Scott Fetzer an independent company, it would
rank close to
the top of the Fortune 500 in terms of return on equity,
although it is
not in businesses that one would expect to be economic champs.
superior results are directly attributable to Ralph.
At World Book, earnings improved on a small decrease
volume. The costs of our decentralization move were considerably
in 1990 than 1989 and the benefits of decentralization are
realized. World Book remains far and away the leader in
encyclopedia sales and we are growing internationally, though
Kirby unit volume grew substantially in 1990 with
the help of our
new vacuum cleaner, The Generation 3, which was an unqualified
success. Earnings did not grow as fast as sales because
start-up expenditures and "learning-curve" problems
in manufacturing the new product. International business,
dramatic growth I described last year, had a further 20%
sales gain in
1990. With the aid of a recent price increase, we expect
earnings at Kirby in 1991.
Within the Scott Fetzer Manufacturing Group, Campbell
its largest unit, had a particularly fine year. This company,
country's leading producer of small and medium-sized air
compressors, achieved record sales of $109 million, more
than 30% of
which came from products introduced during the last five
In looking at the figures for our non-insurance operations,
will see that net worth increased by only $47 million in
earnings were $133 million. This does not mean that our
in any way skimping on investments that strengthen their
franchises or that promote growth. Indeed, they diligently
But they also never deploy capital without good reason.
In the past five years they have funneled well over 80%
earnings to Charlie and me for use in new business and investment
The combined ratio represents total insurance costs
incurred plus expenses) compared to revenue from premiums:
below 100 indicates an underwriting profit, and one above
indicates a loss. The higher the ratio, the worse the year.
investment income that an insurer earns from holding policyholders'
funds ("the float") is taken into account, a combined
ratio in the 107 -
111 range typically produces an overall breakeven result,
earnings on the funds provided by shareholders.
For the reasons laid out in previous reports, we
industry's incurred losses to grow at an average of 10%
in periods when general inflation runs considerably lower.
last 25 years, incurred losses have in reality grown at
a still faster rate,
11%.) If premium growth meanwhile materially lags that 10%
underwriting losses will mount, though the industry's tendency
under-reserve when business turns bad may obscure their
size for a
Last year premium growth fell far short of the required
underwriting results therefore worsened. (In our table,
severity of the deterioration in 1990 is masked because
1989 losses from Hurricane Hugo caused the ratio for that
year to be
somewhat above trendline.) The combined ratio will again
1991, probably by about two points.
Results will improve only when most insurance managements
become so fearful that they run from business, even though
it can be
done at much higher prices than now exist. At some point
managements will indeed get the message: The most important
to do when you find yourself in a hole is to stop digging.
But so far
that point hasn't gotten across: Insurance managers continue
to dig -
sullenly but vigorously.
The picture would change quickly if a major physical
catastrophe were to occur. Absent such a shock, one to two
likely pass before underwriting losses become large enough
management fear to a level that would spur major price increases.
When that moment arrives, Berkshire will be ready - both
and psychologically - to write huge amounts of business.
In the meantime, our insurance volume continues to
be small but
satisfactory. In the next section of this report we will
give you a
framework for evaluating insurance results. From that discussion,
will gain an understanding of why I am so enthusiastic about
performance of our insurance manager, Mike Goldberg, and
of stars, Rod Eldred, Dinos Iordanou, Ajit Jain, and Don
In assessing our insurance results over the next
few years, you
should be aware of one type of business we are pursuing
cause them to be unusually volatile. If this line of business
it may, our underwriting experience will deviate from the
might expect: In most years we will somewhat exceed expectations
and in an occasional year we will fall far below them.
The volatility I predict reflects the fact that we
have become a
large seller of insurance against truly major catastrophes
("super-cats"), which could for example be hurricanes,
earthquakes. The buyers of these policies are reinsurance
that themselves are in the business of writing catastrophe
primary insurers and that wish to "lay off," or
rid themselves, of part of
their exposure to catastrophes of special severity. Because
for these buyers to collect on such a policy will only arise
at times of
extreme stress - perhaps even chaos - in the insurance business,
seek financially strong sellers. And here we have a major
advantage: In the industry, our strength is unmatched.
A typical super-cat contract is complicated. But
in a plain- vanilla
instance we might write a one-year, $10 million policy providing
the buyer, a reinsurer, would be paid that sum only if a
caused two results: (1) specific losses for the reinsurer
threshold amount; and (2) aggregate losses for the insurance
of, say, more than $5 billion. Under virtually all circumstances,
levels that satisfy the second condition will also have
caused the first
to be met.
For this $10 million policy, we might receive a premium
of, say, $3
million. Say, also, that we take in annual premiums of $100
from super-cat policies of all kinds. In that case we are
very likely in
any given year to report either a profit of close to $100
million or a
loss of well over $200 million. Note that we are not spreading
insurers typically do; we are concentrating it. Therefore,
combined ratio on this business will almost never fall in
range of 100 - 120, but will instead be close to either
zero or 300%.
Most insurers are financially unable to tolerate
such swings. And if
they have the ability to do so, they often lack the desire.
back away, for example, because they write gobs of primary
insurance that would deliver them dismal results at the
very time they
would be experiencing major losses on super- cat reinsurance.
addition, most corporate managements believe that their
dislike volatility in results.
We can take a different tack: Our business in primary
insurance is small and we believe that Berkshire shareholders,
properly informed, can handle unusual volatility in profits
so long as
the swings carry with them the prospect of superior long-term
(Charlie and I always have preferred a lumpy 15% return
to a smooth
We want to emphasize three points: (1) While we expect
super-cat business to produce satisfactory results over,
say, a decade,
we're sure it will produce absolutely terrible results in
at least an
occasional year; (2) Our expectations can be based on little
subjective judgments - for this kind of insurance, historical
are of very limited value to us as we decide what rates
to charge today;
and (3) Though we expect to write significant quantities
business, we will do so only at prices we believe to be
with risk. If competitors become optimistic, our volume
will fall. This
insurance has, in fact, tended in recent years to be woefully
underpriced; most sellers have left the field on stretchers.
In the previous section I mentioned "float,"
the funds of others
that insurers, in the conduct of their business, temporarily
Because these funds are available to be invested, the typical
property-casualty insurer can absorb losses and expenses
premiums by 7% to 11% and still be able to break even on
Again, this calculation excludes the earnings the insurer
net worth - that is, on the funds provided by shareholders.
However, many exceptions to this 7% to 11% range
example, insurance covering losses to crops from hail damage
produces virtually no float at all. Premiums on this kind
are paid to the insurer just prior to the time hailstorms
are a threat,
and if a farmer sustains a loss he will be paid almost immediately.
Thus, a combined ratio of 100 for crop hail insurance produces
profit for the insurer.
At the other extreme, malpractice insurance covering
liabilities of doctors, lawyers and accountants produces
a very high
amount of float compared to annual premium volume. The float
materializes because claims are often brought long after
wrongdoing takes place and because their payment may be
delayed by lengthy litigation. The industry calls malpractice
certain other kinds of liability insurance "long- tail"
recognition of the extended period during which insurers
get to hold
large sums that in the end will go to claimants and their
to the insurer's lawyers as well).
In long-tail situations a combined ratio of 115 (or
even more) can
prove profitable, since earnings produced by the float will
15% by which claims and expenses overrun premiums. The catch,
though, is that "long-tail" means exactly that:
Liability business written
in a given year and presumed at first to have produced a
ratio of 115 may eventually smack the insurer with 200,
300 or worse
when the years have rolled by and all claims have finally
The pitfalls of this business mandate an operating
too often is ignored: Though certain long-tail lines may
profitable at combined ratios of 110 or 115, insurers will
find it unprofitable to price using those ratios as targets.
prices must provide a healthy margin of safety against the
trends that are forever springing expensive surprises on
industry. Setting a target of 100 can itself result in heavy
aiming for 110 - 115 is business suicide.
All of that said, what should the measure of an insurer's
profitability be? Analysts and managers customarily look
combined ratio - and it's true that this yardstick usually
is a good
indicator of where a company ranks in profitability. We
believe a better
measure, however, to be a comparison of underwriting loss
This loss/float ratio, like any statistic used in
results, is meaningless over short time periods: Quarterly
figures and even annual ones are too heavily based on estimates
much good. But when the ratio takes in a period of years,
it gives a
rough indication of the cost of funds generated by insurance
operations. A low cost of funds signifies a good business;
a high cost
translates into a poor business.
On the next page we show the underwriting loss, if
any, of our
insurance group in each year since we entered the business
that bottom line to the average float we have held during
From this data we have computed a "cost of funds developed
The float figures are derived from the total of loss
adjustment expense reserves and unearned premium reserves
agents' balances, prepaid acquisition costs and deferred
applicable to assumed reinsurance. At some insurers other
should enter into the calculation, but in our case these
unimportant and have been ignored.
During 1990 we held about $1.6 billion of float slated
to find its way into the hands of others. The underwriting
sustained during the year was $27 million and thus our insurance
operation produced funds for us at a cost of about 1.6%.
As the table
shows, we managed in some years to underwrite at a profit
those instances our cost of funds was less than zero. In
such as 1984, we paid a very high price for float. In 19
years out of the
24 we have been in insurance, though, we have developed
funds at a
cost below that paid by the government.
There are two important qualifications to this calculation.
fat lady has yet to gargle, let alone sing, and we won't
know our true
1967 - 1990 cost of funds until all losses from this period
settled many decades from now. Second, the value of the
shareholders is somewhat undercut by the fact that they
must put up
their own funds to support the insurance operation and are
double taxation on the investment income these funds earn.
investments would be more tax-efficient.
The tax penalty that indirect investments impose
is in fact substantial. Though the calculation is necessarily
would estimate that the owners of the average insurance
would find the tax penalty adds about one percentage point
cost of float. I also think that approximates the correct
Figuring a cost of funds for an insurance business
analyzing it to determine whether the operation has a positive
negative value for shareholders. If this cost (including
the tax penalty)
is higher than that applying to alternative sources of funds,
is negative. If the cost is lower, the value is positive
- and if the cost is
significantly lower, the insurance business qualifies as
a very valuable
So far Berkshire has fallen into the significantly-lower
more dramatic are the numbers at GEICO, in which our ownership
interest is now 48% and which customarily operates at an
profit. GEICO's growth has generated an ever-larger amount
for investment that have an effective cost of considerably
zero. Essentially, GEICO's policyholders, in aggregate,
company interest on the float rather than the other way
handsome is as handsome does: GEICO's unusual profitability
from its extraordinary operating efficiency and its careful
of risks, a package that in turn allows rock-bottom prices
Many well-known insurance companies, on the other
an underwriting loss/float cost that, combined with the
produces negative results for owners. In addition, these
like all others in the industry, are vulnerable to catastrophe
could exceed their reinsurance protection and take their
cost of float
right off the chart. Unless these companies can materially
their underwriting performance - and history indicates that
almost impossible task - their shareholders will experience
similar to those borne by the owners of a bank that pays
a higher rate
of interest on deposits than it receives on loans.
All in all, the insurance business has treated us
very well. We have
expanded our float at a cost that on the average is reasonable,
have further prospered because we have earned good returns
low-cost funds. Our shareholders, true, have incurred extra
they have been more than compensated for this cost (so far)
benefits produced by the float.
A particularly encouraging point about our record
is that it was
achieved despite some colossal mistakes made by your Chairman
to Mike Goldberg's arrival. Insurance offers a host of opportunities
error, and when opportunity knocked, too often I answered.
years later, the bills keep arriving for these mistakes:
In the insurance
business, there is no statute of limitations on stupidity.
The intrinsic value of our insurance business will
always be far
more difficult to calculate than the value of, say, our
newspaper companies. By any measure, however, the business
worth far more than its carrying value. Furthermore, despite
problems this operation periodically hands us, it is the
one - among
all the fine businesses we own - that has the greatest potential.
1,727,765 The Washington Post Company ......... 9,731 342,097
5,000,000 Wells Fargo & Company ............... 289,431
Lethargy bordering on sloth remains the cornerstone of
investment style: This year we neither bought nor sold a
share of five
of our six major holdings. The exception was Wells Fargo,
superbly-managed, high-return banking operation in which
increased our ownership to just under 10%, the most we can
without the approval of the Federal Reserve Board. About
our position was bought in 1989, the rest in 1990.
The banking business is no favorite of ours. When assets
twenty times equity - a common ratio in this industry -
involve only a small portion of assets can destroy a major
equity. And mistakes have been the rule rather than the
many major banks. Most have resulted from a managerial failing
we described last year when discussing the "institutional
the tendency of executives to mindlessly imitate the behavior
peers, no matter how foolish it may be to do so. In their
bankers played follow-the-leader with lemming-like zeal;
are experiencing a lemming-like fate.
Because leverage of 20:1 magnifies the effects of managerial
strengths and weaknesses, we have no interest in purchasing
a poorly-managed bank at a "cheap" price. Instead,
our only interest is
in buying into well-managed banks at fair prices.
With Wells Fargo, we think we have obtained the best managers
in the business, Carl Reichardt and Paul Hazen. In many
combination of Carl and Paul reminds me of another - Tom
and Dan Burke at Capital Cities/ABC. First, each pair is
the sum of its parts because each partner understands, trusts
admires the other. Second, both managerial teams pay able
well, but abhor having a bigger head count than is needed.
attack costs as vigorously when profits are at record levels
they are under pressure. Finally, both stick with what they
and let their abilities, not their egos, determine what
(Thomas J. Watson Sr. of IBM followed the same rule: "I'm
he said. "I'm smart in spots - but I stay around those
Our purchases of Wells Fargo in 1990 were helped by a chaotic
market in bank stocks. The disarray was appropriate: Month
the foolish loan decisions of once well-regarded banks were
public display. As one huge loss after another was unveiled
- often on
the heels of managerial assurances that all was well - investors
understandably concluded that no bank's numbers were to
Aided by their flight from bank stocks, we purchased our
in Wells Fargo for $290 million, less than five times after-tax
and less than three times pre-tax earnings.
Wells Fargo is big - it has $56 billion in assets - and
earning more than 20% on equity and 1.25% on assets. Our
of one-tenth of the bank may be thought of as roughly equivalent
our buying 100% of a $5 billion bank with identical financial
characteristics. But were we to make such a purchase, we
to pay about twice the $290 million we paid for Wells Fargo.
that $5 billion bank, commanding a premium price, would
with another problem: We would not be able to find a Carl
run it. In recent years, Wells Fargo executives have been
recruited than any others in the banking business; no one,
has been able to hire the dean.
Of course, ownership of a bank - or about any other business
is far from riskless. California banks face the specific
risk of a major
earthquake, which might wreak enough havoc on borrowers
to in turn
destroy the banks lending to them. A second risk is systemic
possibility of a business contraction or financial panic
so severe that it
would endanger almost every highly-leveraged institution,
how intelligently run. Finally, the market's major fear
of the moment is
that West Coast real estate values will tumble because of
and deliver huge losses to banks that have financed the
Because it is a leading real estate lender, Wells Fargo
is thought to be
None of these eventualities can be ruled out. The probability
the first two occurring, however, is low and even a meaningful
real estate values is unlikely to cause major problems for
well-managed institutions. Consider some mathematics: Wells
currently earns well over $1 billion pre-tax annually after
more than $300 million for loan losses. If 10% of all $48
billion of the
bank's loans - not just its real estate loans - were hit
by problems in
1991, and these produced losses (including foregone interest)
averaging 30% of principal, the company would roughly break
A year like that - which we consider only a low-level possibility,
not a likelihood - would not distress us. In fact, at Berkshire
love to acquire businesses or invest in capital projects
no return for a year, but that could then be expected to
earn 20% on
growing equity. Nevertheless, fears of a California real
similar to that experienced in New England caused the price
Fargo stock to fall almost 50% within a few months during
though we had bought some shares at the prices prevailing
fall, we welcomed the decline because it allowed us to pick
more shares at the new, panic prices.
Investors who expect to be ongoing buyers of investments
throughout their lifetimes should adopt a similar attitude
market fluctuations; instead many illogically become euphoric
stock prices rise and unhappy when they fall. They show
confusion in their reaction to food prices: Knowing they
going to be buyers of food, they welcome falling prices
price increases. (It's the seller of food who doesn't like
prices.) Similarly, at the Buffalo News we would cheer lower
newsprint - even though it would mean marking down the value
large inventory of newsprint we always keep on hand - because
know we are going to be perpetually buying the product.
Identical reasoning guides our thinking about Berkshire's
investments. We will be buying businesses - or small parts
businesses, called stocks - year in, year out as long as
I live (and
longer, if Berkshire's directors attend the seances I have
Given these intentions, declining prices for businesses
benefit us, and
rising prices hurt us.
The most common cause of low prices is pessimism - some
times pervasive, some times specific to a company or industry.
want to do business in such an environment, not because
pessimism but because we like the prices it produces. It's
that is the enemy of the rational buyer.
None of this means, however, that a business or stock is
intelligent purchase simply because it is unpopular; a contrarian
approach is just as foolish as a follow-the-crowd strategy.
required is thinking rather than polling. Unfortunately,
Russell's observation about life in general applies with
unusual force in
the financial world: "Most men would rather die than
think. Many do."
Our other major portfolio change last year was large additions
our holdings of RJR Nabisco bonds, securities that we first
late 1989. At yearend 1990 we had $440 million invested
securities, an amount that approximated market value. (As
I write this,
however, their market value has risen by more than $150
Just as buying into the banking business is unusual for
us, so is
the purchase of below-investment-grade bonds. But opportunities
that interest us and that are also large enough to have
impact on Berkshire's results are rare. Therefore, we will
look at any
category of investment, so long as we understand the business
buying into and believe that price and value may differ
(Woody Allen, in another context, pointed out the advantage
open-mindedness: "I can't understand why more people
bi-sexual because it doubles your chances for a date on
In the past we have bought a few below-investment-grade
bonds with success, though these were all old-fashioned
angels" - bonds that were initially of investment grade
but that were
downgraded when the issuers fell on bad times. In the 1984
report we described our rationale for buying one fallen
Washington Public Power Supply System.
A kind of bastardized fallen angel burst onto the investment
scene in the 1980s - "junk bonds" that were far
grade when issued. As the decade progressed, new offerings
manufactured junk became ever junkier and ultimately the
outcome occurred: Junk bonds lived up to their name. In
1990 - even
before the recession dealt its blows - the financial sky
with the bodies of failing corporations.
The disciples of debt assured us that this collapse wouldn't
happen: Huge debt, we were told, would cause operating managers
focus their efforts as never before, much as a dagger mounted
steering wheel of a car could be expected to make its driver
with intensified care. We'll acknowledge that such an attention-getter
would produce a very alert driver. But another certain consequence
would be a deadly - and unnecessary - accident if the car
hit even the
tiniest pothole or sliver of ice. The roads of business
are riddled with
potholes; a plan that requires dodging them all is a plan
In the final chapter of The Intelligent Investor Ben Graham
forcefully rejected the dagger thesis: "Confronted
with a challenge to
distill the secret of sound investment into three words,
we venture the
motto, Margin of Safety." Forty-two years after reading
that, I still
think those are the right three words. The failure of investors
this simple message caused them staggering losses as the
At the height of the debt mania, capital structures were
concocted that guaranteed failure: In some cases, so much
issued that even highly favorable business results could
the funds to service it. One particularly egregious "kill-
case a few years back involved the purchase of a mature
station in Tampa, bought with so much debt that the interest
exceeded the station's gross revenues. Even if you assume
labor, programs and services were donated rather than purchased,
capital structure required revenues to explode - or else
was doomed to go broke. (Many of the bonds that financed
purchase were sold to now-failed savings and loan associations;
taxpayer, you are picking up the tab for this folly.)
All of this seems impossible now. When these misdeeds were
done, however, dagger-selling investment bankers pointed
"scholarly" research of academics, which reported
that over the years
the higher interest rates received from low-grade bonds
than compensated for their higher rate of default. Thus,
friendly salesmen, a diversified portfolio of junk bonds
greater net returns than would a portfolio of high-grade
(Beware of past-performance "proofs" in finance:
If history books
were the key to riches, the Forbes 400 would consist of
There was a flaw in the salesmen's logic - one that a first-
student in statistics is taught to recognize. An assumption
made that the universe of newly-minted junk bonds was identical
the universe of low-grade fallen angels and that, therefore,
experience of the latter group was meaningful in predicting
experience of the new issues. (That was an error similar
the historical death rate from Kool-Aid before drinking
served at Jonestown.)
The universes were of course dissimilar in several vital
For openers, the manager of a fallen angel almost invariably
to regain investment-grade status and worked toward that
junk-bond operator was usually an entirely different breed.
much as a heroin user might, he devoted his energies not
to finding a
cure for his debt-ridden condition, but rather to finding
Additionally, the fiduciary sensitivities of the executives
typical fallen angel were often, though not always, more
developed than were those of the junk-bond-issuing financiopath.
Wall Street cared little for such distinctions. As usual,
enthusiasm for an idea was proportional not to its merit,
but rather to
the revenue it would produce. Mountains of junk bonds were
those who didn't care to those who didn't think - and there
shortage of either.
Junk bonds remain a mine field, even at prices that today
often a small fraction of issue price. As we said last year,
never bought a new issue of a junk bond. (The only time
to buy these
is on a day with no "y" in it.) We are, however,
willing to look at the
field, now that it is in disarray.
In the case of RJR Nabisco, we feel the Company's credit
considerably better than was generally perceived for a while
the yield we receive, as well as the potential for capital
gain, more than
compensates for the risk we incur (though that is far from
nil). RJR has
made asset sales at favorable prices, has added major amounts
equity, and in general is being run well.
However, as we survey the field, most low-grade bonds still
unattractive. The handiwork of the Wall Street of the 1980s
worse than we had thought: Many important businesses have
mortally wounded. We will, though, keep looking for opportunities
the junk market continues to unravel.
We continue to hold the convertible preferred stocks
earlier reports: $700 million of Salomon Inc, $600 million
Gillette Company, $358 million of USAir Group, Inc. and
of Champion International Corp. Our Gillette holdings will
converted into 12 million shares of common stock on April
Weighing interest rates, credit quality and prices of the
common stocks, we can assess our holdings in Salomon and
Champion at yearend 1990 as worth about what we paid, Gillette
worth somewhat more, and USAir as worth substantially less.
In making the USAir purchase, your Chairman displayed
timing: I plunged into the business at almost the exact
moment that it
ran into severe problems. (No one pushed me; in tennis parlance,
committed an "unforced error.") The company's
troubles were brought
on both by industry conditions and by the post-merger difficulties
encountered in integrating Piedmont, an affliction I should
expected since almost all airline mergers have been followed
In short order, Ed Colodny and Seth Schofield resolved
problem: The airline now gets excellent marks for service.
Industry-wide problems have proved to be far more serious.
purchase, the economics of the airline industry have deteriorated
alarming pace, accelerated by the kamikaze pricing tactics
carriers. The trouble this pricing has produced for all
illustrates an important truth: In a business selling a
product, it's impossible to be a lot smarter than your dumbest
However, unless the industry is decimated during
the next few
years, our USAir investment should work out all right. Ed
have decisively addressed the current turbulence by making
changes in operations. Even so, our investment is now less
at the time I made it.
Our convertible preferred stocks are relatively simple
yet I should warn you that, if the past is any guide, you
may from time
to time read inaccurate or misleading statements about them.
year, for example, several members of the press calculated
of all our preferreds as equal to that of the common stock
they are convertible. By their logic, that is, our Salomon
convertible into common at $38, would be worth 60% of face
Salomon common were selling at $22.80. But there is a small
with this line of reasoning: Using it, one must conclude
that all of the
value of a convertible preferred resides in the conversion
that the value of a non-convertible preferred of Salomon
zero, no matter what its coupon or terms for redemption.
The point you should keep in mind is that most of
the value of our
convertible preferreds is derived from their fixed-income
characteristics. That means the securities cannot be worth
the value they would possess as non-convertible preferreds
be worth more because of their conversion options.
I deeply regret having to end this section of the
report with a note
about my friend, Colman Mockler, Jr., CEO of Gillette, who
January. No description better fitted Colman than "gentleman"
word signifying integrity, courage and modesty. Couple these
with the humor and exceptional business ability that Colman
possessed and you can understand why I thought it an undiluted
pleasure to work with him and why I, and all others who
knew him, will
miss Colman so much.
A few days before Colman died, Gillette was richly
praised in a
Forbes cover story. Its theme was simple: The company's
shaving products has come not from marketing savvy (though
exhibits that talent repeatedly) but has instead resulted
devotion to quality. This mind-set has caused it to consistently
its energies on coming up with something better, even though
existing products already ranked as the class of the field.
depicting Gillette, Forbes in fact painted a portrait of
Regular readers know that I shamelessly utilize the
annual letter in
an attempt to acquire businesses for Berkshire. And, as
preach at the Buffalo News, advertising does work: Several
have knocked on our door because someone has read in these
of our interest in making acquisitions. (Any good ad salesman
you that trying to sell something without advertising is
like winking at
a girl in the dark.)
In Appendix B (on pages 26-27) I've reproduced the
essence of a
letter I wrote a few years back to the owner/manager of
business. If you have no personal connection with a business
might be of interest to us but have a friend who does, perhaps
pass this report along to him.
We will not engage in unfriendly takeovers. We can
complete confidentiality and a very fast answer - customarily
five minutes - as to whether we're interested. We prefer
to buy for
cash, but will consider issuing stock when we receive as
intrinsic business value as we give.
Our favorite form of purchase is one fitting the
Friedman-Heldman mold. In cases like these, the company's
managers wish to generate significant amounts of cash, sometimes
themselves, but often for their families or inactive shareholders.
same time, these managers wish to remain significant owners
continue to run their companies just as they have in the
past. We think
we offer a particularly good fit for owners with such objectives.
invite potential sellers to check us out by contacting people
we have done business in the past.
Charlie and I frequently get approached about acquisitions
don't come close to meeting our tests: We've found that
advertise an interest in buying collies, a lot of people
will call hoping
to sell you their cocker spaniels. A line from a country
our feeling about new ventures, turnarounds, or auction-like
"When the phone don't ring, you'll know it's me."
Besides being interested in the purchase of businesses
described above, we are also interested in the negotiated
large, but not controlling, blocks of stock comparable to
those we hold
in Capital Cities, Salomon, Gillette, USAir, and Champion.
We are not
interested, however, in receiving suggestions about purchases
might make in the general stock market.
Ken Chace has decided not to stand for reelection
as a director at
our upcoming annual meeting. We have no mandatory retirement
for directors at Berkshire (and won't!), but Ken, at 75
and living in
Maine, simply decided to cut back his activities.
Ken was my immediate choice to run the textile operation
Buffett Partnership, Ltd. assumed control of Berkshire early
Although I made an economic mistake in sticking with the
business, I made no mistake in choosing Ken: He ran the
well, he was always 100% straight with me about its problems,
generated the funds that allowed us to diversify into insurance.
My wife, Susan, will be nominated to succeed Ken.
She is now the
second largest shareholder of Berkshire and if she outlives
inherit all of my stock and effectively control the company.
and agrees, with my thoughts on successor management and
shares my view that neither Berkshire nor its subsidiary
and important investments should be sold simply because
high bid is received for one or all.
I feel strongly that the fate of our businesses and
should not depend on my health - which, it should be added,
excellent - and I have planned accordingly. Neither my estate
that of my wife is designed to preserve the family fortune;
both are aimed at preserving the character of Berkshire
the fortune to society.
Were I to die tomorrow, you could be sure of three
None of my stock would have to be sold; (2) Both a controlling
shareholder and a manager with philosophies similar to mine
follow me; and (3) Berkshire's earnings would increase by
annually, since Charlie would immediately sell our corporate
Indefensible (ignoring my wish that it be buried with me).
About 97.3% of all eligible shares participated in
shareholder-designated contributions program. Contributions
through the program were $5.8 million, and 2,600 charities
We suggest that new shareholders read the description
shareholder-designated contributions program that appears
54-55. To participate in future programs, you must make
shares are registered in the name of the actual owner, not
nominee name of a broker, bank or depository. Shares not
registered on August 31, 1991 will be ineligible for the
In addition to the shareholder-designated contributions
Berkshire distributes, managers of our operating businesses
contributions, including merchandise, averaging about $1.5
annually. These contributions support local charities, such
United Way, and produce roughly commensurate benefits for
However, neither our operating managers nor officers
parent company use Berkshire funds to make contributions
national programs or charitable activities of special personal
to them, except to the extent they do so as shareholders.
employees, including your CEO, wish to give to their alma
other institutions to which they feel a personal attachment,
they should use their own money, not yours.
The annual meeting this year will be held at the
in downtown Omaha at 9:30 a.m. on Monday, April 29, 1991.
Attendance last year grew to a record 1,300, about a 100-fold
increase from ten years ago.
We recommend getting your hotel reservations early
at one of
these hotels: (1) The Radisson-Redick Tower, a small (88
nice hotel across the street from the Orpheum; (2) the much
Lion Hotel, located about a five-minute walk from the Orpheum;
the Marriott, located in West Omaha about 100 yards from
and a twenty minute drive from downtown. We will have buses
Marriott that will leave at 8:30 and 8:45 for the meeting,
after it ends.
Charlie and I always enjoy the meeting, and we hope
make it. The quality of our shareholders is reflected in
the quality of
the questions we get: We have never attended an annual meeting
anywhere that features such a consistently high level of
An attachment to our proxy material explains how
you can obtain
the card you will need for admission to the meeting. Because
parking can be tight around the Orpheum, we have lined up
of nearby lots for our shareholders to use. The attachment
contains information about them.
As usual, we will have buses to take you to Nebraska
Mart and Borsheim's after the meeting and to take you to
hotels or to the airport later. I hope that you will allow
plenty of time
to fully explore the attractions of both stores. Those of
early can visit the Furniture Mart any day of the week;
it is open from
10 a.m. to 5:30 p.m. on Saturdays, and from noon to 5:30
Sundays. While there, stop at the See's Candy cart and see
the dawn of synergism at Berkshire.
Borsheim's normally is closed on Sunday, but we will
shareholders and their guests from noon to 6 p.m. on Sunday,
At our Sunday opening last year you made Ike very happy:
totaling the day's volume, he suggested to me that we start
annual meetings quarterly. Join us at Borsheim's even if
you just come
to watch; it's a show you shouldn't miss.
Last year the first question at the annual meeting
was asked by
11-year-old Nicholas Kenner, a third-generation shareholder
New York City. Nicholas plays rough: "How come the
stock is down?"
he fired at me. My answer was not memorable.
We hope that other business engagements won't keep
away from this year's meeting. If he attends, he will be
chance to again ask the first question; Charlie and I want
to tackle him
while we're fresh. This year, however, it's Charlie's turn
U. S. STEEL ANNOUNCES SWEEPING MODERNIZATION SCHEME*
* An unpublished satire by Ben Graham, written in 1936
and given by the author to Warren Buffett in 1954.
Myron C. Taylor, Chairman of U. S. Steel Corporation,
announced the long awaited plan for completely modernizing
world's largest industrial enterprise. Contrary to expectations,
changes will be made in the company's manufacturing or selling
policies. Instead, the bookkeeping system is to be entirely
By adopting and further improving a number of modern accounting
and financial devices the corporation's earning power will
amazingly transformed. Even under the subnormal conditions
it is estimated that the new bookkeeping methods would have
a reported profit of close to $50 per share on the common
scheme of improvement is the result of a comprehensive survey
by Messrs. Price, Bacon, Guthrie & Colpitts; it includes
Myron C. Taylor-美国钢铁公司的董事长，今天宣布令人期待已久，有关全世
1. Writing down of Plant Account to Minus $1,000,000,000.
2. Par value of common stock to be reduced to 1￠.
3. Payment of all wages and salaries in option warrants.
4. Inventories to be carried at $1.
5. Preferred Stock to be replaced by non-interest
redeemable at 50% discount.
6. A $1,000,000,000 Contingency Reserve to be established.
The official statement of this extraordinary Modernization
follows in full:
The Board of Directors of U. S. Steel Corporation
is pleased to
announce that after intensive study of the problems arising
changed conditions in the industry, it has approved a comprehensive
plan for remodeling the Corporation's accounting methods.
by a Special Committee, aided and abetted by Messrs. Price,
Guthrie & Colpitts, revealed that our company has lagged
behind other American business enterprises in utilizing
advanced bookkeeping methods, by means of which the earning
may be phenomenally enhanced without requiring any cash
any changes in operating or sales conditions. It has been
only to adopt these newer methods, but to develop them to
higher stage of perfection. The changes adopted by the Board
summarized under six heads, as follows:
1. Fixed Assets to be written down to Minus $1,000,000,000.
Many representative companies have relieved their
accounts of all charges for depreciation by writing down
account to $1. The Special Committee points out that if
are worth only $1, the fixed assets of U. S. Steel Corporation
a good deal less than that sum. It is now a well-recognized
many plants are in reality a liability rather than an asset,
only depreciation charges, but taxes, maintenance, and other
expenditures. Accordingly, the Board has decided to extend
write-down policy initiated in the 1935 report, and to mark
Fixed Assets from $1,338,522,858.96 to a round Minus
The advantages of this move should be evident. As
the plant wears
out, the liability becomes correspondingly reduced. Hence,
the present depreciation charge of some $47,000,000 yearly
be an annual appreciation credit of 5%, or $50,000,000.
increase earnings by no less than $97,000,000 per annum.
2. Reduction of Par Value of Common Stock to 1￠, and
3. Payment of Salaries and Wages in Option Warrants.
Many corporations have been able to reduce their
expenses substantially by paying a large part of their executive
salaries in the form of options to buy stock, which carry
against earnings. The full possibilities of this modern
apparently not been adequately realized. The Board of Directors
adopted the following advanced form of this idea:
The entire personnel of the Corporation are to receive
compensation in the form of rights to buy common stock at
share, at the rate of one purchase right for each $50 of
wages in their present amounts. The par value of the common
to be reduced to 1￠.
The almost incredible advantages of this new plan
from the following:
A. The payroll of the Corporation will be entirely
saving of $250,000,000 per annum, based on 1935 operations.
B. At the same time, the effective compensation of
employees will be increased severalfold. Because of the
per share to be shown on our common stock under the new
it is certain that the shares will command a price in the
above the option level of $50 per share, making the readily
value of these option warrants greatly in excess of the
wages that they will replace.
C. The Corporation will realize an additional large
through the exercise of these warrants. Since the par value
common stock will be fixed at 1￠, there will be a gain of
each share subscribed for. In the interest of conservative
however, this profit will not be included in the income
account, but will
be shown separately as a credit to Capital Surplus.
D. The Corporation's cash position will be enormously
strengthened. In place of the present annual cash outgo
$250,000,000 for wages (1935 basis), there will be annual
of $250,000,000 through exercise of the subscription warrants
5,000,000 shares of common stock. The Company's large earnings
and strong cash position will permit the payment of a liberal
which, in turn, will result in the exercise of these option
immediately after issuance which, in turn, will further
improve the cash
position which, in turn, will permit a higher dividend rate
-- and so on,
Serious losses have been taken during the depression
due to the
necessity of adjusting inventory value to market. Various
-- notably in the metal and cotton-textile fields -- have
dealt with this problem by carrying all or part of their
extremely low unit prices. The U. S. Steel Corporation has
adopt a still more progressive policy, and to carry its
at $1. This will be effected by an appropriate write-down
at the end of
each year, the amount of said write-down to be charged to
Contingency Reserve hereinafter referred to.
The benefits to be derived from this new method are
Not only will it obviate all possibility of inventory depreciation,
will substantially enhance the annual earnings of the Corporation.
inventory on hand at the beginning of the year, valued at
$1, will be
sold during the year at an excellent profit. It is estimated
income will be increased by means of this method to the
extent of at
least $150,000,000 per annum which, by a coincidence, will
equal the amount of the write-down to be made each year
A minority report of the Special Committee recommends
Accounts Receivable and Cash also be written down to $1,
interest of consistency and to gain additional advantages
those just discussed. This proposal has been rejected for
being because our auditors still require that any recoveries
receivables and cash so charged off be credited to surplus
to the year's income. It is expected, however, that this
auditing rule --
which is rather reminiscent of the horse-and-buggy days
-- will soon
be changed in line with modern tendencies. Should this occur,
minority report will be given further and favorable consideration.
5. Replacement of Preferred Stock by Non-Interest-Bearing
Redeemable at 50% Discount.
During the recent depression many companies have
been able to
offset their operating losses by including in income profits
from repurchases of their own bonds at a substantial discount
par. Unfortunately the credit of U. S. Steel Corporation
stood so high that this lucrative source of revenue has
been available to it. The Modernization Scheme will remedy
It is proposed that each share of preferred stock
be exchanged for
$300 face value of non-interest-bearing sinking-fund notes,
redeemable by lot at 50% of face value in 10 equal annual
This will require the issuance of $1,080,000,000 of new
which $108,000,000 will be retired each year at a cost to
Corporation of only $54,000,000, thus creating an annual
profit of the
Like the wage-and/or-salary plan described under
3. above, this
arrangement will benefit both the Corporation and its preferred
stockholders. The latter are assured payment for their present
at 150% of par value over an average period of five years.
short-term securities yield practically no return at present,
non-interest-bearing feature is of no real importance. The
will convert its present annual charge of $25,000,000 for
dividends into an annual bond-retirement profit of $54,000,000
aggregate yearly gain of $79,000,000.
6. Establishment of a Contingency Reserve of $1,000,000,000.
The Directors are confident that the improvements
described will assure the Corporation of a satisfactory
under all conditions in the future. Under modern accounting
however, it is unnecessary to incur the slightest risk of
adverse business developments of any sort, since all these
provided for in advance by means of a Contingency Reserve.
The Special Committee has recommended that the Corporation
create such a Contingency Reserve in the fairly substantial
$1,000,000,000. As previously set forth, the annual write-down
inventory to $1 will be absorbed by this reserve. To prevent
exhaustion of the Contingency Reserve, it has been further
that it be replenished each year by transfer of an appropriate
from Capital Surplus. Since the latter is expected to increase
by not less than $250,000,000 through the exercise of the
Option Warrants (see 3. above), it will readily make good
any drains on
the Contingency Reserve.
In setting up this arrangement, the Board of Directors
confess regretfully that they have been unable to improve
devices already employed by important corporations in transferring
large sums between Capital, Capital Surplus, Contingency
and other Balance Sheet Accounts. In fact, it must be admitted
entries will be somewhat too simple, and will lack that
extreme mystification that characterizes the most advanced
in this field. The Board of Directors, however, have insisted
clarity and simplicity in framing their Modernization Plan,
even at the
sacrifice of possible advantage to the Corporation's earning
In accordance with a somewhat antiquated custom there
appended herewith a condensed pro-forma Balance Sheet of
the U. S.
Steel Corporation as of December 31, 1935, after giving
proposed changes in asset and liability accounts.
*Given a Stated Value differing from Par Value, in accordance
with the laws of the
State of Virginia, where the company will be re-incorporated.
It is perhaps unnecessary to point out to our stockholders
modern accounting methods give rise to balance sheets differing
somewhat in appearance from those of a less advanced period.
of the very large earning power that will result from these
the Corporation's Balance Sheet, it is not expected that
attention will be paid to the details of assets and liabilities.
In conclusion, the Board desires to point out that
procedure, whereby plant will be carried at a minus figure,
bill will be eliminated, and inventory will stand on our
virtually nothing, will give U. S. Steel Corporation an
competitive advantage in the industry. We shall be able
to sell our
products at exceedingly low prices and still show a handsome
of profit. It is the considered view of the Board of Directors
the Modernization Scheme we shall be able to undersell all
competitors to such a point that the anti-trust laws will
only barrier to 100% domination of the industry.
In making this statement, the Board is not unmindful
possibility that some of our competitors may seek to offset
advantages by adopting similar accounting improvements.
confident, however, that U. S. Steel will be able to retain
the loyalty of
its customers, old and new, through the unique prestige
accrue to it as the originator and pioneer in these new
fields of service
to the user of steel. Should necessity arise, moreover,
we believe we
shall be able to maintain our deserved superiority by introducing
more advanced bookkeeping methods, which are even now under
development in our Experimental Accounting Laboratory.
*This is an edited version of a letter I sent some years
ago to a man who had
indicated that he might want to sell his family business.
I present it here because it is
a message I would like to convey to other prospective sellers.
Here are a few thoughts pursuant to our conversation
of the other
Most business owners spend the better part of their
building their businesses. By experience built upon endless
they sharpen their skills in merchandising, purchasing,
selection, etc. It's a learning process, and mistakes made
in one year
often contribute to competence and success in succeeding
In contrast, owner-managers sell their business only
frequently in an emotionally-charged atmosphere with a multitude
pressures coming from different directions. Often, much
pressure comes from brokers whose compensation is contingent
consummation of a sale, regardless of its consequences for
and seller. The fact that the decision is so important,
and personally, to the owner can make the process more,
less, prone to error. And, mistakes made in the once-in-a-lifetime
sale of a business are not reversible.
Price is very important, but often is not the most
critical aspect of
the sale. You and your family have an extraordinary business
-- one of
a kind in your field -- and any buyer is going to recognize
also a business that is going to get more valuable as the
years go by.
So if you decide not to sell now, you are very likely to
money later on. With that knowledge you can deal from strength
take the time required to select the buyer you want.
(1) A company located elsewhere but operating in
your business or
in a business somewhat akin to yours. Such a buyer -- no
promises are made -- will usually have managers who feel
how to run your business operations and, sooner or later,
will want to
apply some hands-on "help." If the acquiring company
is much larger,
it often will have squads of managers, recruited over the
years in part
by promises that they will get to run future acquisitions.
They will have
their own way of doing things and, even though your business
undoubtedly will be far better than theirs, human nature
will at some
point cause them to believe that their methods of operating
superior. You and your family probably have friends who
their businesses to larger companies, and I suspect that
experiences will confirm the tendency of parent companies
over the running of their subsidiaries, particularly when
knows the industry, or thinks it does.
(2) A financial maneuverer, invariably operating
amounts of borrowed money, who plans to resell either to
or to another corporation as soon as the time is favorable.
this buyer's major contribution will be to change accounting
so that earnings can be presented in the most favorable
light just prior
to his bailing out. I'm enclosing a recent article that
describes this sort
of transaction, which is becoming much more frequent because
rising stock market and the great supply of funds available
If the sole motive of the present owners is to cash
their chips and
put the business behind them -- and plenty of sellers fall
category -- either type of buyer that I've just described
But if the sellers' business represents the creative work
of a lifetime
and forms an integral part of their personality and sense
buyers of either type have serious flaws.
Berkshire is another kind of buyer -- a rather unusual
one. We buy
to keep, but we don't have, and don't expect to have, operating
in our parent organization. All of the businesses we own
autonomously to an extraordinary degree. In most cases,
managers of important businesses we have owned for many
not been to Omaha or even met each other. When we buy a
the sellers go on running it just as they did before the
sale; we adapt
to their methods rather than vice versa.
You know of some of our past purchases. I'm enclosing
a list of
everyone from whom we have ever bought a business, and I
to check with them as to our performance versus our promises.
should be particularly interested in checking with the few
businesses did not do well in order to ascertain how we
Any buyer will tell you that he needs you personally
-- and if he
has any brains, he most certainly does need you. But a great
buyers, for the reasons mentioned above, don't match their
subsequent actions to their earlier words. We will behave
promised, both because we have so promised, and because
we need to
in order to achieve the best business results.
This need explains why we would want the operating
your family to retain a 20% interest in the business. We
need 80% to
consolidate earnings for tax purposes, which is a step important
It is equally important to us that the family members who
business remain as owners. Very simply, we would not want
unless we felt key members of present management would stay
our partners. Contracts cannot guarantee your continued
would simply rely on your word.
The areas I get involved in are capital allocation
and selection and
compensation of the top man. Other personnel decisions,
strategies, etc. are his bailiwick. Some Berkshire managers
some of their decisions with me; some don't. It depends
personalities and, to an extent, upon their own personal
Furthermore, there would be no chance that a deal
announced and that the buyer would then back off or start
adjustments (with apologies, of course, and with an explanation
banks, lawyers, boards of directors, etc. were to be blamed).
finally, you would know exactly with whom you are dealing.
not have one executive negotiate the deal only to have someone
in charge a few years later, or have the president regretfully
that his board of directors required this change or that
required sale of your business to finance some new interest
It's only fair to tell you that you would be no richer
after the sale
than now. The ownership of your business already makes you
and soundly invested. A sale would change the form of your
but it wouldn't change its amount. If you sell, you will
a 100%-owned valuable asset that you understand for another
asset -- cash -- that will probably be invested in small
of other businesses that you understand less well. There
is often a
sound reason to sell but, if the transaction is a fair one,
the reason is
not so that the seller can become wealthier.
I will not pester you; if you have any possible interest
in selling, I
would appreciate your call. I would be extraordinarily proud
Berkshire, along with the key members of your family, own
believe we would do very well financially; and I believe
you would have
just as much fun running the business over the next 20 years
have had during the past 20.