Founders - #88 Warren Buffett's Shareholder Letters— All of them!

Episode Date: September 8, 2019

What I learned from reading Berkshire Hathaway Letters to Shareholders by Warren Buffett.----Come see a live show with me and Patrick O'Shaughnessy from Invest Like The Best on October 19th in New York City. Get your tickets here! ----Subscribe to listen to Founders Premium — Subscribers can listen to Ask Me Anything (AMA) episodes and every bonus episode. --- ----Founders Notes gives you the ability to tap into the collective knowledge of history's greatest entrepreneurs on demand. Use it to supplement the decisions you make in your work.  Get access to Founders Notes here. ----“I have listened to every episode released and look forward to every episode that comes out. The only criticism I would have is that after each podcast I usually want to buy the book because I am interested so my poor wallet suffers. ” — GarethBe like Gareth. Buy a book: All the books featured on Founders Podcast

Warren Buffett first took control of Berkshire Hathaway, a small textile company, in April of 1965. A share changed hands for around $18 at that time. 54 letters to shareholders later, and that same share trades for $306,000, compounding investor capital at just under 20% per year. Buffett has said many times that he was wired at birth to allocate capital. By allocating resources to assets and endeavors that have the greatest potential for gain, Buffett has guided Berkshire to creating enormous value, not only for shareholders, but for the managers, employees, and customers of its holdings. The numbers and charts you see

on the following pages tell the story of a compounding machine. The rest of the book tells of the people, companies, and philosophies that have driven it for five decades. That's also the part that I'm going to be focused on today. In addition to providing an outstanding case study on Berkshire's success, Buffett shows an incredible willingness to share his methods and act as a teacher to his many students. All right, so that's from the introduction of the book that I read, which is Berkshire Hathaway, Letters to Shareholders, all of them. 54 years of unbelievably long shareholders. This is by far the largest book that I've ever read for the podcast so far, maybe two or three times the size because it's almost 800 pages, but it's the size of a textbook.

So we have no time to waste. Let's go ahead and jump but it's the size of a textbook. So we have no time to waste. Let's go ahead and jump into it. Okay. So I want to start with the very first sentence, the very first sharehold letter. It says the fiscal year ended October 2nd, 1965. It resulted in net earnings of $2.2 million. And when I read that, I think this part illustrates one of my favorite Jeff Bezos quotes of all time. He says, this is a quote from Bezos. He says, big things start small. The biggest oak starts from an acorn. You've got to be willing to let that acorn grow into a little sapling

and then finally into a small tree. And then maybe one day it'll be a big business on its own. You can't skip steps. You have to put one foot in front of the other. Things take time. There are no shortcuts. But you want to do those steps with passion and ferocity. So in our story, we're right here this is at this point Brookshire is essentially just a tiny little

acorn it's not even a sapling and so let's go into the condition of the business that Warren is inheriting I mean he purchased it so he chose this path but he's going to tell us basically what is the blueprint for like what do you want to do if you have a cyclical business, which is what the textile industry is. And then the summary of the section I'm about to read to you is essentially he sets out his idea. And he's like, I'm going to acquire more companies and I'm going to build a buffer. And then he does that for 54 years straight. So it says, this is now Warren writing, the sales picture of the last half of 1966 was one of generally depressed markets.

So he's talking about the textile business and then his business within that industry. In particular, he says, in a business as highly cyclical as the textile business, the past decade for Berkshire Hathaway has been a recurring story of a period of earnings followed by a period of relatively heavy losses. The past year has been a significant one in this history

because not only was 1966 a year of profitable operations, but also it witnessed a restoration of our financial strength to the level that existed at the end of the 1960s. This one he means by cyclical. You will recall that with heavy losses of the years 1957 and 1958 had not been fully recouped by the profitable operations of the years 1959 and 1960 when our business was hit again, was again hit with a three-year period of loss operations. So even before he took over the company, he would make money for a few years, lose even more money than it made for a few years, make money for a few years. He winds up,

and I guess I'm going to run over my own point here, but he sticks with this business. He diversifies, which is what we're going to get into here, into other more profitable industries. But he's somewhat loyal and that's part of strategy, where he doesn't like to sell businesses, even if they're poorly performing. His goal is to keep something forever. And in this case, that might have worked against him, because in later years, he talks about when he kept unproductive capital, locked up, I think is the word he used, by the textile industry for an additional 15 years longer longer than he than he than he wanted to.

He winds up shutting down this business, but he doesn't do it till like I think 1985. So we're almost two decades until he finally cuts his losses. But these are not profitable businesses. So if he would have stuck with them, he just would have went out of business. So he basically said he had to do what he's what he's about to start doing here. Okay, so it says, It has always been among the goals of Berkshire Hathaway to maintain a strong financial condition. Indeed, it has been this practice that has enabled the company to survive in light of the highly cyclical nature of the business. It says,

The company has been searching for suitable acquisitions within and conceivably without the textile field. We obviously know he goes outside of that. He does wind up buying one more textile company later on, like sometime in the 2000s. He's like, that was just another stupid idea. And this is what I love about reading the shareholder letters is because, you know, everybody has this idea of Warren Buffett's obviously one of the most successful entrepreneurs and investors of all time. Arguably, Berkshire has like the greatest set of returns in human history,

I think is how Charlie Lemonger puts it. And so before reading these, let me not project what I think maybe you think, but let me just tell you what I thought. I was like, okay, well, this is going to be like a string of amazing successes one after the other, and it couldn't be further from the truth. Almost every single letter he's talking about the dumb ideas and dumb decisions he makes. And it just goes back to the point that there are no perfect people, but even imperfect people like all of us are can build wonderful businesses.

And so we're going to learn a lot more about that today. All right. So this is the present state of the money market in which funds are virtually unattainable for acquisition purposes. Makes it imperative that we have available liquid assets with which to consummate such acquisitions. So we need money. We need to be liquid so we can buy businesses. Pretty straightforward. Present uncertainties such as war, tax rates, and decreased level of business activity

also all combine to emphasize the continuing need for a strong financial condition. This is something that later on he calls Berkshire like a Gibraltar of capital. Like it's a castle. It's impenetrable. Like he builds up large buffers, calls it the march of safety. It's known by, he talks a lot about it, but this is one of his main core philosophies of running business that you need to have strong, you need to be always operating from a point of strength. The reason that Berkshire was able to get such advantageous

deals is because they never dealt ever in the entire history of the company from a position of weakness. So this is extremely important. And he's going to repeat this over and over again. Most of the important parts he talks about dozens of times, and that's good because that's how we're going to – if something's important to you, you have to repeat it because people may not get it the first time, but they'll get it the 20th time, or they're more likely to if they're going to. All right, so it says highly cyclical business.

We need some money. Let's see. Let's skip ahead. We talked about we need strong financial conditions. He says it is the present intention of the directors to proceed toward the interim investment of a major portion of these funds in marketable common stocks. They should hold promise not only of greater income than can be achieved through alternative investment possibilities, but also provides us with the opportunity to participate in the earnings derived outside of our textile business, even if only temporary and indirectly. It doesn't wind up being temporary or indirect, I would argue.

But he definitely wants to. Even young Warren Buffett here understands the textile. And it's really interesting looking back now that um i read like the the letters that he's just done in the last like let's say two or three years um it's very he even says it's stupid the way he bought berkshire he should he because he had a partner a limited partnership it's called buff buffett limited i think or buffett partnership something like that and he had another company he's like basically, he calls it like a multi, maybe like a $50 billion mistake. I forgot how he came up with his calculations.

But essentially starting to do what he says here. He's like, hey, why don't we get out and start making investment in stocks so we can yield the benefits outside of our textile industry. He could have done that. He already had a partnership that could have bought stocks. And he could have bought companies too. But now his amazing picking of companies and doing his acquisitions he's going to do over the next 54 years from this point he winds up giving away like a third of that to the legacy shareholders of berkshire and he calls them strangers so i don't

know it's it's it's just fascinating how like you know now they've read all of them i understand where this is going and but I'm reading it to you. And at this point that Warren is writing this, like he doesn't know what's ahead of him, which I find really, that's a really fascinating thought. It says, so now we're going back into the next year. He's describing the state of his business, and this is what we're talking about with the textile industry.

It's terrible, for lack of a better word. Total sales showed a decline from 49 million to 39 million. So he's down 10 million a year. And he says depressed conditions of the textile markets in which we operate. That's what he's saying. But this is also the year they expanded into other industries. So I'll get there in a minute. So he's saying there's depressed conditions of the textile markets,

poor demand, depressed prices. That's what he's having to deal with. However, we are highly pleased with the results of our insurance subsidiaries since their acquisition in March 1967. All right, so we see that he's expanded into one of his, I would argue, his favorite industry, which is the insurance industry. It's a huge part of Berkshire's story. But at this point, he says, we are highly pleased with the results of our insurance subsidiaries since their acquisition in March 1967. These two companies, it's called National Indemnity Company and National Fire and Marine Insurance Company, continue their variable management by Mr. Jack Ringwald, who's guided them since inception. Our investment in the insurance

companies reflects a first major step in our efforts to achieve a more diversified base of earning power. So now he's continuing the theme he was talking about last year. The success of this effort is indicated by the attainment of earnings in the subsidiaries during 1967, which substantially exceeded the earnings in the textile business. We believe it is an added factor of strength to have these two unrelated sources of earnings rather than to be solely exposed to the conditions of one industry. And I think towards the end, he winds up having like 70, I want to say something like 76 different companies that Berkshire owns at least 80% of. Okay. So this is the very beginning of that. And that was in 1967. Moving on to the next year, he has a lot of thoughts about what the author,

or I guess the person that compiled this, was talking about at the beginning where they're saying he kind of tells a story of his philosophy on business. And the fact that he was so willing to share his wisdom. He's a very, very good writer. He comes across extremely likable and is able to take complex subjects and then tell a story, which usually illustrates his main point, which I find really fascinating.

But I also find fascinating is how often he talks about how his viewpoint differs from what you normally see. And so he's talking about, like in the insurance industry, there's a lot of crazy behavior that goes on because of all the float, which is money that they don't own, but they can invest because they're getting the money up front from their premiums, right? And so what happens is when you have all this large money up front, a lot of people focus on size. They just want more of it. And Buffett right here is going to lay out his kind of thesis where he's like, I'm not focused on size. I'm focused on profit so he says the emphasis the emphasis continues to

be on underwriting at a profit rather than volume simply for the sake of size because he wants his underwriting to make take a profit which essentially means that the money the float that he's able to invest he gets for free he's actually paid to invest so he's the main point here is focus on profit not size he sold stock for profit and then flipped it into another industry we sold a portion of our marketable securities portfolio at a profit of approximately 1.5 million dollars after tax and what did he do with that money he says we purchased all the stock of sun newspapers and blacker printing company which represented on

an initial entry into the publishing business which which they have holdings in that for a long time, including they make over like a billion dollars in real returns on their investment in the Washington Post stock in the 1970s too. So this is something that they're going to constantly invest in. Let me read my note here. It says, what he is really talking about is differentiation between him and the other managers of textile companies. So that's what I was referencing earlier,

how he's going to constantly compare and contrast with, okay, this is what you can expect in the industry, this is where I feel that thinking falls short, and this is the decision I have made, which I think is really, really actually helpful. I like the use of the word case study in the introduction. And then I wrote, they expand into banking. I wonder how this will turn out.

It wound up turning out pretty well for them, actually. Okay, four years ago, your management committed itself to the development of more substantial and more consistent earning power than appeared possible if capital continued to be invested exclusively in the textile industry. The funds for this program were temporarily utilized in marketable securities pending the acquisition of operating business meeting or investment management criteria. He doesn't really write like that too much. That's a lot of, like jargon for him this policy has proved reasonably successful particularly when contrasted with results achieved by firms which have continued to commit large sums to textile expansion in the face of totally inadequate inadequate returns that's what he's talking about it's like well you can see the money you guys are putting into this

industry you could see the return you're getting on that money why are we still doing that that's a bad idea maybe we should diversify into other industries that are more profitable so that's him comparing and contrasting we are presently in the midst of a textile recession of great intensity greater excuse me intensity than we have seen for some years it's basically the dwindling of an american uh there's a large textile base in the new england area it's kind of dwindled away to the point where it moves south not only in southern states where they have less labor agreements with unions, but eventually out of the country, of course, as we kind of know. So it says we're in a pickle. We're in the textile recession, so we've got to find our way out of

this. The most significant event of 1969 for Berkshire Hathaway is the acquisition of 97.7% of the stock of the Illinois National Bank and Trust Company. It will not be easy to achieve greater earnings in 1970 because, one, our bank is already a bank that is highly efficient business, and two, the unit banking law of Illinois makes more than modest deposit growth difficult for a major downtown bank. Now, what I don't understand is, I guess he's telling's telling us like but why would you buy it if i mean why he wants to make money so i don't think this one's being correct but that's i it's interesting he didn't elaborate on that the summary of this next section is we

are doing better than if we just limited ourselves to this exile business this is essentially what he's telling us here he says the past year the past the past year witnessed dramatically diverse earnings uh results among our various operating units the illinois national bank and trust reported reported earnings continue to rank right at the top that's what i meant i didn't know if it's true because he does make money on it our insurance operations had some deterioration and underwriting results but increased investment income produced a continued excellent return so what he's talking about is the money that he's investing that flow to keep referencing he's actually making a good return on top of it.

So even if the underwriting results deteriorate a little bit, he still makes money on top of that. The textile business became progressively more difficult throughout the year. And the final break-even result is understandable considering the industry environment. So they're working really hard to essentially stand still. So they're making the – they produced a a return about 10 percent on average. It says, well, this figure is only about average for American industry. It is considerably in excess of what would have been achieved had resources continued to be devoted exclusively to the textile business, as was the pattern until five years ago. So what he's saying there is, yeah, I only returned 10 percent to you guys this year or increased the net worth of the company that by that much I could do better I could have done better if I didn't have the textile industry and we already did better than if we just invested in

the textile industry we would have had either zero percent or maybe even less and he's going to repeat that over and over again I'm not gonna I don't think I keep repeating it but it is something he talks about up until you know 15 years from now we're actually finally close to the thing the plan's working though I'm skipping ahead now another year. The plan that he set out, the blueprint from a few years ago, that plan is working. We're seeing the improvement here as the year goes by. And then he still maintains a focus on profitability and financial strength. And again, I think that is something that he never really deviates from. There's a great quote that I think I share with you later on in the notes that takes place about 25 years from now,

but I'm just going to talk about it now because it made me think of the fact that I left a note to myself that says, Warren maintains a focus on profitability and financial strength. The CEO of one of the CEOs of Coke, I think in the 80s, described Warren Buffett, who was already a major shareholder on Coke at that time. And he said, I thought it was very fascinating. He says, what other people call obsession, Warren calls focus. And I think that one sentence is probably a good,

something good to retain to understand Buffett and how he thinks and how he goes about things. I mean, now just looking back on it, the fact that he just keep from the very beginning, he focused on profitability and financial strength, and he kept focusing on it for 50 years is amazing. So let me read this whole point. This result, considered above the average of American industry, which achieves in the face of inadequate earnings in our textile operation, making clear the benefits of redeployment of capital inaugurated five years ago it will continue to be the objective of management to improve return on total capitalization as well as a return on equity capital so that's what's his point uh what's important to him um so this is a little bit about the textile business he says strong efforts to hammer down costs and continuous search for less price sensitive fabrics produced only marginal profits however without these

efforts we would have operated substantially in the red. So again, I'm doing a lot of effort, have a lot of talent just to break even. So he'll talk about later on. One of his most famous quotes is the fact, and it comes from the shareholder letters. It comes from the fact he's like, listen, if you have a business with poor fundamental economics, which is how I want you to think about the textile business that he's describing, because that's definitely fitting. And you have a manager, a brilliant operator with a reputation of excellence. And you combine the two,

the reputation of the business with poor fundamental economics is going to be the one that survives. So he says there's some businesses that just are terrible. You need to get out of them. The opportunity cost is too high. You're wasting your talents.

The textiles is one of them. Okay, so it says, it would have been in the red. We set no volume goals in our insurance business generally and certainly not in reassurance so he's expanded into reinsurance which he expands quite a bit he'll keep investing in this for another another like three decades we said no volume goals so you don't have sales goals and certainly not in reassurance as virtually any volume can be achieved if profitability standards are ignored so again he wants his underwear the underwriting the business does to at least break even, hopefully be profitable. He's not just going to write business. And again, he talks about how weird the industry is because it's a product that's relatively expensive that no one wants to buy, but they have to buy in many cases.

So it's just a bizarre industry. A highlight of 1971 was the acquisition of home and automobile insurance company uh he talks about the person running it which he talks about uh over and over again you need to be working with people that you enjoy that you like that will not lie to you that have integrity he winds up buying like multiple hundred million dollar businesses without even doing audits or anything just based on the fact that the person said the business is what it is um and so this is extremely important so the guy named vick is the one running um the acquisition of home automobile uh he's the one running this this insurance

company and so he says vick is cut from the same cloth as jack ringwald which is the guy that runs other insurance company and gene ab Abag, with a talent for operating profitably and company by enthusiasm for his business. These three men have built their companies from scratch. Moving ahead to more of the financial section of Berkshire from that year, he says, we retain

a fundamental belief in operating from a very strong financial position so as to be in a position to unquestionably fulfill our responsibilities. Thus, we will continue to map our financial future for maximum financial strength in our subsidiaries as well as the parent company level. So before I move on, let me just pause in case I haven't made this clear. If you listen to my other podcasts I did, I've done two podcasts on Charlie Munger so far, and I have probably two more coming up in the future because it's such a fascinating mind. But he talks a lot about the

structure of Berkshire. It's weird. There's this huge conglomerate, but at their main headquarters in Omaha, there's like 20 people working, something like that. And essentially, when they buy a business, the reason he brings up the importance of these managers is because he buys a lot of family businesses, people that built their business from scratch, already independently wealthy, don't have to work, but they want a good home. You know, a lot of cases,

they want to sell their business towards the end of their life so it doesn't become an estate issue or somebody else determines who winds up with their business. So it winds up, the reason somebody even picked Berkshire is because of their unique structure where the only thing Charlie and Warren take care of is capital allocation. So they decide where all the profits from all their various businesses are going to go because that's what they feel they're best at. And they set the compensation for their top people.

Other than that, the C's of the company never even hear. They don't even have to hear from them. They just they're free to run their businesses as they see fit. So that would only work if he can if he's working with people that are honest and trustworthy, et cetera. So I don't know if I explained that before. I talked about it in the past podcast, but it's essential to understand Berkshire and how it's able to do so much with, you know, they have hundreds of thousands of employees and it's still relatively decentralized because one thing that both Warren and Charlie hate, and they talk about a lot in the shareholder

letters and in any talks you happen to might see. It's like they have a strong distaste for bureaucracy. All right, so operating earnings, where we're seeing now moving forward in 1972, in case you want to know, we're seeing early signs of what becomes the blueprint, and it's working. So operating earnings for Berkshire Hathaway during 1972 amounted to highly satisfactory 19.8%. Remember, they do that number, almost 20% compounded for 50 years. So that's how you turn $22 million into whatever, half a billion or whatever they have now. So he's reflecting on this. Like why, what does this mean? He says, it seems clear that our diversification moves of recent years

have established a significantly higher base of normal earning power than if you would have stayed with just the textiles. So now he talks about more of the businesses they buy. Our three major acquisitions of recent years have all worked out exceptionally well from both the financial and human standpoints. In all three cases, the founders were major sellers and received significant proceeds in cash. And in all three cases, the founders were major sellers and received significant proceeds in cash. And in all three cases, the same individuals have committed to run the business with undiminished energy and imagination,

which resulted in further improvement of the fine records previously established. and the advantages, let's see, I'm trying to read my note before I read this part to you. Advantages, compound dramatic gains in premium volume, plus high interest rate environment, plus low tax structure. Okay, so this is, remember, 54 years, you're going to see this bizarre, like almost every single economic environment you could possibly imagine, outside of like a Great Depression, although there were several deep and severe recessions as these shareholder letters unfold.

So it's always interesting to see how the larger macroeconomic environment impact what's happening and how little attention they paid to it genuinely. I mean, obviously you can adapt somewhat, but we'll talk more about that. So it says, We were most fortunate to experience dramatic gains in premium volume from 1969 to 1971, coincidental with virtually record high interest rates. Large amounts of investable funds were thus received. So he's talking about what's the outcome of this confluence of these economic outcomes

when you have what's becoming a large insurance business and a broad one. The end result is large amounts of investable funds were thus received at a time when they could be put to highly advantaged use. Most of these funds were placed in taxes and bonds. So it talks about they increased their investment income from, let's say, $2 million in 1969 to almost $7 million three years later. And it's subject to a low effective tax rate, so they actually keep it. And that's one of – he also talks about the reason they picked this conglomerate structure for Berkshire.

It's because they can shuffle profits from one subsidiary into other businesses, and there's, like, tax benefits. They don't have to pay tax on it yet. Okay. Okay, so this is bizarre. And I had to actually, let me read it to you. And then my notes actually might be longer than this part. So he says, diversified, he talks about this company he wants to buy. Diversified retailing company through subsidiaries operates a chain of popular price women's apparel stores and also conducts a reinsurance business. In the opinion of your management, its most important asset is 16% of the stock of blue chip stamps.

Okay, blue chip stamps, right? You got to remember this is important, one of the most important things that ever happens to Berkshire. And I couldn't understand why the hell he bought this business, and I had to go and do outside research. If I would have just didn't know research and read shareholder letters 20 years from now, I might have been able to piece it together, but I'm going to tell you about it in one second. So let me describe this business because it's almost like reward points that you can turn in,

like early gift cards where a lot of them are never going to be redeemed again. But in such, blue chip's trading stamp business has declined drastically over the past year or so. But as important sources of sources of earning power in its seized candy shop, which ones becomes one of the most profitable businesses that Berkshire owns, as well as Westco Financial Corporation. We expect blue chip blue chip stamps to achieve satisfactory earnings in future years related to capital employed, although certainly at a much lower level than would have been achieved if the trading stamp

business had been maintained at anything close to former levels. So it's like the earnings it's getting from this trading stamp business is like falling off a cliff. And again, we're still early in letters. So I had no idea what the hell is going on here. I was like, why are you buying this? So it says, okay, so let me read. And essentially, this is what I had to find out on my own. So how I describe what's taking place here is essentially Warren is teaching us how to capitalize on assets that are hiding right in plain sight. So blue chip revenue declined from 85% from 1970 to 1980 and was already in decline in 1960s. So it's in the middle of decline and he's buying it.

So my question was like, why are you doing this? I don't understand what's happening. The same thing that happens like with Starbucks today where I just read they have like something, I don't know, let's say whatever the number is numbers it's like two billion dollars worth of gift cards outstanding at any given time and they estimate like a billion of that is never going to be redeemed another way to think about that is that customers are giving billions of dollars in interest-free loans to Starbucks and so blue chip from their trading stamp business had 90 million dollars in float which which again,

is the definition Warren uses other people's money that we can then invest. Of that 60 million turns out to be permanent float. We don't know that at this time, maybe Warren did, but it's not in the shareholder letter. So anything he's going to actually buy here, he's buying the company with essentially free money. Buffett and Munger thought the float was being mismanaged. From that float, they bought See's Candies, Wesco, and Buffalo Evening News, all effectively from the $24 million investment in blue chip stamps.

So now they're going to get $60 million, what turned out to be a permanent float from a $24 million investment. They took that float and bought See's Candies, which returns to, I forgot how much money, I want to say over a billion dollars of real returns to them, Wesco and Buffalo Evening News. So this was a steal of a lifetime.

A huge, like, early win for Berkshire. Okay, so, okay, so it already says we expect blue chips to achieve satisfactory earnings in the future. And now we're going to run into, it's not all up, as we see a lot of mistakes here. Operating results for 1974, moving forward a year. Overall, we're unsatisfactory. One of the most famous Charlie Munger quotes is,

you must learn to react to significant price declines with equanimity. So they're laying out for the shareholders, listen, 1974 results sucked. The outlook for 1975 is not encouraging. This is why the tone of this section is pessimistic as to 1974 and 1975. We consider the insurance business to be inherently attractive.

Our overall return on capital employed in this area, even including the poor results of 1974, remains high. So it's getting dragged down by some, but not only are they buying a lot of businesses, but they are still losing money in the textile industry. Many of our competitors are in substantially, I mean, now we're talking about in the insurance industry, many of our competitors are in substantially weakened financial position and our strong capital picture leaves us prepared to grow significantly when conditions become right. Our stock portfolio declined again in 1974 along with most equity portfolios to the point at year end it was worth approximately $17 million less

than its carrying value. Again, we are under no pressure. Again, one reason you can react with equanimunger just said, you can react with equanimity is because they never want to sell most things and they work from a strong financial position. So it says, yeah, it may be like on paper, our assets in this particular portfolio is worth $17 million less,

but it doesn't really mean anything. Again, we are under no pressure to sell such securities except at times when we deem it advantageous, and it is our belief that over a period of years, the overall portfolio will prove to be worth more than its cost. Next year, he elaborates on this. He's going to repeat this, and the quote is,

we expect to hold permanently. His long-term focus is maintained. He says, our equity investments are heavily concentrated in a few companies which are selected based on favorable economic characteristics, competent and honest management, and a purchase price attractive when measured against the yardstick

of value to a private owner. And so he says with this approach, now he's going to elaborate on like why is this important. Like it sounds good, right? Okay, we have competent and honest management. We have favorable economic characteristics. We think what we bought is less than it's worth but like what if you're wrong so he's saying with this approach stock market fluctuations are of little importance to us except as they may provide buying opportunities but business

performance is of major importance i love this this um this distinction he. He's like, I don't care what the Mr. Market is temporarily saying it's worth. I care how the business is performing underneath it. So he just wants a bunch of profitable companies throwing off cash in a bunch of different industries. And that's his blueprint. So he goes out and collects it. And then as he makes more, as these businesses make more money, he buys more profitable businesses. It's very simple. I mean, not easy. I'm not diminishing that, but it is simple. You just take it to the extreme. more profitable businesses. On this score, we have been delighted with the progress made by practically all of the companies in which we now have significant investments. We have continued to maintain a strong liquid position on uninsurance companies there's that that phrase again he loves having vast amounts of money just sitting there in last

year's annual report we explained how variations of one-tenth of one percent in interest rates resulted in a million dollar swings in market value of our bonds we consider such market fluctuation of minor importance as our why why can you why can you have such a privileged uh like why can you have such a good like why can you have such a privileged, like, why can you have such a good, like, why can you have such a unique, like, he's responding with equanimity to swings between a million dollars and market value of an asset he owns, right? You can't do that if you're broke. But you can if you have a large buffer, if you're conservative with your finances, we consider such market fluctuations of minor importance as our liquidity and general financial strength make it improbable that bonds will have to be sold at times other than those of our choice. And that's huge. He didn't get taken advantage of because he never has to sell in a panic.

He's the buyer when you're panicking. That's what he talks about over and over again. We'll talk more about this, how he studies human nature and human intuition. He flips it in situations. In plain English, see how these people are acting? This is not how you want to act. Okay, so it says, this is Warren's performance to date, which I thought was fantastic. I mean, it gets so much bigger from here. This is, says, Your present management assumed responsibility at Berkshire Hathaway in May 1965. The net worth of the company was $22 million.

Ten years earlier, Berkshire Hathaway's net worth had been $53 million. So it went from $53 million ten years later down to $22 million. That's when he buys it, right? And now he's up to $92 million. So he went from $53 million, goes down to $22 million. $22 million is when he grabs it. And in a few short years, he took that $22 million and turned it into $92 million. And again, today I think it sits at, I don't know, $500 billion, something like that.

I didn't know it. I left myself because I was so confused because every year it's the same thing about this textile industry. We're only in 1976. And I was like, how much longer can this go on? And this is what I was referencing. Our textile division was a significant disappointment during 1976. Earnings measured either by return on sales or return on capital employed were inadequate. It should be recognized that the textile business does not offer the expectation of high returns on investment.

That's a nice way to put it. Wait, this is, this, oh, actually, what I'm about to read to you next, I think comes from, yep, comes from insurance. Okay, so this is going back to, here's an interesting quote. He says, temporary prosperity produces unwise competition. Temporary prosperity produces unwise competition.

When a human sees another human making money or a business making money in something, they try to copy. And that obviously produces unwise competition. This is happening in the insurance industry right now, but he's still focused on profitable growth, not just growth. So he says, our opinion is that before long, perhaps in 1978, the industry will fall behind on rates as temporary prosperity produces unwise competition. If this happens, we must be prepared to meet the next wave of inadequate pricing by significant reduction in volume. So what he means by that is once other companies are willing to write stupid policies that they can't possibly make money on, but they don't understand that because they're unwise, we have to reduce and only keep writing policies that we know will make a profit on.

Don't just chase volume. Don't just chase growth. It's fake. It's not how you build real wealth over a long period of time, which is what Warren's trying to do here. And he does do. Another note, year-to-year fluctuation of market prices are unimportant. Year-to-year business performance is important. And there's just another line. Here again, we consider such market fluctuations from year-to-year relatively unimportant. However, we consider the yearly business progress of the companies in which we own stocks to be very important.

If the business results continue excellent over a period of years, we are certain eventually to achieve good financial results from our stock holdings. That's what I mean about being simple. And I just heard, I was taking notes on a talk that Charlie Munger just gave like a few months ago. And he talks about essentially like the future is like the reason Berkshire's blueprint can work is as long as the businesses that invest in it continue to make profit, even if they don't buy any more,

the growth of this profit means the company will survive. It's such a scale that it can continue to grow. It's not going to grow like on a percentage basis as fast as it did the previous 54 years because now the amount of money and the size of the company is larger. And therefore, like the amount of opportunities that move the needle are much smaller.

But I just love that. Like it's, I never got to, I just realized I just rambled. I never told you what Charlie said. He's like, I've never, like he says says, we've never, I forgot the exact quote, but he's like, we never essentially deviated from simplicity. Like, you can't get in trouble with things that are simple. And he feels Berkshire investing profitable businesses with good managers

that should continue to throw off cash in the future is relatively simple, but hard to do. If business results continue to excel over a period of years, we return to achieve good financial results from our stock holdings regardless of wide-to-wide fluctuations in market values. So he just ignores it other than the point where he feels he can take advantage of it. Another famous quote of theirs is you only need a few wonderful businesses in a lifetime to get wealthy. So now he's talking about like why do they own – they're not fans of diversification in the in the normal sense of the word they're like if you feel that you cannot properly analyze businesses then go buy an index

fund that's the smartest thing for you to do but if you feel you can and you have a skill to analyze businesses then why would you put more money in your 35th best company instead of your top one or two or three because essentially if you have one or two or three opportunities in your lifetime to own a part of a wonderful business, you're going to be fabulously wealthy. And if you look at their holdings here, which I found interesting, there's two holdings they're having that are related to people I've already covered on the podcast. So one was Kaiser Industries, and the other one is Ogilvy & Mather. So David Ogilvy and then Henry Kaiser.

But anyways, he says, we've noticed that our major equity holdings are relatively few. We select such investments on a long-term basis weighing the same factors as would be involved in a purchase of 100% of an operating business. So what are those factors? Number one, favorable long-term economic characteristics.

Number two, competent and honest management. Number three, purchase price attractive when measured against a yardstick of value to a private owner. And four, an industry with which we're familiar and whose long-term business characteristics we feel competent to judge. So he talks about like, you know,

I can't tell you in the future. He's like, I don't know how good, I know Google makes a lot of money, but I just don't know which ones, like I'm not good at picking, picking which technology companies are going to be winners. So I kind of stick to what I know is what he says. He calls this the circle of competence, which we'll talk about more.

It is difficult to find investments meeting such a test, and that is one reason for our concentration of holdings. We simply can't find 100 different securities that conform to our investment requirements. However, we feel quite comfortable concentrating our holdings in the much smaller number that we do identify as attractive. So he's got skin in the game. He always has the entire time he runs Burschauer. He's like, listen, I'm not going to diversify. I think I'm right on this and I'm going to put my money where my mouth is. Okay. Now in 1977, this is Warren's answer to why stay in the textile business. So it says, a few shareholders have questioned the wisdom of

remaining in the textile business, which over the long term is unlikely to produce returns on capital comparable to those available in many other businesses. Our reasons are several. Number one, our mills in both New Bedford and Manchester are among the largest employers in each town. In fact, when they close, there's like 1,400 people in a small town that put out of among the largest employers in each town. In fact, when they closed, there was like 1,400 people in a small town that put out of work, so it's very sad. Utilizing a labor force of high age average, possessing relatively non-transferable skills. So they're older, they don't really have other skills.

Our workers and unions have exhibited unusual understanding and effort in cooperating with management to achieve a cost structure and product mix which might allow us to maintain a viable operation. And management has also been energetic and straightforward in its approach to our textile problems. So with hard work and some imagination regarding manufacturing and marketing

configurations, it seems reasonable that at least modest profits in the textile division can be achieved in the future. That doesn't actually happen. And about eight years from this point, he closes it. He talks a lot about this. In fact, he talks about tailwinds and headwinds a lot. And so a lesson that he has to learn, one that he's not getting,

or that he had to learn from the textile, investing in the textile industry, is the importance of being in businesses prone to tailwinds instead of headwinds. The textile business is prone to tailwinds. or excuse me, headwinds rather. The insurance business is prone to tailwinds. So it says, in aggregate, the insurance business has worked out very well. Some major mistakes have been made during the decade, both in products and personnel. It is comforting to be in a business where some mistakes can be made and yet quite a satisfactory overall performance can be achieved. In a sense, this is the opposite case for our textile business,

where even very good management probably can only average with modest results. One of the lessons your management has learned, and unfortunately sometimes relearned, is the importance of being in businesses where tailwinds prevail rather than headwinds. And I've heard this described a lot of other ways. Mark ways market recent's point on what's the most important single factor for startup success is the the market it operates in which sounds crazy right because we want to think that you know our skill and effort and hard work influence them and certainly does in the sense of what what warren saying he's like i have really good managers in textile but even but fighting against even really good managers in textile, but even, but fighting against this,

even really good people fighting against the headwind is going to produce average modest results. And so obviously getting a business like insurance, where you kind of like push from the back instead of, or push from the back instead of pushing the front. All right. So it says unusual. I just left this quote to myself. I don't know what it means. So let me just read it. As markets loosen and rates become inadequate, we again will face the challenge of philosophically accepting reduced volume. Oh, okay. So now he's talking about the same things happening in the

insurance industry. Unusual managerial discipline will be required as it runs counter to normal institutional behavior to let the other fellow take away business even at foolish prices. So that's a huge – I should have left a better note for myself. But what he's talking about here, unusual managerial discipline. It's a good way to describe himself and Charlie. What they excel at is understanding the fact that humans are are they make a lot of mistakes um i think munger says like the the base uh the base um like the the normal operating of a of a human is high levels of uh discognition i think is the word he uses so he's like we we fool ourselves

we make a lot of mistakes we're not that rational if we can just understand that that's how we are and then make sure that we're not being irrational, that's a good way to win over a long period of time. So unusual managerial discipline. What he's talking about there is most people say, hey, I don't want you to take my market share. Even if that market share is unprofitable, I'm going to fight you for it. Well, that doesn't make any sense. And Buffett's like, that's a stupid idea. So go ahead. We're going to write less business in our insurance business, but that business will be profitable. And then we're going to invest afloat. And you can go ahead and go out of business in it for years.

Unusual managerial discipline. I think this applies to, again, all aspects of life. I just think we happen to be focused on creation of companies and running of companies, production of value. Unusual discipline

in all aspects of your life, whether it's the fact that you spend more time learning, you don't put a bunch of bad stuff in your body with diet. You're at some form of activity, levels of activity. Like all the stuff, like if you take the average person and what they do and then do the opposite, it's like a good way to do well in life. Because most people are lazy.

Most people are not passionate about their work. Most people are not spending enough time learning. I mean, take everything everybody's doing, like, oh, I'm going to do the opposite. So again, the word that Buffett's using here is unusual discipline. He just happens to manage your discipline, but you manage yourself too.

And it's a fight we all have to have. Like sometimes I read a lot of books, but sometimes Twitter takes up too much of my time where I'm like, I just spent 30 minutes on Twitter. That's like a couple dozen pages maybe on a book. What was a better use of my time? So no one's perfect. It's just understanding that usually it's required.

In industries where there's little differentiation, the competency of management is more important. So he talks about insurance. He talks about like the, again, he talks, I would say a lot about how bizarre the insurance industry is because it's fundamentally, it's a commodity product. They're just papers with promises written on them.

So he says, 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, and very little consumer differentiation to produce insulation from competition. In other words, if it wasn't the insurance industry, it sounds like a terrible business to be in, right? So he says, 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's no question that the nature of the insurance business magnifies the effect which individual managers have on company performance

so he's saying his insurance businesses are not going to do it run well if they're not run by extremely smart and competent people um now he's talking about there's no, he lists all the things that they don't have. They don't have trademarks, they don't have patents, they don't have location. One moat that he feels is durable in the insurance business and why he eventually later buys all of Geico is low costs, which is pounded again and again in our heads when we're reading these biographies of these entrepreneurs about setting up a long, durable advantage for your business by being ruthless in monitoring and maintaining your costs. And that's definitely something that Geico does.

Okay. And now he's going to tell us. So here's a straight up, some notes I left that avoid owning businesses that offer, one, undifferentiated goods, and two, are high capital intensive. It was true back then. It's still true today. So he says, the textile industry illustrates in textbook style how producers of relatively undifferentiated goods and capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage. As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than

capital capital employed such a supply excess condition appears likely to prevail most of the time in the textile industry and our expected what's the end result of a situation like this our expectations are for profits of relatively modest amounts in relation to capital this takes a lot of money invested to make a little bit of money. We hope we don't get into too many more businesses with such tough economic conditions. And something that's going to pop up over and over again in these letters, which I think is one of the most inspiring parts about reading them, is even Warren makes bad decisions. And he makes a lot of them, and some of them are giant, losing multiple billions of dollars on one decision. So perfection is not required to build a great company. We continue to look for ways to expand our insurance operation,

but your reaction to this intent should not be unrestrained joy. Some of our expansion efforts largely initiated by your chairman, that's what he calls himself. I mean, that's his title, but that's how he's referring to himself is my point here. Some of our expansion efforts largely initiated by your chairman have been lackluster. Others have been expensive failures. All right, so sometimes he buys the entire insurance agency or insurance company.

Sometimes he buys just their stock. But he says, he's talking about now we're in the year, we're in what, the 1978. And he's talking about, so buying i'm going to read this part to you but the main takeaway is buying parts of businesses through common stock yields better returns than buying the entire company through acquisition now later on he well maybe always they would prefer acquisition they're just saying that the prices are not always like as good as you can get by buying partially, partially buying the business through the open market. And he talks about people criticize this, this,

this idea of his, but cause you don't have control. Right. But he says, given their skill, why would we want control? They're better at managing the business than we would be. So he's talking about,

and to give you an illustration of this, he's talking about this company called Safeco. So it says Safeco is much better insurance operation than our own. It is better than the one we could develop and similarly is far better than any in which we might negotiate purchase of a controlling interest. Yet our purchase at Safeco was made at substantially under book value.

We paid less than 100 cents on the dollar for the best company in the business when far more than 100 cents on the dollar is being paid for mediocre companies and corporate transactions. And there's no way to start a new operation. Of course, with a minor interest, we do not have the right to direct or even influence management policies at Safeco. But why should we wish to do this?

The record would indicate that they do a better job of manning their operation than we do ourselves. While there may be less excitement and prestige in sitting back and letting others do the work, we think that this is all one loses by accepting passive participation and excellent management. Because quite clearly, if one controlled a company run as well as Safeco,

the proper policy also would be to sit back and let management do its job. Which again is something that's his modus operandi here. Just let them do what they do. I bought the company because it's great. I want you to keep making it great. The note I left myself is resourceful people stay resourceful and wasteful people stay wasteful.

Our experience has been the manager of an already high cost operation frequently is uncommonly resourceful in finding new ways to add to overhead. So this is what I mean. They constantly focus on cost. They hate people that spend unwisely. So our experience has been if a manager already has a high-cost business, and that person frequently is uncommonly resourceful in finding new ways to add to overhead, right? So they keep doing what they're good at, adding expenses.

While the manager of a tightly run operation usually continues to find additional methods to curtail costs, even when his costs are already well below those of his competitors. And he's not yet describing this person, but that's the person that runs Geico. Tony, I think, I forgot his last name, maybe Nicely or something like that, but we'll get to him eventually. So his costs are well below his competitors and he keeps decreasing them or he did when he was running a company um okay so now we move to 1979 he's talks about a lot about his failures and in this case he failed he's we failed at our primary

objective and this is what he feels is a better way to understand businesses. 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. So now this is his better way to understand businesses. The primary test of managerial economic performance is the achievement of high earnings rate on equity capital employed without undue leverage, accounting, gimmickry, etc. And not the achievement of they place upon earnings per share and upon yearly changes in that figure. Okay, this next part, he starts talking about, well, he changes. Remember, he's famous for following the teachings of Ben Graham and being like a value investor.

And he made a lot of money doing that, but he realized and he learned this from Charlie Munger that it's never going to scale. So what he decides to change, and he was pushed by Charlie in this direction, which is what winds up becoming the blueprint for Berkshire, and that's I need to be buying fantastic businesses at fair prices instead of poor businesses at bargain prices. You're going to make a lot more money over the long term if you just go for quality.

So now he's going to lay about a little bit about like his thinking on this. So I'm just going to read this whole section to you. In some businesses, a network TV station, for example, it is virtually impossible to avoid earning extraordinary returns on tangible capital employed in the business. And assets in such businesses sell at equally extraordinary prices, 1,000 cents or more on the dollar, a valuation reflecting the splendid, almost unavoidable economic results obtainable. So a fantastic business. Despite a fancy price tag, the quote unquote easy business may be the better route to go. So he's saying like maybe you're better off paying a higher price for some business that's going to generate a lot more money, right? We can speak

from experience having tried the other route. Your chairman made the decision a few years ago to purchase Wham Buck Mills in Manchester, New Hampshire, thereby expanding our textile commitment, right? Isn't that a strange decision though? And he owns up to this, why it's a bad idea, but think about it. He's already mentioned multiple times in the last few shareholder letters have gone over about how terrible the textile industry is avoid going into a business that has a headwind go for one that has a tailwind he didn't take his own advice that's human that is normal we just have to know that that happens he's making a mistake here he talks about this mistake for many years ago like you could know what to do is right, but you're going to –

and it's not that you should forget what you learned. It's that inevitably your humanness is going to get in the way. And this is the exact example. He's been lecturing us on not to do this, and he just expanded into the crappy industry. So he says, by any statistical test, the purchase price was an extraordinary bargain. Look how cheap I got this piece of crap is essentially what happened. We bought well below the working capital of the business and in effect got various potential amounts of machinery and restate for less than nothing. But the purchase was a mistake. While we labored mightily, new

problems arose as fast as old problems were tamed. Both our operating and investment experience causes us to conclude that turnarounds seldom turn and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price. And he's talking about things that he's not explicitly stating it, but what he means is the opportunity cost is too high. You have a limited amount of time, a limited amount of energy, and to some degree, a limited amount of capital. And you're spending it unwisely by trying to turn around a dud. And you should have just ponied up and bought a better asset. And over the long term, that's the best way to do it.

That's the best route to go as far as building wealth over a long period of time. Because that's nice that you he bought this mill even if he would have made money short term he's going to make money for a few years a truly fantastic business like he gets involved in coca-cola geico and all these other ones sees candies etc they just print money for for berkshire for decades um so that's what he's talking about here all right um this is something i heard Jeff Bezos say before. This is part one of two.

And this also applies, the same applies to the type of customers you want. So he says, in large part, companies obtain the shareholder constituency that they seek and deserve. If they focus their thinking and communication on short-term results or short-term stock market consequences, they will, in large part, attract shareholders who focus on the same factors. We prefer owners who like our service and menu and who return year after year. It would be hard to find a better group to sit in the Berkshire Hathaway shareholder seats than those already occupying them. We hope to continue to have a very low turnover among our owners, reflecting a constituency that understands our operation, approves of our policy, and shares our expectations. And we hope to deliver on those expectations.

So it says Berkshire's wants investors, which essentially are customers like themselves, stable and long-term investors. So this is very similar. If you remember the podcast I did when I read all of Jeff Bezos' shareholder letters, although a lot, I thought that was a lot. That was like 18. We're in this 54 of them. He says the same thing. Like he is very upfront about what he's doing.

This is my idea. If you want to invest, invest. But if you're looking for a short-term flip, then you got the wrong company, buddy. And Warren is essentially saying the same thing. And that's a wonderful thing about people though, where if you can just tell them, if you set their expectations upfront and you tell them, listen, this is what you're in for. I think this is why this strategy of mine is going to work. Invest if you set their expectations up front and you tell them this listen this is what you're in for i think this is why this strategy of mine is going to work invest if you want but you know don't he even says later on i hope people don't buy bursar stock if they're not going to keep it forever not going to keep it at least five years whatever the case is so he he spends a lot of time like they said earlier on education like um explaining exactly like why he thinks the way

he does. Do you agree with this? This is my thinking. If you agree, then buy stock. If you don't, then don't. So one way to talk about their philosophy, how they run their actual company is extreme centralization of investment decisions and extreme decentralization of everything else. And then you add to that a very strong frugal streak.

And that's where you have like a recipe for Berkshire. He says, your company is run on the principle of centralization of financial decisions at the top, meaning him and Charlie, and rather extreme delegation of operating authority to a number of key managers at the individual company or business unit level. We could just field a basketball team with our corporate headquarters group which utilizes only about 1,500 square feet of space. This approach produces an occasional major mistake that might have

been eliminated or minimized through closer operating controls. Okay so he's saying like if we were a little more centralized we might make fewer mistakes but we'd move slower. But it also eliminates large scale, large, and we'd spend more, but it also eliminates large layers of cost and dramatically speeds decision making because everyone has a great deal to do, a very great deal gets done. Most important of all, it enables us to attract and retain some extraordinary talented individuals, people who simply can't be hired in the normal course of events,

who find working for Berkshire to be almost identical to running their own show. Remember, all the people that sell their business to Berkshire, they're already wealthy. If you don't need to work another day in your life, you want to be micromanaged, there's just no way. And that's why I like how he puts it. These people just simply couldn't be hired in normal course events. They have skills way outside the average employee.

This is him telling why he likes share buybacks. 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 you find businesses selling in the marketplace for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interest of all owners at that bargain price? 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-like nature of security markets often allows finely run companies the opportunity to purchase portions of their own business at a price under 50% of that needed to acquire the same earnings power through negotiated acquisition of large enterprises. So essentially, instead of buying, overpaying for another business, why don't you just underpay for your own? That's what he's telling us here. That's why I like share buybacks. He just says it in a couple of paragraphs.

This is Warren's quick description of what makes a great business. GEICO represents the best of all investment worlds. The coupling of a very important and very hard duplicate business advantage with an extraordinary management whose skills and operations are matched by skills and capital allocation. This is what I referenced earlier great managers cannot fix and great entrepreneurs cannot fix a business that has poor fundamental economics. We have written in past reports about the disappointments that usually result from purchases and operations of turnaround businesses. Literally hundreds of turnaround possibilities in dozens of industries have been described to us over the years. And either as participants or as observers, we have tracked performance against expectations. This is their

conclusion. Our conclusion is that with few exceptions, when a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact. Geico may appear to be an exception, having been turned around from the very edge of bankruptcy in 1976. And he says it may be an exception, but it's also a weird business to use that word. I mean, this is my word. That's my description of the insurance industry, not his. But he kind of echoes this here. He says, but it is also true the fundamental business advantage that Geico has enjoyed,

an advantage that previously had produced staggering success, was intact with the company although submerged in sea of financial and operating troubles there make some bad deals to Ted had to be unwound Geico was designed to be the low-cost operation in an enormous marketplace which is auto insurance populated largely by companies who marketing structures restricted adaption adaptation rather run is designed it could offer unusual value to its customers while earning unusual returns for itself. So it uses a direct marketing, like it sells its insurance directly to its customers as opposed to going to like a network of agents like most insurance companies do. For decades, it has been run in this manner.

Its troubles in the mid-1970s were not produced by any diminutation or disappearance of this essential economic advantage. Geico's problems at that time put it in a position analogous to that of American Express in 1964 following the salad oil scandal. Both were one-of-a-kind companies, temporary reeling from the effects of a fiscal blow that did not destroy their exceptional underlying economics. The Geico and American Express situation's extraordinary business franchises with a localized excisable cancer, needing to be sure a skilled surgeon, So he's saying they're like they needed a turnaround,

but they had a specific problem that could be removed as opposed to just poor fundamental economics that you can't do anything about. Update on the textile business. The end is near. Warren showing ownership of mistakes as usual. That's what I wrote to myself. During the past year, we have cut back the scope of our textile business. Your chairman made a costly mistake in not facing the realities of the situation sooner Current conditions indicate Another tough year In textiles

But with substantially less capital Employed in the operation So it's still going to be bad But at least we have less of our money on the line And we can reallocate that money elsewhere So This is basically how Warren runs a business A large buffer, low debt And and if you do have debt,

it's going to be on good terms. So he borrows when he didn't need the money, and that's how he gets better turns, and an abundance of capital strength. Under all circumstances, we plan to operate with plenty of liquidity, with debt that is moderate in size and properly structured, and with an abundance of capital strength. Our return on equity is penalized

somewhat by this conservative approach, but is the only one which we feel comfortable. That's a really important point. There's a lot of times where he says, I could take another strategy and it might give me an extra few percentage points in profit, but I wouldn't be able to sleep. So I'm optimizing for sleep. I think that's extremely smart. smart this must be important to warn because he repeats this a lot reputation is persuasion small portions of exceptionally good businesses are are usually available in the securities markets at reasonable prices so I've already brought this up to you like you can you can buy you can't buy the whole business for a lot for a good amount, but you can buy small pieces,

and you can keep doing this in various different industries. But such businesses are available for purchase in their entirely only, rarely, and then almost at high prices, something you must run away from. He's basically talking about his general acquisition behavior. As our history indicates, we are comfortable both with total ownership of businesses and with marketable securities representing small portions of businesses that's essentially is mixed right we

continually look for ways to employ large sums in each area but we try to avoid small commitments if something's not worth doing at all it's not worth doing well so he doesn't want to be tepid. He said, if he makes a decision that this is a business he wants to be in, he wants to own as much as he can. So he's actually not done describing why this is important to him. So he, he's the next section I'm going to read to you. It's he's Warren's telling us like, why do other managers not share Warren's belief in buying small portions at better prices instead of paying a premium for the whole company?

He criticizes, like, how often other companies are buying full acquisitions and overpaying. And in a lot of cases, they're giving away shares. So they give away shares of their own great business for a business that's worse. So it kind of compounds a mistake. And Warren notices that behavior in other people and still does it himself. So it's important, again. Okay, so it says, and then i have another quote of myself we have occasionally been quite successful in purchasing fractional interests oh he's got a funny toad

reference this is what i mean about he he says stuff that's rather complex but then gives like a good illustration so you understand his point with a story he's a very good communicator all right it says however we suspect three motivations, usually unspoken, to be used one at a time or in combination, the important ones in most high premium takeovers. So that's a lot of word salad I just did. He's saying we suspect these are the three motivations for why people pay a lot in high premium takeovers. One, leaders, businesses, or otherwise seldom are deficient in animal spirits and often relish increased activity and challenge. At Berkshire, the corporate pulse

never beats faster than when an acquisition is in prospect. It's exciting. That's why they're doing it. It's much harder, but sometimes it's a better decision to just sit on your butt, which, again, goes against our nature. Two, most organizations, businesses, or otherwise measure themselves, are measured by others others and compensate their managers far more by the yardstick of size

than by any other yardstick. Ask a Fortune 500 manager where his corporation stands on that famous list, and invariably the numbers responded will be from the list ranked by size of sales. He may well not even know where his corporation placed on the list. Fortune on the list. Fortune justice basically compiles ranking the same 500 corporations by profitability. So he's saying like you're optimizing for size instead of profitability. It's common.

Number three, many, many management, apparently many managements, apparently were overexposed and impressionable childhood years to the story in which the imprisoned handsome prince is released from a toad's body by a kiss from a beautiful princess. Consequently, they are certain their managerial kiss will do wonders for the profitability of the company, the one that they're targeting. And so what does warren think about that like are they are they successful

in turning all these toads into a prince we've observed many kisses but very few miracles nevertheless many managerial princesses remain serenely confident about the future potency of their kisses even after the corporate backyards are knee-deep in unresponsive toads. See what I mean? That's a really good illustration there. It's like you think you're going to turn around. You're not. It's just going to be a dead toad,

and you're going to be standing knee-deep in a corporate graveyard of acquisitions. This is a good heuristic. For life, no empty talk. Bet. If you believe something, bet on it. It's going to happen. So he says our preaching, he talks about like, oh, we saw this company coming but we didn't do anything about it so he says our preaching was better than our performance we neglected the noah principle predicting rain doesn't count building arcs does so he criticizes himself many many times and he

shared whole letters about knowing something was going to happen but then his brain turns off for a second he just doesn't act on it he He's like, it doesn't make a difference. You can predict that there's going to be a crash or predict there's going to be an increase, predict whatever you think is going to happen. But if you didn't bet on it, if you didn't build arcs, then what's the point? Now we're in the 1980s. This is him elaborating on the advantages of buying fractional portions of great businesses again. I have to repeat this because he repeats it. It's obviously important to him.

This very unevenness and irregularity offers advantages to the value-oriented purchaser of fractional portions of businesses, i.e. people buying stocks. This investor may select from almost the entire array of major American corporations, including many far superior to virtually any of the businesses that could be bought in their entirety in a negotiated deal.

So saying you can own a small portion of a business that's better than the ones that are available for sale. And fractional interest purchases can be made in an auction market where prices are set by participants with behavior patterns that sometimes resemble those of an army of manic depressive lemmings. So not only can you get a better deal, but you can get an even better deal because you're compounding what humans do when they panic. So this is the joy of missing out and the value of patience. As we look at the major acquisitions that others made during 1982,

our reaction is not envy, but relief that we were non-participants. For in many of these acquisitions, managerial intellect wilted in competition with managerial adrenaline. So saying you did it because you got excited, but it wasn't a smart thing to do. The thrill of the chase blinded the pursuers to the consequence of the catch. Pascal's observation seems apt. It has struck me that all men's misfortunes spring from the single cause

that they are unable to stay quietly in one room. And he also says, Your chairman left the room once too often last year and almost started in the acquisition follies of 1982. He caught himself. Our partial ownership approach can be continued soundly only as long as portions of attractive businesses can be acquired at attractive prices. So this is the conditions that,

so he's laying out what his strategy is, but it's not going to work all the time. So these are the conditions that are required for the strategy to work. And if done incorrectly, it can ruin your progress. It's not foolproof. So let me start that again. Our partial ownership approach can be continued soundly only as long as portions of attractive businesses

can be acquired at attractive prices. Don't buy them if it's overpriced or if you're never going to get a return. Or you have to wait too long for the return. Then you did the exact opposite of what you're trying to do. He says, the market does not forgive those who know not what they do. For the investor, a too high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.

So you messed up by paying too much, and now you just wiped away what could have been a decade of profits. Should the stock market advance to considerably higher levels our ability to utilize capital effectively in partial ownership positions will be reduced or eliminated this will happen periodically there's multiple times he's like it's nothing to buy i think right now they're sitting on 112 120 billion dollars something like that so he's going to a period like that now but he's talking about this you know what 40 years ago um the problem with businesses to sell commodity products he talks about this a lot and the expected economic result of such an activity to understand the change we need to look at some major factors that affect levels of corporate profitability

generally businesses and industries with both substantial overcapacity and a commodity product, and he's going to define a commodity product that's undifferentiated in any customer important way by factors such as performance, appearance, service, or support, are prime candidates for profit troubles. These may be escaped, true, if prices or costs are administered in some manner

and thereby insulated at least partially from normal market forces. So he's talking about the insurance industry. If, however, costs and prices are determined by full-bore competition, there is more than ample capacity and the buyer cares little about whose product or distribution services he uses. Industry economics are almost certain to be unexciting. They may well be disastrous. There's nothing protecting you. So all of your profits are going to be competed away. Hence the constant struggle of every vendor to establish and emphasize special qualities of product or service.

This works with candy bars. Customers buy a brand name, not by asking for a two-ounce candy bar, but doesn't work with sugar. How often do you hear, I'll have a coffee with a cream and C&H sugar, please? In many industries, differentiation simply can't be made meaningful. A few producers in such industries may constantly do well if they have a cost advantage that is both wide and sustainable.

By definition, such exceptions are few, and in many industries are non-existent. So this is very rare. It's hard to find. For the great majority of companies selling commodity products, a depressing equation of business economics prevails. Persistent overcapacity without administrated prices or cost equals poor profitability. So it's the expected economic result of such activity. Okay, so this is him talking again now

about don't optimize for growth and action if you're worse off after you take the action for growth. And then common rationalizations heard and a story to illustrate his point. He says, the thirst for size and action is strong enough. The acquirer's manager will find ample rationalizations for such a value-destroying issuance of stock, meaning buying a poor company with your valuable company stock. Friendly investment bakers will reassure him

as to the soundness of his actions. But don't ask the barber whether you need a haircut. A few favorite rationalizations employed by stock-issuing managers follow. So he says, this is the reason they tell you they have to buy,

they make poor acquisitions. We have to grow, and then this is the reason they tell you they have to buy, that they make poor acquisitions. We have to grow. And then this is now Warren's answer to that. Who, it might be asked, is the we? For present shareholders, the reality is that all existing businesses shrink when shares are issued. Were Berkshire to issue shares tomorrow for an acquisition, Berkshire would own everything that it owns now plus the new business,

but your interest in such a hard-to-match businesses as See's Candies acquisition, Berkshire would own everything that it owns now, plus the new business. But your interest in such a hard to match businesses as See's Candies and the other ones would automatically be reduced. If your family, and this is the illustration of the story that's going to make his point make more sense. And then keep in mind what he's describing, he does exactly this. He buys Dexter Shoe Company for stock. And instead of paying a couple hundred million or whatever it would have been in cash, it winds up being like a $5 billion mistake. So again, you can know this, and it's good for us to understand this, but understanding is not enough.

We have to actually act on the information that we're learning here. So it says, here's the story. If your family owns a 120-acre farm and you invite a neighbor with 60 acres of comparable land to merge his farm into an equal partnership, then your managerial domain will have grown to 180 acres, so overall size is better, right? But you will have permanently shrunk by 25% your family's ownership interest in both acreage and crops. Managers who want to expand their domain at the expense of owners might better be considered a career in government. So he's saying, like, don't do it. What you're doing is you're growing in size,

but now you're making all your shareholders fundamentally less wealthy, which is the opposite of what you should be doing. This is just a great quote. We will not equate activity with progress or corporate size with owner wealth? Warren is the next, this next thing. He always talks about world headquarters, which is hilarious because it's like there's barely any people there

given the size of the company. And I just wrote Warren is hilarious and confident. In a characteristically rash move, we have expanded world headquarters by 252 square feet and increased by 17 coincidental with the signing of a new five-year lease the five people who work here with me and list them all outproduce corporate groups many times their number a compact organization lets all of us spend our time managing the business rather than managing each other it's another way to say he hates bureaucracy. Charlie Munger, my partner in management, will continue to operate from Los Angeles.

Whether or not the blue chip merger occurs, it obviously occurs later. Charlie and I are interchangeable in business decisions. Distance impedes us not at all. We've always found a telephone call to be more productive than a half-day committee meeting. Warren on how Berkshire uses debt. We rarely use much debt, and when we do, we attempt to structure it on a long-term fixed-rate basis.

We will reject interesting opportunities rather than over-leverage our balance sheet. He doesn't want to get himself into a precarious position. This conservatism has penalized our results, but it is the only behavior that leaves us comfortable. So that's what I mentioned earlier, how he'll optimize for his ability to sleep at night and a few extra percentage points in profit.

So this is what he calls the gin rummy management. And he says it's not their style. This is a great, I must have really liked this part because I put it on all caps, and contrarian point. Let's see what I meant. Okay, you should be fully aware of one attitude Charlie and I share that hurts our financial performance.

Regardless of price, we have no interest at all in selling any good business that Berkshire owns and are very reluctant to sell subpar businesses as long as we expect them to generate at least some cash and as long as we feel good about the managers and labor relations. We hope not to repeat the capital allocation mistakes that led us into such subpar businesses and we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures, meaning money is not the solution here. The projections will be dazzling.

The advocates will be sincere. But in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand. Nevertheless, gin-rummy managerial behavior, which he defines as discard your least promising business at each turn, is not our style. We would rather have our overall results penalized a bit than engage in it. Okay, I need to tell you about Mrs. B, Mrs. Blumpkin. The story is incredible. This story is incredible.

This is absolutely incredible. Okay, so this is how they come to own the Nebraska Furniture Mart. Last year in discussing how managers with bright but adrenaline-soaked minds scramble after foolish acquisitions, I quoted Pascal. It has struck me that all the misfortunes of men spring from the single cause that they are unable to stay quietly in one room. Okay, so he's quoting Pascal here. Even Pascal would have left the room for Mrs. Blomkin. All right, so this is a story of Mrs. Blomkin. This is blow your mind. About 67 years ago, Mrs. Blomkin, then 23, talked her way past the border guard to leave Russia for America.

She had no formal education, not even at the grammar school level, and knew no English. After some years in this country, she learned the language when her older daughter taught her every evening the words she had learned in school during the day. In 1937, after many years of selling used clothing, Mrs. Blumpkin had saved $500 with which to realize her dream of opening a furniture store. Upon seeing the American Furniture Mart in Chicago, then the center of the nation's wholesale furniture activity, she decided to christen her dream Nebraska Furniture Mart. She met every obstacle you would expect and a few you wouldn't. When a business endowed with only $500 in no location or product, Advantage goes up against rich, long-entrenched competition. Oh, sorry. I put the emphasis wrong on the wrong word there. So she met every obstacle you would

expect when a business endowed with only $500 goes up against rich, long-entrenched competition. At one early point, when her tiny resources ran out, Mrs. B coped in a way not taught at business school. She simply sold the furniture and appliances from her home in order to pay her creditors precisely as promised. Omaha retailers began to recognize that Mrs. B would offer customers far better deals than they had been giving, and they pressured furniture and carpet manufacturers not to sell to her. But by various strategies, she obtained merchandise and cut prices sharply. Mrs. B was then hauled into court for a violation of fair trade laws. She not only won all the cases, but received invaluable publicity.

She got sued because she was selling merchandise too cheap. How funny is that? And what do you think is the end result of that? Publicity is going to be. At the end of one case, after demonstrating to the court that she could properly sell carpet at a huge discount from the prevailing price, she sold the judge $1,400 worth of carpet. Today, Nebraska Furniture Mart generates over $100 million of sales annually

out of one 200,000 square foot store. No other home furnishing store in the country comes close to that volume. That single store also sells more furniture, carpet, and appliances than all the other Omaha competitors combined. One question I always ask myself when appraising a business is how I would like, assuming I had ample capital and skilled personnel, to compete with it. I'd rather wrestle grizzlies than compete with Mrs. B and her progeny. Her family runs a business with her. They buy brilliantly. They operate at expense ratios competitors don't even dream about. And then they pass on to their customers much of the savings. It's the ideal

business, one built upon exceptional value to the customer that in turn translates into exceptional economics for its owners. Mrs. B is wise as well as smart for farsighted family reasons. She was willing to sell the business last year. I had admired both the family and the business for decades, and a deal was quickly made. But Mrs. B, now 90 years old, is not one to go home and risk, as she puts, losing her marbles. She remains chairman and is

on the sales floor seven days a week carpet sales are her specialty so she's she's poor has no formal education at all starts a business for 500 that she saves up selling used clothes and works at the business every day and eventually does over $100 million in sales annually. Oh, and she continues working every day, or she continues working until she's 103, right up until the point she dies. This is one of the craziest stories I've ever come across. One question I ask myself in appraising a business

is how I would like, oh, I already read that part. He says he'd rather wrestle grizzlies. I thought that story was incredible. All right, so this is... Okay, so even Warren Buffett makes a lot of mistakes, something I'll highlight a lot. So now we're talking more about their insurance operations. We both operate insurance companies and have a large economic interest in insurance we don't operate, Geico.

The result for all can be summed up easily. In aggregate, the companies we operate in whose underwriting results reflect the consequences of decisions that were my responsibility had absolutely terrible results. Fortunately, Geico, whose policies I do not influence, simply shot the lights out. The inference you draw from this summary is the correct one. I made some serious mistakes a few years ago that came home to roost. other quotes of his on the circle of competence but he definitely knows the circle of competence and stays within it and it says a lot about having your ego unchecked um and it says he's like these guys are way better running this business than me so let me just give them like remove all obstacles out of their way and give them the the financial like resources they need to do though um so not only does munger always say you should react to equanimity about price decreases but you should

also for wild price increases especially just comparing it on like a yearly basis. So it says, now we're in 1985. You may remember the wildly upbeat message of last year's report. Nothing much was in the works, but our experience has been something big popped up occasionally. This carefully crafted corporate strategy paid off in 1985, meaning they don't know what the opportunity is going to be in advance, but they're just prepared for when they do come. And that happened. It says our gain in net worth during this year was 600 million or 48%. It is fitting that the visit of Haley's Comet coincided with this percentage gain. Neither will be seen again in my lifetime. I don't know if they ever get close

to 48%, but their absolute numbers become monstrous. So, I mean, I guess he's technically correct, but he continues to put up some amazing numbers. Um, while this is why Charlie and Warren are optimistic about achieving return higher than most American corporations, we have several things going for us. One, we don't have to worry about quarterly or annual figures, but instead can focus on whatever actions will maximize long-term value to, we can expand the business into any areas that make sense. Our scope is not circumscribed by history, structure, or concept. And three, which is extremely important and extremely rare, we love our work. This is him on closing down the textile business.

I won't close down businesses for subnormal profitability merely to add a fraction of a point to our corporate rate of return. However, I also feel it inappropriate for even an exceptionally profitable company to fund an operation once it appears to have unending losses and prospects. So that's different. If it's making a little bit of money and it's not returning, let's say it's returning zero or one percent or one percent or whatever the case is i'm not gonna shut it down but if he's losing 10 15 if i'm

losing money every year then i have to this is what happened with um with the textile mills so he's finally getting out of it um so he says however i also feel inappropriate for an exceptionally profitable company to fund an operation once it appears to have unending losses and prospect adam smith would disagree with my first proposition and car. Adam Smith would disagree with my first proposition, and Karl Marx would disagree with my second. The middle ground is the only position that leaves me comfortable. He's still talking about it. So the market you're in matters most. That's the quote from Marc Andreessen.

Sometimes it's better to switch to a different game than keep trying to improve the one you're in. Opportunity costs is how smart people make decisions. That's a quote from Charlie Munger. So it says, to switch to a different game and keep trying to improve the one you're in. Opportunity costs is how smart people make decisions. That's a quote from Charlie Munger. So it says, my conclusion from my own experiences and from much observation of other businesses is that a good managerial record

is far more a function of what business boat you get into than it is how effectively you row. Some years ago, I wrote, when a management with a reputation for brilliance tackles a business reputation for poor fundamental economics is a reputation of the business that remains intact nothing has since changed my point of view on that matter should you find yourself in a chronically leaking boat energy devoted to changing vessels is more likely to be more productive than energy devoted to patching leaks.

And that's exactly the situation he found himself in the textile industry. Question the conventional thinking because history shows it changes, meaning that it was wrong. Okay, let's see what this means. Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they should buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly fashioned theory.

The new theory that they were preaching that the stock market was totally efficient. And let me just stop, pause here. He's going to pick on like business schools and academics a lot he finds a lot of the stuff uh charlie munger's quoted like a lot of the stuff you learn in business schools twaddle and they pick on them a lot i mean not not undeservingly um but they're like you know we're what you're teaching in theory is now what we're seeing in practice so now he he's going to disagree heavily with the idea that the stock market is totally efficient. He's like, this is obviously not true. And therefore, calculations of business value, and even though itself were of no importance in investment activities, we are enormously indebted to those academics.

What could be more advantageous in an intellectual contest, whether it be bridge, chess, or stock selection, than to have opponents who have been taught that thinking is a waste of energy. This is now Warren's philosophy on managing businesses, which I may have mentioned on the podcast with David Ogilvie. I'm also going to be doing his biography soon because Warren likes to quote from him. And so I'm going to move it ahead in the stack

and that should be done in the next week or two. So he says, we subscribe to the philosophy of the founding genius, David Ogilvie. If each of us hires people who are smaller than we are, we shall become a company of dwarfs. But if each of us hires people who are bigger than we are, we should be a company of giants. A byproduct of our managerial style is the ability it gives us to easily expand Berkshire's activities. We've read management treatises

that specify exactly how many people should report to any one executive, but this makes little sense to us. When you have able managers of high character running businesses about which they are passionate, you can have a dozen or more reporting to you and still have time for an afternoon nap. Conversely, if you have even one person reporting to you who is deceitful, inept, or uninterested, you will find yourself with more than you can handle. This is Warren talking about how low costs can expand your moat. In other words, he's telling us to be frugal. The most important ingredient in Geico's success is rock bottom operating costs, which set the company apart from literally hundreds of competitors that offer auto insurance. The total of Geico's underwriting

expense and loss adjustment expense is, I'm just going to tell you, the number is 23% of premiums. Many major companies show percentage points 15, show percentages 15 points higher than that. loss adjustment expense is, I'm just going to tell you the numbers, 23% of premiums. Many major companies show percentage points, show percentages 15 points higher than that. So 20% of the money that, 20% of the, it costs them 20% of their premium to write the policy as opposed to, what would that be? 40, no, not 40. What are you talking about? Can't do math 38 it's a big it's 15 it's a giant difference right the difference between geico's costs and those of

its competitors is a kind of moat that protects a valuable much sought after business castle no one understands this moat around the castle concept better than bill snyder chairman of geico he continually widens the moat by driving down costs still more, thereby defending and strengthening this economic franchise. So he's talking about Bill Snyder. Later, this guy named Tony. I thought, what the heck? I thought Tony, oh, that's a chairman. I think Tony's the CEO at this point. Okay, so watch your costs is what he's telling us there. This is a lesson from studying human nature. Fear and greed will forever occur in investment communities. Common stocks, of course, are the most fun.

When conditions are right, that is, when companies with good economics and good management sell well below an intrinsic business value, stocks sometimes provide grand slam-hole runs. But we currently find no equities that come close to meeting our tests. This statement in no way translates into a stock market prediction. We have no idea and never have had an idea whether the market is going up, down, or sideways in the near or intermediate term future. What we do know, however, is that occasional outbreaks of those two super contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable,

and the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful. So he's saying, the next section is basically saying, hey, most businesses are either poorly run or averagely run. And that's expected. No one said that it's supposed to be easy. It's not easy. So he says, our major

contribution to the operations of our subsidiaries is applause but it is not the indiscriminate applause of a pollyanna rather it is informed applause based on upon the two long careers we have spent intensively observing business performance and managerial behavior charlie and i have seen so much of the ordinary in business that we can truly appreciate a virtuoso performance so one one thing that he talks about and almost actually in every letter is he's constantly giving credit to the managers usually by name um over and over again so that's what they're saying it's like listen our managers the people the ceos running the businesses that we own they're all stars and the reason we know they're all stars because most of the businesses that we observe, it's average, which, of course, makes sense.

This is advice from David Ogilvie. Charlie and I have long followed David Ogilvie's advice. Develop your eccentricities while you're young. That way, when you get old, people won't think that you're going gaga. This is why Berkshire continues to run their business conservatively and avoid high levels of debt and leverage. So it says, We do not wish it to be only likely that we can meet our obligations.

We wish that to be certain. It's the margin of safety. Thus, we adhere to policies both in regard to debt and all other matters that will allow us to achieve acceptable long-term results under extraordinary adverse conditions rather than optimal results under a normal range of conditions. He just got done telling us that you can't predict the degree or when they will occur, like these contractions. So I can't run a business that only works under

normal conditions. I have to run it under extraordinary adverse conditions as my default. Good business or investment decisions will eventually produce quite satisfactory economic results with no aid from leverage. Therefore, it seems to us to be both foolish and improper to risk what is important for some extra returns that are relatively unimportant. This view is not the product of either our advancing age or prosperity. Our opinions about debt have remained constant. I love this quote. He's talking about accounting rules, but I think this applies to the creation

and management of businesses as well. There's many ways to succeed at it. The business world is simply far too complex for a single set of rules to effectively describe economic reality for all enterprises. If anybody tells you, this is the key,

just follow this and you're going to be successful, they're lying to you. It's way too complex. That's why I think if you look at the actions of Buffett and Munger, they're famous for reading a lot of biographies. And I think they do that. I mean, they could be learning from literally anybody in the world, and they definitely do. And they still choose to read life stories,

essentially what we're doing here on this podcast. Same thing. It's because you understand that these situations are dynamic and exposing yourself to a variety of dynamic situations. You pick up all kinds of useful ideas that you might not even use five years, ten years down the line. But when something does pop up where the ideas of other people's life experience are helpful, you're going to be glad that you read these books and listened to these podcasts. I love that.

They understand the chaos and the randomness that they're operating in. All right, time as a filter. Again, experience over time is greater than academic education. At Berkshire, associations like these last a long time. We do not remove superstars from our lineup merely because they've attained a specific age. Now he's going back to CEOs and managers. Whether the traditional 65 or the 95 years of age reached by Mrs. B on the eve of Hanukkah in 1988.

So bird managers are too scarce of resources to be scarred simply because a cake gets crowded with candles. Moreover, this is what I mean about experience over time is more valuable than academic education and again why would they read all these biographies in fact one of the books i just ordered that he read he talks about in his um one of his shareholder letters later on he reads this guy's autobiography and then he buys the he like and he buys the guy's business clayton homes i'll get there in a minute or i don't even know when it's in sometime in the future um okay so so

superb managers are too scarce a resource to be discarded simply because the cake gets crowded with candles. Moreover, our experience with newly minted MBAs has not been that great. Their academic records always look terrific and the candidates always know just what to say, but too often they are short on personal commitment to the company and general business savvy. It is difficult to teach a new dog old tricks.

So he uses time as a filter If this guy, this woman Has successfully run this business And most of them started the business And done it for a very long time It's likely that they have knowledge That you cannot replicate Just by going to get an MBA for a few years

I have a long note here He buys Freddie Mac's stock to get an MBA for a few years. I have a long note here. He buys Freddie Mac stock and says will hold forever. He sells a few years before the financial crisis. Why? Asked if he sold stocks because the stocks were no longer good investments. Buffer responded that he didn't know they weren't going to be good investments but became concerned about – so now he's –

okay, so this is other research I had to do outside of the shareholder letters. Cause he talked, he talks about how the risk is building up for Fannie and Fannie Mae and Freddie Mac. And then eventually sells before they always explode a few years later. And he's not usually, he doesn't usually buy things to try to sell like that. So anyways, after he sells, he's asked why. And he said he became concerned about their management. Remember, he needs honest and managers with

integrity. And he felt the management there stopped being such. He says they were trying to and proclaiming that it could increase earnings per share in some low double digit range, something of that sort, Buffett said. And any time a large financial institute starts promising regular earning increases, you're going to have trouble, you know? Management's promises seemed impossible to keep, and the doubt it cast on their ability to make scrupulous decisions in the future was enough for Buffett to sell. I mean, it isn't given to man to be able to run a financial institution

where different interest rate scenarios will prevail on all that is to produce some kind of smooth regular earnings from a very large base to start with this is buffett talking and so if people are thinking about thinking about it that way they're going to do things maybe in accounting as it turns out to be the case in both freddie and fanny but also in operations that i regard as unsound and i don't know when it will happen i don't even know for sure it will happen, if it will happen. It will happen eventually if they just keep that policy and so we just decided to get out. When he questioned the lender about his decision,

so he also asked him, he's like, why are they diversifying to hold, they invest in bonds like a cigarette maker and so Buffett's like, he asked the manager, why did you do that? He did not like like the response uh he says they gave me some half-baked explanation about how to increase it increase liquidity which was just nonsense um and then what what what i what i took away from this then i have another note sorry this is the longest note i think i have an entire podcast the moral of it now this is me writing have another note. Sorry, this is the longest note I think I have in the entire podcast. Now, this is me writing.

The moral of this story to me is that at some point, you're going to have to put in the work to get to the ability to think for yourself. Oh, my goodness. This is terrible writing. The moral of the story to me is at some point, you're going to have to put in the work to get your ability to think for yourself to the level to which you trust your own judgment. Oh, my God.

That's a terrible, terrible writing on my part. I apologize that you have to hear this. This isn't automatic. What I'm trying to say there is that Buffett had put in a lot of work to get to the point where he can actually understand if other people are bullshitting him about something. And he believes in his gut. Now, sometimes he'll admit that gut, gut for lack of a better word, but he believes in his ability to analyze businesses. And when he finds holes in the way other people are analyzing businesses that he's ownership in, he realizes that may be hiding something. And so he gets out.

That's what I mean about this isn't automatic. Like at some point, it's going to come down to the starting a business. Like you have to believe in what you're doing. You have to believe in your strategy or it's not going to work out. You're in charge of it. You see what I'm saying? Buffett's not – it's not like somebody can tell Buffett what to do. At the end of the day, the ownership – he's responsible for the performance of Berkshire.

And he keeps himself in line with this, which I'll talk about later, but he keeps a very large percentage of his own net worth in, I mean, essentially he has almost all of, I mean, it's a large, obviously, net worth, but it's in one asset, and that's Berkshire. It's pretty crazy the level of skin in the game this guy has, I guess my point. So that was a long, I need to get to what we're talking about. So it says, in 1988, we made major purchases of Freddie Mac and Coca-Cola. We expect to hold these securities for a long time. In fact, when we own outstanding businesses with outstanding management, our favorite holding period is forever.

That's what I mean. It's like, why did he, he says it's forever, but why did he sell it? So what I just told you happened in the future, years after where I'm at in the actual shareholder letters. I just wanted to understand because I know he didn't get burned by that and I've heard about it before and I wanted to understand why. We are just the opposite of those

who hurry to sell and book profits when companies perform well, but who tenaciously hang on to businesses and disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds. Our holdings of Freddie Mac are the maximum allowed by law.

So he winds up getting rid of that a few years later. Actually, about 12 years from now, 10 years, maybe around there. Oh, so same thing here. Like he invested $700 million in Salomon Brothers, but I read Michael Lewis's book, Liar's Poker, and this guy John Gutfried, who Warren references all the time,

this is him making a big mistake. So he says, the close association we have had with John Gutfried, CEO of Salomon, during the past year has reinforced our admiration for him, but we continue to have no great insights about the near, intermediate, or long-term economics of the investment banking business. This is not an industry in which it's easy to forecast future levels of profitability.

So they invest $700 million in Salomon Brothers. A few years later, Salomon Brothers gets caught rigging treasury bond bids. John gets kicked out, and Warren has to serve as the CEO or maybe the chairman. Maybe he's the interim CEO, something like that. But he has to leave Berkshire and do this for several months. So, again, just another illustration that no one's perfect. know he didn't want this to happen and it happened um and sometimes you're bad at i don't think he i don't necessarily think he blamed i mean john obviously ceo so if something happened in the business it's his responsibility you know but i don't know if

he endorsed the illegal behavior but he certainly was the one held responsible for it. Okay, so now he's going to talk more about his opinion about how wrong efficient market theory is. And this section just reminds me, like, the importance of knowing the difference between what people say something is versus what you actually observe it to be. And language can be very imprecise, and sometimes humans mislead on purpose. And so his point is, like, let's just look at what they're saying to be. And language can be very imprecise and sometimes humans mislead on purpose. And so his point is like let's just look at what they're saying to us. Like is that actually is that theory hold up in the real world? So he says

he talks about this is going to make for a small discussion on EMT which is efficient market theory. He says this doctrine became highly fashionable indeed almost holy scripture in academic circles during the 1970s. Essentially, he said that analyzing stocks was useless because all public information about them was appropriately reflected in their prices. What a weird.

That's just bizarre. In other words, the market always knew everything. As a corollary, the professors who taught EMT said that someone throwing darts at the stock tables could select a stock portfolio having prospects just as good as one selected by the brightest, most hardworking security analysts. Amazingly, EMT was embraced not only by academics, but by many investment professionals and corporate managers as well. Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between those proposals is night and day. In my opinion, the continuous 63-year arbitrage experience at Graham Newman Corp, where he used to work, Buffett Partnership, which is his company before he started Berkshire,

and Berkshire illustrates just how foolish EMT is. There is plenty of other evidence too. Yet proponents of the theory have never seemed interested in discordant evidence of this type. True, they don't talk quite as much about their theory today as they used to, but no one, to my knowledge, has ever said it was wrong, no matter how many thousands of students have been sent forth misinstructed. EMT, moreover, continues to be an integral part of the investment curriculum at major business schools. Apparently, a reluctance to recant and thereby to demystify the priesthood is not limited to theologians. the disservice done students and global investment professionals who have swallowed EMT has been an extraordinary service to us and other followers of Graham. In any sort of a contest, financial, mental, or physical,

it's an enormous advantage to have opponents who have been taught that is useless to even try. Oops. Okay, so now we're moving now we're all the way almost in the 1990s all right so make money but don't forget you're living life it is a better way to spend your time with people you enjoy instead of people you won't even if people you wouldn't enjoy could make you money he says indeed it is possible we could earn even greater after-tax returns by moving rather frequently than one investment to another.

Many years ago, that's exactly what Charlie and I did. Now we would rather stay put even if that means slightly lower returns. Our reason is simple. We have found splendid business relationships to be so rare and so enjoyable that we want to retain all we develop. This decision is particularly easy for us because we feel these relationships will produce good, though perhaps not optimal financial results. Considering that, we think it makes little sense for us to give up time with people we know to be interesting and admirable for time with others we do not know and who are likely to have human qualities far closer to average.

That would be akin to marrying for money, a mistake under most circumstances, but insanity if one is already rich. Oh, so now he's going to give us his mistakes of the first 25 years of running Berkshire. And this is the condensed version. I love this idea. My first mistake, of course, was in buying control of Berkshire. Though I knew it business textile manufacturing to be unpromising,

I was enticed to buy because the price looked cheap. Stock purchases of that kind have proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965, I was becoming aware that the strategy was not ideal. First, the original bargain price probably would not turn out to be such a

steal after all. In a difficult business, no sooner is one problem solved than another surfaces. Never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million immediately, then you can realize a high return. But if the investment will disappoint, if the business is sold for $10 million 10 years from now, you just basically lost a lot of money. Like that's fine. You can make $2 million really fast or you can make $2 million really slow. You need to be optimizing for making it fast. Time is the friend. This is one of the most important

quotes in the entire shareholder letters. Time is the friend of the wonderful business and the enemy of the mediocre. And don't forget your goal here is to build a wonderful company, not just like a commodity, you know, business the same as everybody else. And if you are in a business like that, use some of Buffett's ideas to add to differentiation, even if it's just on cost. I could give you another personal example of bargain purchase folly but I'm sure to let to I'm sure you get the picture it is far better to buy a wonderful company at a fair price and a fair company at a wonderful price

Charlie understood this early I was a slow learner but now when buying companies or common stocks we look for first-class businesses as a company by first-class management and he says this leads right into a related lesson good jockeys do well on good horses but not on broken down nags i've said many times in a management with a reputation for brilliance tackles the business reputation about an economics it's a reputation the business that remains intact he repeats it a lot i had i've said it to you probably two or three times too, so we got to remember that. I just wish I hadn't been so energetic in creating examples. A further related lesson, easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have learned not or have not learned how to solve difficult business problems. What we have learned is to avoid them. That's a good idea, right? To the extent we've been successful, it is because we've concentrated on identifying one-foot hurdles that we could step over rather than acquiring any ability to clear seven-footers.

The finding may seem unfair, but in both business and investment, it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult. My most surprising discovery, the overwhelming importance in business of an unseen force that we might call the institutional imperative. And so he's going to give examples of what the institutional imperative is. He says, I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions, but I learned over time that isn't so. Instead, rationality frequently wilts when the institutional imperative comes into play. For example, as if governed by Newton's first law of motion,

an institution will resist any change in its current direction. That was the first example. Number two, just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds. And another example, the behavior of peer companies, whether they are expanding, acquiring, setting executive compensation, or whatever, will be mindlessly imitated. So that's the examples of institutional imperative, and those are the ones you want to avoid. So institution will resist change in current direction.

Work will expand to fill up time and fill up financial resources, and the behavior of peer companies are sure to be imitated. So that's what impedes a smart person from making rational decisions. This is him telling us that he doesn't take and Berkshire doesn't take tail risks. Another way to think about that is risk of ruin, absolute ruin. A risk that you might make money, let's say 99% chance to make a billion dollars, but you have a 1% chance to lose everything. He's not taking that risk. Our consistently conservative financial policies may appear to have been a mistake, but in my view, we're not.

In retrospect, it is clear that significantly higher, though still conventional, leverage ratios at Berkshire would have produced considerable better returns, right? So if we had more leverage, we would have made more money. That's true, he's saying. Perhaps we could have judged that there'd be a 99% probability that higher leverage would lead to nothing but good. Correspondingly, we might have seen only a 1% chance that some shock factor,

external or internal, would cause a conventional debt ratio to produce a result failing someone between temporary anguish and default, meaning he's done. We wouldn't have liked those 99 to 1 odds and never will. A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns.

If your actions are sensible, you are certain to get good results. In most such cases, leverage just moves things along faster. Charlie and I have never been in a big hurry. We enjoy the process far more than the proceeds, though we have learned to live with those also. We hope in another 25 years to report on the mistakes of the first 50. If we are around in 2015 to do that, you can count on this section occupying many more pages than it does. And directly related to them not taking tail risk is the fact that they made it to 2015. How cool is that?

And the very next year, we're dealing with businesses that did not follow. They were not conservative, like Warren suggests to do. So he's telling us here that your business should have a buffer to deal with future uncertainty. So he says, in 1990, even before the recession dealt its blow, the financial sky became dark 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 to focus their efforts as never before. Much as a dagger mounted on the steering wheel of a car could be expected to make its driver proceed with intensified care. We'll acknowledge that such an attention getter would produce a very alert driver, but another certain consequence would be deadly and unnecessary. So there'd be an accident if the car even hit the tiniest pothole or slower ice. The roads of business are riddled with potholes. A plan that requires dodging them all is a plan for disaster. It's impossible. In the final chapter of Intelligent Investor,

Ben Graham forcibly rejected the dagger thesis. That's a quote from the book. Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, margin of safety. 42 years after reading that, I still think those are the right three words. He talks a lot about avoiding commodity businesses, and this is a great quote on that.

In a business selling a commodity-type product, it's impossible to be a lot smarter than your dumbest competitor. The fact is that newspaper, television, and magazine properties have begun to resemble businesses more than franchises in their economic behavior. Now we're in the 90s, so already there's a continued softening of some media companies.

There's going to be increased competition with the internet. But the main point here applies to all different kinds of businesses. So the idea is like, well, let me just finish reading what he talks about. You want a business that looks more like a franchise than a business, and not a franchise like I'm buying a McDonald's franchise.

He says, let's take a quick look at the characteristics separating the two classes of enterprise, keeping in mind, however, that many operations fall in some middle ground and can be best and can be best as described and can best be described as weak franchises or strong businesses. So this is going to lay out what a franchise is. An economic franchise arises from a product or service that, one, is needed or desired, two, is thought by its customers to have no close substitute,

and three, it's not subject to price regulation. The existence of all three conditions will be demonstrated by a company's ability to regularly price its product or service aggressively and thereby earn high rates of return on capital. Most commodity businesses have no control over what they're going to charge. regularly price its product or service aggressively and thereby earn high rates of return on capital. Most commodity businesses have no control over what they're going to charge. Moreover, franchises can tolerate mismanagement. Inept managers may diminish a franchise's profitability, but they cannot inflict mortal damage. Those are important characteristics.

Now he moves on to describing what most businesses fall into, and that's just like a business. In contrast, a business earns exceptional profits only if it's a low-cost operator or if its supply of its product or service is tight. Tightness and supply usually does not last long. With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then, unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management. So a franchise has a product that's needed or desired.

It's thought of by its customers to have no close substitute. And I can't just give the dollar I was going to give you to somebody else and get the exact same thing. And three, it's not subject to price regulation. So that's what you should be going for. Okay. So he's using the example of See's Candies as a franchise. This is important. Ownership of See's has taught us much about the evaluation of franchises. We've made significant money in certain common stocks because of the lessons we've learned at Seas. Seas is definitely a franchise. It's not like, oh, I'll have a Seas candy bar. Oh, they don't have it. I'll take your next one. No,

they want Seas. And as a result, people are willing to pay more for that product. It's amazing how much money you can make at candy. When they bought it, I think it was like, they were making like 4 million a year at Seas. I think I looked up last year. They made like $90 million selling candy in profit. Like it's something crazy like that. It's amazing to me. I always forget. You kind of – and that's another great thing about reading all these shareholders.

He just talks constantly about numbers of businesses. Like, oh, yeah, I have this business over here. Something you never heard of that manufactures something that you need in house construction. Guess what? They made $300 million last year. Like just that there's a largest seller of like carpet in America makes like $5 billion a year. The numbers are just amazing when you think of like the size,

how big markets are. You kind of forget that there's a lot of unsexy businesses that make tons and tons of money. And a lot of them Burschauer owns. Oh, this is like a he's funny these are the kind of businesses that they don't like and they don't want to invest in a line from a country song expresses our feelings about new ventures so you don't like startups turnarounds they've talked about that are auction like sales when the phone don't ring you'll know it's me so they don't they don't want to invest in that.

Oh, I love this idea. He looks at it. He says, listen, there's no correlation between the high corporate cost and good corporate performance, which means just because you're spending more money on operations doesn't mean you're going to make more money. At some companies, corporate expenses run 10% or more of operating earnings. This tithing that the operations thus makes to headquarters not only hurts earnings, but more importantly, slashes capital capital values he's telling us to be frugal again if the business that spends

10 on headquarter cost achieves earnings at its operating levels identical to those achieved by the business that occurs only one percent meaning one business is spending 10 on overhead one business is spending one shareholders of the first enterprise suffering nine percent loss in the value they're holding simply because of corporate overhead. Charlie and I observe no correlation between high corporate costs and good corporate performance. In fact, we see the opposite. We see the simpler, low-cost operation

as more likely to operate effectively than its bureaucratic brethren. And their own. I think their headquarters is like 1-tenth of 1% of costs. So some are doing 10. He's giving an example of 1%. They're 10 times less than that. That's insane.

They are long on cash right now. This may help explain how they look at such situations. Okay, so this is happening in 1983. Right now, markets are difficult, but they can and will change in unexpected ways and at unexpected times. We've heard this before. In the meantime, we will try to resist the temptation to do something marginal simply because we are long on cash. There's no use running if you're on the wrong road. And what I meant by that is right now, in present day at the time I'm recording this,

they're long on cash. So this is something they've done many times throughout their corporate history, and it gives you an idea of why, like they're describing why they're doing it in 1983, that the answers are probably similar to why they're doing it now. Another example, it only takes a few,

the quote I always say from them, I think it's from Charlie Munger, it might be from Buffett, but it only takes a few wonderful businesses quote I always say from them, I think it's from Charlie Munger, might be from Buffett, but it only takes a few wonderful businesses in a lifetime to become wealthy. Charlie and I decided long ago that in an investment lifetime, it's just too hard to make hundreds of smart decisions. That judgment became even more compelling as Berkshire's capital mushroomed and the universe of investments that can significantly affect our results

shrank dramatically. Therefore, we adopted a strategy that required our being smart and not too smart at that only a few times. They don't think they can get it right on a few businesses, and even a few great businesses are going to pay for many, many mistakes. This is more on diversification and its relation to risk. Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes

it's in his interest to be a long-term owner of American industry. So he's telling you what to do if you're not, just buy the index. If you don't know what you're doing, just buy the index. The fees are low and you're going to grow as American industry grows. That investor should own a large number of equities and space out his purchases by periodically investing in an index fund. For example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when dumb money acknowledges its limitation, it ceases to be dumb. So he's saying there's nothing wrong.

It takes a lot of learning and reading and skill to do what we're doing. And if you're doing something else, then just buy the index. It's fine. It's not dumb money when you acknowledge your limitation. You're not dumb anymore. On the other hand, if you are a know-something investor, which is what him and Charlie are, and able to understand business economics and to find

five to ten sensibly priced companies that possess important long-term competitive advantages conventional diversification makes no sense for you that's why they talk so much crap about it it is app it is app simply to hurt your results and increase your risk i cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding the money to his top choices the businesses he understands best and that present the least risk along with the greatest profit potential in the words of the prophet may west too much of a good thing can be wonderful and so i'm going to run over my point because it's one of the craziest things that i learned from any shareholder letters is that war Warren Buffett for a long time has had

over 99% of his net worth in Berkshire. Now, Berkshire in and of itself is diversified to a bunch of other businesses that they own and everything else, but think about that. Listen to what he just said here. I cannot understand why an investor of that sort likes to put money into a business that is his 20th favorite rather than simply adding that money to one of his top choices, the business he understands best. Well, what businesses does he understand best? The one he's running. That's why I think personal finance advice for entrepreneurship is really, really flawed. In many cases, it goes against the grain. If you have a wonderful business, what did Andrew Carnegie tell us? Study how all the world's great

fortunes have been built. It's not a scattershot approach. He's like, put all your eggs in one basket and watch that basket. Buffett is doing that. Munger is doing that. They have an insane amount of skin in the game. They put almost all of their family's assets into their company. So again, what happens if you put all your family's assets into a company that's going to go bankrupt? Don't do that. But if you know that you have a good business,

you know it's profitable, especially if it's a private business, you have information about your business no one else has. Why are you investing in other things? Why are you picking your 20th best guess? Go for number one. Again, that's very counterintuitive.

It goes against everything other normal people do with their money it's it it's very very um I don't know I I understand it's risky advice but I think it's the correct advice if you have some kind of information advantage and you and you were running a business and you own large percent of that business and it's working what what other investment is going to generate more money than that? Very few, if any. So you kind of have to know. Too much of a good thing can be wonderful.

This is his whole point. And again, it may go against your natural human instinct, but the degree of difficulty doesn't count. That's another good idea that he has in this shareholder letter. He says, investors should remember that their scorecards is not computed using Olympic diving methods. Degree of difficulty doesn't count.

If you are right about a business whose value is largely dependent on a single key factor that is both easy to understand and enduring, the payoff is the same as if you would correctly analyze an investment alternative characterized by many constantly shifting and complex variables. Degree of difficulty doesn't count if he bought he wasn't making tons of money on nebraska furniture mark think about it it's one giant store that

resells carpet and uh and other furniture but he knows about it he bought it up first of all at a good price i think he paid 55 million dollars for it or whatever the case was but like that's that's a perfect example of this it's very simple and straightforward other people had to make it more complicated he's going to make the money's going to flow to his bottom line the same way doesn't then if he had to buy a chain of furniture stores which he also does that i'm not saying they're mutually exclusive but he may he probably does make more money from nebraska furniture more than than than uh the investments in running an entire chain. Okay. Oh, this is hilarious.

Another mistake Warren learned from. And I just bring it up because I have a fascination with Walt Disney. And I've already done two podcasts on him, but one of them was like the first or second, like the second or third podcast I ever did. The book's great, but the podcast is probably, I'm probably better at podcasting now. So I've got to go back and read that book and do it again. Because he's just a fascinating, fascinating person.

So one more bit of history. I first became interested in Disney in 1966 when its market valuation was less than $90 million. I was duly impressed and the Buffett partnership that he's running bought a significant amount of Disney stock at a split adjusted price of $0.31 per share. That decision may appear brilliant given that the stock now sells for $66, but your chairman was up to the

task of nullifying it. A year later, I sold it for 48 cents per share. That's crazy. He had it at 31 cents and he sold it at 48 cents and went to $66. Seriously, costs matter. Warren buffett that's a quote from warren buffett everyone talks about revenue no one ever talks about costs uh these costs may be lower than that of uh those of any other large american corporation our after-tax headquarter expense amounts to less than two basis points i was wrong it's 1 50th of one percent not one tenth of one percent measured against net worth even so, Charlie used to think this expense percentage outrageously high, blaming it on my use of Berkshire's corporate jet. So this is another funny part about it because again, he doesn't hide the fact that he's not

hiding his flaws. So he railed against corporations spending too much money on corporate jet saying it's too expensive. Berkshire starts doing well, he buys a corporate jet. Then it starts doing better. He trades that jet for a different jet. And Charlie hates this. Berkshire starts doing well. He buys a corporate jet. Then it starts doing better. He trades that jet for a different jet. And Charlie hates this. He's like, what are you doing? And so they named the jet the indefensible because he's like, listen, I just like it.

It's very convenient. But yes, it's more expensive than it needs to be. He winds up getting rid of it because he buys NetJet, that fractional ownership jet company. But I think it's funny. The indefensible, like, come on. That's really funny. So yeah, Charlie used to think that this expense percentage already they say hi blaming it on my use of berkshire's corporate jet the indefensible that's in the hq um cost uh so he

says seriously costs matter charlie and i make no promises about berkshire's results we do promise you however that virtually all the gains berkshire makes will end up with shareholders. We are here to make money with you, not off of you. This is the low-cost flywheel of Geico that comes up a bunch. There's nothing esoteric about Geico's success. The company's competitive strength flows directly from its position as a low-cost operator. Low costs permit low prices, and low prices attract and retain good policyholders. The final segment of a virtuous cycle is drawn when policyholders recommend us to their friends. Geico gets more than 1 million referrals annually and these produce more than half of our new business. An advantage that gives us enormous savings in acquisition expenses and that makes our costs still lower. So it just goes

over and over and over again. So this echoes Bezos' idea that you should invest in things that won't change. She says, obviously all businesses change to some extent. Today's Seas is different in many ways from what it was in 1972 when we bought it. It offers a different assortment of candy, employs different machinery, and sells through different distribution channels. But the reasons why people today buy boxed chocolates and why they buy them from us rather than someone else are virtually unchanged from what they were in the 1920s. So that's what he means about what's actually going to stay the same.

When the C family was building the business. Moreover, those motivations are not likely to change over the next 20 or even 50 years. That's a good point. Okay, so it says, this next section is why, given its current size, it would be hard for Berkshire to grow substantially. A $500 million profit would add just 1% to Berkshire's performance, and there are way more $500 million opportunities than, say, 10 million opportunities. And then I said, but I think this metaphor also applies to picking the businesses you operate. Stick to where your natural strengths are.

So it says, we try to exert Ted Williams, this is a famous baseball player, we try to exert a Ted Williams kind of discipline. In his book, The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball, swinging it only at balls in his best cell he knew would allow him to bat 400, which is like a really high percentage in baseball.

Reaching for balls in his worst spot, the low outside corner of the strike zone, would reduce him to 230, so way worse. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame. Swinging indiscriminately would mean a ticket to the minors. If they are in the strike zone at all, the business pitches we now see are just catching the lower outside corner. If we swing, we will be locked into lower turns. But if we let all of today's balls go by, there could be no assurance that the next one we see will be more attractive to our liking. Perhaps the attractive prices of the past were the aberrations, not the full prices of today.

Unlike Ted, we can't be called out if we resist three pitches that are barely in the strike zone. Nevertheless, just standing there day after day with the bat on my shoulder is not my idea of fun. So, unfortunately, he's a prisoner of his own success um there's just way fewer opportunities and he talks about this from now forever and we're in the 90s because uh clinton he's talking about president clinton here in a minute um and this problem only increases with time because obviously it becomes more and more successful and more capital i mean but they still do relatively well so it's amazing um okay so it talks about listen like it be be nice to us if we if we screw up because um we're he says along with president clinton we will be feeling your pain meaning the if you're having a recession

he says the munger family has more than 90 of its net worth in berkshire and the buffett's along with President Clinton, we will be feeling your pain, meaning you're having a recession. He says the Munger family has more than 90% of its net worth, and Berkshire and the Buffetts family has more than 99%. And I already trampled over this point earlier, but 99% of his net worth in his business. That is a lot of skin in the game. That's rather remarkable. In this next example, he takes the normal human reaction and reverses it. In a lot of cases, this is a good strategy.

I referenced that earlier. If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they're going to be net buyers of stocks for many years to come, they are always elated when stock prices rise and depress when they fall. So it's normal. You own stocks. Even though you're going to continue to buy them in the future, you're not realizing you're excited they're going up. But now you

can buy less of them. You should be hoping they go up in the future, but down now. She says they are elated when stock prices rise and depress when they fall. In effect, they rejoice because prices have risen for the hamburgers they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Perspective purchasers, which is everybody investing over the long term, should much prefer sinking prices. So he said, so smile when you read a headline that says investors lose as market falls. Edit it in your own mind to disinvestors lose as market falls,

but investors gain. Though writers often forget this truism, there's a buyer for every seller and what hurts one necessarily helps the other. There's another idea I like of his. When you're setting compensation, distribute merit badges, not lottery tickets. So it says, we are paying in a way that makes sense for both our owners and our managers. We distribute merit badges, not lottery tickets. In none of Berkshire subsidiaries do we relate compensation to our stock price, which our

associates cannot affect in any meaningful way. Instead, we tie bonuses to each unit's business performance, which is a direct product of the unit's people. When that performance is terrific, as it has been at Geico, there's nothing Charlie and I enjoy more than writing a big check. So you're going to get paid based on what you can actually control. It's actually a good idea. Warren's Buffett. I love it. So this is another.

This is close to one of my favorite ideas out of all shareholder letters. Warren Buffett's advice on the mindset to have when you're running your business. Just run your business as if, one, you own 100% of it. Two, this is a, this is really unique idea. It is the only asset in the world that you and your family have or will ever have. And three, you can't sell or merge it for at least a century. Oh, I mentioned this in one of the Charlie Munger podcasts, but I have to say it again because it's hilarious. They buy this company called Scott Fetzer.

Here's one story I can't resist relating. In 1985, a major investment baking house undertook to sell Scott Fetzer, offering it widely but with no success. Upon reading of this strikeout, I wrote to Ralph Shea, then and now Scott Fetzer's CEO, expressing an interest in buying the business. I had never met Ralph, but within a week we had a deal. Unfortunately, Scott Fetzer's letter of engagement with the banking firm provided it a $2.5 million fee upon sale, even if it had nothing to do with finding the buyer. I guess the lead banker felt that he should do something for his payment, so he graciously offered us a copy of the book on Scott Feltzer that his firm had prepared. With his customary tack, Charlie responded,

I'll pay $2.5 million not to read it. step one, identify your circle of competence. Step two, stay inside of it. If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter. Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter. If others claim predictive skill in those industries and seem to have their claims

validated by the behavior of the stock market, we neither envy nor emulate them. Instead, we just stick with what we understand. If we stray, we will have done so inadvertently, not because we got restless and substituted hope for rationality. Fortunately, it's almost certain there will be opportunities from time to time for Bershara to do well within the circle that we've staked out. It's so hard to say no. They're saying no to the majority of things that they say. No, no, no, no, no. It goes against our predisposition for action.

This is such a great quote. Nothing sedates rationality like large doses of effortless money the line separating investment and speculation which is never bright and clear becomes blurred still further when most market participants have recently enjoyed triumphs nothing sedates rationality like large doses of effortless money after a heady experience of that kind normally sensible people drift into behavior akin to that of cinderella at the bar ball they know that overstaying the festivities that is continue to speculate in companies that ball they know that overstaying the festivities that is continue to speculate in companies that have gigantic valuations relative to the cash they

are likely to generate in the future will eventually bring on pumpkins and mice but they nevertheless hate to miss a single minute of what is one hell of a party therefore the giddy participants all plan to leave just seconds before midnight there's a problem though they are dancing in a room in which clocks have no hands see what i mean like these are shareholder letters like he's a really good writer though that's a really interesting metaphor using there um oh something that we're trying to do on founders for sure by studying all these biographies is he's saying here, a few hours studying from a master prove more valuable than 10 years of supposedly original thinking.

So he says, a bit of nostalgia. It was exactly 50 years ago that I entered Ben Graham's class at Columbia. During the decade before it, I had enjoyed, make that loved analyzing, buying and selling stocks. But my results were no better than average. Beginning in 1951, my performance improved. No, I hadn't changed my diet or taken up exercise.

The only new ingredient was Ben's ideas. Quite simply, a few hours spent at the feet of the master proved far more valuable to me than 10 years of supposedly original thinking. In addition to being a great teacher, Ben was a wonderful friend. My debt to him is incalculable. He loves baseball analogies. Here's another one. This is actually really interesting. My managerial model is Eddie Bennett, who is a bat boy. In 1919, at age 19, Eddie began to work with the Chicago White Sox, who that year won the World Series. The next year, Eddie switched to the Brooklyn Dodgers,

and they too won their league title. Our hero, however, smelled trouble. Changing boroughs, he joined the Yankees in 1921, and they promptly won their first pennant in history. Now, Eddie settled in, shrewdly seeing what was coming. In the next seven years, the Yankees won five titles. What does this have to do with management? It's simple.

To be a winner, work with winners. In 1927, for example, Eddie received $700 for one eighth World Series share voted to him by the legendary Yankee team of Babe Ruth and Lou Gehrig. This sum, which Eddie earned by working only four days because New York swept a series, was roughly equal to the full year pay then earned by Batboys who worked with Ordinary Associates. So just because they won the World Series, he made more in four days than they made all year. Eddie understood that how he lugged bats was unimportant. What counted instead was hooking up with the cream of those on the playing field. I've learned from Eddie. At Berkshire, I regularly hand bats

to many of the heaviest hitters in American business. Another great, more great writing and a great story. It's fantastic. Oh, this is another fantastic story. There's so many stories of entrepreneurs starting a business like the Rose Blumkin. No education,

barely speak English, has to escape from a country, comes here for 500 bucks and builds a giant business. Here's another example. The largest acquisition we initiated in 2002 was the Pampered Chef, a company with a fascinating history dating back to 1980. Doris Christopher was then a 34-year-old suburban Chicago home economics teacher with a husband, two little girls, and absolutely no business background. Wanting, however, to supplement

her family's modest income, she turned to thinking about what she knew best, food preparation. Why not, she wondered, make a business out of marketing kitchenware, focusing on the items she herself found most useful. To get started, Dor doris borrowed three thousand dollars against her life insurance policy that was all the money ever injected into the company she went to the merchandise mart on a buying expedition there she picked up a dozen each of this and that and then went home and set up operations in her basement her plan was to conduct in-home presentations like tupperware parties to small groups of women gathered at the homes of their friends. While driving to her first presentation, though, Doris almost talked herself into returning home, convinced she was doomed to

fail. But the women she faced that evening loved her and her products, and they purchased $175 of goods. Working with her husband, Jay, Doris did $50,000 of business the first year. Today, only 22 years later, she did more than 700 million of business annually. I love stories like that. That's fantastic. I love entrepreneurship. A funny way to think about controlling costs.

We cherish cost consciousness at Berkshire. Our model is the widow who went to the local newspaper to place an obituary notice. Told there was a 25 cents word charge, she requested. Fred Brown died. She was then informed that there was a seven word minimum. Okay, the bereaved woman replied. Make it Fred Brown died. Golf clubs for sale. Okay, this was interesting. This is six years before, about six years before the subprime mortgage crisis. And if Warren and Charlie can't figure it out, what I'm about to read you, it's a good chance that the bank didn't know that either.

Okay, so he says, he's talking about like credit swaps. And then, well, let me just read it. Even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts. When Charlie and I finished reading the long footnotes

detailing derivative activities of major banks, the only thing we understand is that we don't understand how much risk the institution is running. So good chances are it's too complex that even the people running it don't understand, which we saw. The derivative genie is now well out of the body,

the bottle rather, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. This is six or so years before what he just said is going to happen will happen. And it reminds me of one of my favorite quotes from one of my favorite books, a book that fundamentally shifted how I view life when I realized it's called

It's a Big Short by Michael Lewis. Way better book than it is a movie. I'd be back around reading it, but I'm going to read it to you. It says, on the surface, these big Wall Street firms appeared robust. Below the surface, Eisman, this is Steve Eisman, one of the guys that makes over a billion dollars betting against the mortgage market. Eisman was beginning to think their problems might not be confined to a potential loss of revenue. If they really didn't believe the subprime mortgage market was a problem for them, this is exactly what Warren's finding out a few years earlier, right?

If they really didn't believe the subprime mortgage market was a problem for them, the subprime mortgage market might be the end of them. He and his team now set about searching for hidden subprime risk. Who was hiding what? We call it the great treasure hunt, he said. They didn't know for sure if these firms were in some way or the other. On the other side of the bets he'd been making against subprime bonds. But the more he looked, the more sure he became that they didn't know either. This is exactly what Warren's describing, right? He'd go to meetings with Wall Street CEOs and ask them the most basic questions about their balance sheets. They didn't know, he said. They didn't know their own balance sheets. So there's a good chance if

Warren can't figure it out and Charlie can't figure it out, the CEOs don't even know their balance sheets, which Steve Eisenman's running into a few years after this right uh once he got himself invited to a meeting with the ceo of bank of america ken lewis i was sitting there listening to him and i had an epiphany i said to myself oh my god he's dumb a light bulb went off the guy running one of the biggest banks in the world is dumb they shorted bank of america along withoup, Lehman Brothers, and a few others. That one quote changed my outlook on life to a large degree. And I read it after, though.

Obviously, the book came out after the financial crisis. But when you realize, especially because I was a lot younger then, you think, oh, these CEOs of these top companies must be smart. I mean, how smart do you have to be to lose $180 billion? You lost $180 billion. That's saying that you weren't smart in terms of running your business, right?

So once you internalize that, like, wow, there really are no adults. A lot of people are making it up as they go along. It was terrifying But then also reassuring Where it's like oh well that means I have a lot more potential I don't have the pedigree Or maybe I didn't come from a rich family Or I didn't have the education pedigree

So a lot of these people did Well that's nice That coming from a rich family And having all the education didn't help them They still got their ass kicked right So it's a book that I mean to reread and i haven't reread in probably two years i'm going to but uh maybe we get the audiobook again because i own the the kindle version and i think the hardcover too but i don't know it's it's a fantastic book and i just like

the idea of the warren demonstrating just common sense here hey i'm reading the report you're making it's garbety gook i don don't even know what it means. Like what is truly happening here and what's the chance that I can't figure out? Maybe you don't know it either. No one can predict the future. Be wary of those that claim this imaginary skill. Charlie and I don't know today what our business will earn next year. We don't even know what they will earn next quarter. We are suspicious of the CEOs who regularly claim they do know the future and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to make the numbers will at some point be tempted to make up the numbers.

Just a good, more basic life advice for us. Now, this is what I was referencing earlier. The gift of an autobiography led Warren to buying the business. So these students come to him every year. They do this Q&A, different colleges and stuff. One year they, and they usually give him like, you know, gift. One year they gave him an autobiography of Jim Clayton. So it says, upon receiving Jim Clayton's book,

I told the students how much I admired his record, and they took the message back to Knoxville, home to both the University of Tennessee, that's where they were from, and Clayton Holmes. Soon thereafter, I made an offer. Talked to, loved the book. Talked to Kevinvin is his name kevin clayton um which is the son of jim clayton the author of the book i should have been clear

there um and said hey i'm gonna buy the business soon thereafter i made an offer for the business based solely on jim's book my evaluation of kevin which is his son and the CEO, and the public financials of Clayton. Hey, now. Oh, so he's got this idea of owner capitalism. I want to share this with you. It's going to... Some big chunks I pulled out here. I'm on my soapbox now only because the blatant wrongdoing that has occurred has betrayed the trust of so many millions of shareholders.

Hundreds of industry insiders had to know what was going on. And publicly publicly nobody said a word. So he's talking about like there's no corporate governance and it really annoys him and that the boards are stacked with just yes men when they shouldn't be doing that. True independence meaning the willingness to challenge a forceful CEO when something is wrong or foolish is an enormously valuable trait in a director. It is also rare. The place to look for it is among high-grade people whose interests are in line with those of the rank-and-file shareholders and are in line with the big way.

So what he's saying is they need to have skin in the game. So a large percentage of their net worth needs to ride on if the CEO is making the right decision or not because if your large percentage of net worth is riding on his ability to make a good decision and you think he's going wrong, you're going to speak up. You won't just placate him. We've made that search at Berkshire. We now have 11 directors and each of them combined with members of their family owns more than 4 million of Berkshire stock.

So it talks about all 11 directors purchased their holdings in the market just as you did. We've never passed out options or restricted shares. Charlie and I love such honest to goodness ownership. After all, whoever washes a rental car. Thus, the upside for Berkshire for all 11 is proportionally the same as the upside for any Berkshire shareholders. They're going to keep him in line, right? And it always will be. The downside for Berkshire directors is actually worse than yours because we carry no directors and officers liability insurance. Therefore, if something really catastrophic happens on our director's watch, they're exposed to losses that will far exceed yours. It's extremely important.

The bottom line with our directors, you win, they win big. You lose, they lose big. Our approach might be called owner capitalism. We know of no better way to engender true independence. He's just really talking about skin in the game. Your incentives have to be aligned. And too much of corporate America is saying people can make bad decisions. They don't have an ownership stake.

They get huge bonuses, then they leave, and then the shareholders are impoverished or not impoverished. Obviously, they lose money. He doesn't like that. I love this idea of viewing your work as an unfolding movie, not a still photograph. Never heard this before. I like it.

Here's a paragraph about it. When analyzing Berkshire, be sure to remember that the company should be viewed as an unfolding movie, not as a still photograph. Those who focused in the past on only the snapshot of the day sometimes reach erroneous conclusions. So think about your work as an unfolding movie. You're not going to know how it turns out until after you're gone or after you stop doing it. Warren and Charlie never thought it would be this large and their decentralized structure helps them enjoy their work charlie munger my partner in

burschardt's vice chairman and i run what run now we're in the mid-2000s uh run what turned out to be a big business one with 217 000 employees and annual revenue is approaching 100 billion we certainly didn't certainly didn't plan it that way. Charlie began as a lawyer and I thought of myself as a security analyst. Sitting in those seats, we both grew skeptical about the ability of big entities of any type to function well. I feel the same way. I could never work in a big organization. Symes seems to make many organizations slow thinking and resistance to change and then smug. So slow thinking, resistance to change and smug. Not all of our businesses are destined. This is him telling us to pick the market we are in wisely. Not all of our businesses are destined to increase profits. When an industry's underlying economics are crumbling, talented management may slow the rate of decline.

Eventually, though, eroding fundamentals will overwhelm managerial brilliance. As a wise friend told me long ago, if you want to get a reputation as a good businessman, be sure to get into a good business. So that's just another way to say find a tailwind instead of fighting a headwind. Oh, so this is interesting he's talking about he owns newspapers and obviously now we're in the mid-2000s so they're getting their you know butts kicked but so he's talking this point i'm about to read to he's talking about the fundamental weakness in the newspaper industry but the last line made me think of a tweet that i read several years ago and i saved and i think about often so he says now however almost all newspaper owners realize that they are constantly losing ground in the battle for eyeballs simply put if cable and satellite

broadcasting as well as the internet had come along first newspapers as we have as we know them probably would have never existed and the tweet I saw he said was somebody talking about podcasts and he says newspapers were a fad the village storyteller is as old as language only there are six billion villagers and podcasts are the campfire i love that that's why i'm so bullish on podcasts um but i like that idea never thought like he's saying listen if the internet was invented first or satellite broadcasting first and you really have a newspaper it's an interesting thought and then you know to tie that into a three or four year old tweet like that tweet obviously i look at a lot um because i think it's very interesting newspapers being a fad

and it is kind of true humans have been talking to one another forever they will be talking to one another as long as their species is around um so yeah it's interesting all right um so he's saying there's trouble ahead for the u.s no one knows when and no one knows how the best protection is a profitable unleveraged business or a portfolio of them like berkshire has so he says in effect we've used up our bank account and turned it to our credit card he's talking about the country now and like everyone who gets in hawk the u.s will now experience reverse compounding as we pay ever-increased amounts of interest on interest.

He doesn't like that. I want to emphasize that even though our course is unwise, Americans will still love better in 10 or 20 years than they do now today. Per capita wealth will increase, but our citizens will also be forced

every year to ship a significant portion of their current production abroad merely to service the cost of our huge debtor position. It won't be pleasant to work part of each day to pay for the overconsumption of your ancestors. What a way to think about it. I believe that at some point in the future, U.S. workers and voters will find this annual tribute so onerous that there will be severe political backlash.

How that will play out in markets is impossible to predict, but to expect a soft landing seems like wishful thinking. So again, the best prediction against anything is a profitable, unleveraged business or a portfolio of them. So now he's going to talk more about the difference between theory and practice and why I think it's another reason why I would recommend reading biographies of practitioners instead of business books. Practitioners, I think learning from them is just a better idea because academic ideas don't correlate to a P&L.

It's an idea, but a practitioner had to back up his ideas with money, and he had to risk losing money or making money. So there's a lot more you can learn from that. So he says, he's talking about this guy named Walter who he learned from. So anyways, the guy who's investing in stocks for 47 years. So anyways, I first publicly discussed

Walter's remarkable record in 1984. At that time, EMT, more on efficient market dairy, was the centerpiece of investment instruction in most major business schools. This theory, as then most commonly taught,

held that the price of any stock at any moment is not demonstrably mispriced, which means that no investor can be expected to overperform the stock market averages using only publicly available information. When I talked about Walter 23 years ago, his record forcefully contradicted this dogma. And what did members of the academic community do when they were exposed to this new and important evidence?

Unfortunately, they reacted in an all-too-human fashion. Rather than opening their minds, they closed their eyes. To my knowledge, no business school teaching EMT made any attempt to study Welch's performance and what it meant for the school's cherished theory. Instead, the faculties of the schools went merrily on their way presenting EMT as having the certainty of a scripture. Typically, a finance instructor who had the nerve to question EMT had about as much chance of a major promotion as Galileo had of being named Pope. Tens of thousands of students were therefore sent out into life believing that on every day the price of every stock was right. And that attempts to evaluate businesses that, as in stocks, were useless.

Walter, meanwhile, went on overperforming, his job made easier by the misguided instructions that had been given to those young minds. Remember, if somebody's telling you, the professor that says this is not penalized financially if you go out and do this. After all, if you're in the shipping business, again, that's why I always say, you always look for revealed preferences

instead of stated preferences, meaning look at people's actions, not what they say. After all, if you're in the shipping business, it's helpful to have all of your potential competitors be taught that the earth is flat. Maybe it was a good thing for his investors that Walter didn't go to college. Profit is the reward of a great business, and it's okay that if it can't be reinvested to make more. Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There's no rule

that you have to invest money where you earned it. That's what I mean. Sometimes you just get to the point where it's like the business is performing as much as it can. Reinvesting is not going to bring more money. Indeed, it's often a mistake to do so. That's an interesting thought, right? Truly great businesses earning huge returns on tangible assets can't, for any extended period, reinvest a large portion of their earnings internally

at higher rates of return. They're already at maximum efficiency. You've got to put that money elsewhere. And that's okay. It's a good thing. It's a great thing. This is his opinion is that brain, passions, and integrity are greater than a resume. Susan came to Borsheim's. This is a jewelry store they bought 25 years ago as a $4 an hour sales woman. Though she lacked a managerial background, I did not hesitate to make her CEO in 1994. She's smart. She loves the business and she loves her associates.

That beats having an MBA degree any time. An aside, Charlie and I are not big fans of resumes. Instead, we focus on brains, passion, and integrity. Another one of our great managers is Kathy Barron, who has significantly increased BusinessWire's earnings since we purchased it in early 2006. She is an owner's dream. It is positively dangerous to stand between Kathy and a business prospect.

Kathy, should be noted, began her career as a cab driver. That's the wonderful thing about entrepreneurship and business. There really is no school for business. I know there's obviously, you can go to college for business, but as far as running a business, entrepreneurship, starting a business, you can have people that were cab drivers be successful.

You have people that are $4 an hour sales women are now CEOs, like that's freaking amazing. That's amazing, amazing thing. Oh, okay. Oh, I'm gonna skip over this section, but just know that he lost $11 billion in net worth in one year. This is during the financial crisis.

And one way to temper your reaction is by inducing a bit of context. And he's like, listen, we've been through a lot of crap. In the 20th century alone, we dealt with two great wars, a dozen or so panics and recession, inflation that led to 21.5% prime rate, Great Depression in the 1930s, unemployment ranging from 15% to 25% for many years.

America's had no shortage of challenges. So this is a challenge. This 2008 sucks, but it happens. We have to be prepared for that. Regardless of the macro environment, anchor yourself around your principles. There's a reason horses have blinders on. Those are notes I left myself.

So in good years and bad, Charlie and I simply focus on four goals. One, maintain Berkshire's Gibraltar have blinders on. Those are notes I left myself. So in good years and bad, Charlie and I simply focus on four goals. One, maintain Berkshire's Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash. Two, widen the moats around our operating businesses that give them durable competitive advantages.

Three, acquiring and developing new and varied streams of earnings. Four, expanding and nurturing the cadre of outstanding operating managers who over the years have delivered Berkshire's exceptional results. So one of my favorite, let me see if I can find it for you. The audio is not going to be the best, but this whole about horses have blinders on, it's a quote from Jimmy Iovine. And he's the one that founded Interscope, sold beats by dre for like three billion dollars to uh to apple but anyways he's got this whole this great quote that comes from that h the documentary uh hbo documentary called

the defiant ones which i would recommend watching it's essentially a documentary on entrepreneurship but he talks about like he doesn't care what other people think he just focuses on what he has to do and then that's all so he's like there's a reason horse said blinders so i'm gonna play this from my phone into the microphone might sound like crap but and there's music and stuff in the background but i like what he has to say so it's when you're a racehorse right the reason why they put blinders on these things because if you look at the horse on the left or the horse on the right you're a racehorse, right? The reason why they put blinders on these things, because if you look at the horse on the left or the horse on the right, you're gonna miss a step.

He's showing horses falling down. So that's why those horses have fucking blinders on them. And that's what people should have. When you're running after something, you should not look left and right. What does this person think? What does that person think? No. Go.

Go. Go. Go. So I love that idea. When you're running after something, you should not look left, not look right. And there's a reason horses have blinders on. Just keep going straight. And how this relates to what's going on here is like Warren at this time in the

shareholders is operating a terrible macro environment. It doesn't matter. I have my principles and I'm going to focus on them. And then in a few years, things will be different. Just like in a few years after that, they'll be different. Sometimes better, sometimes worse. So I think that's a huge benefit to reading all these. Like you see 50, I saw half of a century

of how a company operates through all different kinds of economic environments. I just didn't know it was going to take me this long. I'm dangerously close to not getting this out on Sunday. It's funny because I bought the book, right? It says Berkshire Hathaway, 50 years. It's a yellow cover, 1965 to 2014. Then I looked again and noticed that they updated it

and only printed a Kindle version. It goes up to 2018. So then I had to start working from the, I didn't want to like stop in 2014 if 2018 is available, right? So I get the Kindle version and it says like estimated time to read, I don't know, like 17 hours. That is a lie. It was triple that. Like it is insane how long this took. So, but again, the benefit is it's not, I'm not complaining how long it takes to read. I don't want you to misunderstand what I'm saying. Like the fact that I had to go through a half a century of shareholder letters and see how they're applying their principles,

even though they're very hard to stick to when everybody's panicking, it was instructive. It's something that's important to learn, that realize that there's a benefit to not bending and to not paying attention to what everybody around you is doing. It doesn't mean you're ignorant. It just means you have a plan. You're going to stick to it because you've thought a lot about it. Okay. Okay. So I just read the principles, the four principles. This is, Warren is describing, these are my notes now.

Warren is describing the subprime mortgage crisis that happened in manufactured homes almost 10 years earlier. Okay, so that book that I'm going to be reading, the one that he bought the business on, they are like the largest producer of manufactured homes, right? And they stayed out of, there was a subprime mortgage crisis like, let's see, 10 years before the subprime mortgage crisis. There's a subprime mortgage crisis in manufactured homes 10 years before the one that played on conventional housing. And this is another example of how the human species fails to learn from history. So he's describing this. So he says, at that time, much of the industry employed sales

practices that were atrocious. Writing about the period somewhat later, I described it as involving borrowers. Remember, he's talking about this is in the 90s. This is people borrowing to buy manufactured homes. So he describes it as borrowers who shouldn't have borrowed being financed by lenders who shouldn't have lent. Moreover, impossible to meet monthly payments were being agreed to by borrowers who signed up because they had nothing to lose. The resulting mortgages were usually packaged. They were securitized and sold to Wall Street firms

to unsuspecting investors. This chain of folly had to end badly. So it says, this 1997-2000 fiasco should have served as a canary in the coal mine warning for the larger conventional housing market. But investors, governments, and rating agencies learned exactly nothing. Instead, in an eerie rerun of that disaster,

the same mistakes were repeated with conventional homes in the 2004 to 2007 period. Lenders happily made loans that borrowers couldn't repay out of their incomes, and borrowers just as happily signed up for Mizo's payments. Both parties counted on house price appreciation to make this otherwise impossible arrangement work. It was Scarlett O'Hara

all over again. I'll think about it tomorrow. The consequences of this behavior are now reverberating through every corner of our economy. And this is,

he leads his thoughts on home ownership, which I really appreciate. Home ownership is a wonderful thing. My family and I have enjoyed my present home for 50 years

with more to come. But enjoyment and I have enjoyed my present home for 50 years with more to come. But enjoyment and utility should be the primary motive for purchase, not profit or refi possibilities. And the home purchased ought to fit the income of the purchaser. The present housing debacle should teach homebuyers, lenders, brokers, and governments some simple lessons that will ensure stability in the future. Home prices should involve an honest to good down payment of at least 10% and monthly payments that can be comfortably handled by the borrower's income.

That income we should be carefully. This is the important part. People putting people into homes, though a desirable goal, shouldn't be our country's primary objective. Keeping them in their homes should be the ambition. Okay, so now I want to get to the part where Warren's telling us how to apply the thinking of Charlie Munger.

So he says, long ago, Charlie laid out his strongest ambition. All I want to know is where I'm going to die so I'll never go there. That bit of wisdom was inspired by Jacobi, the great Prussian mathematician who counseled, invert, always invert, as an aid to solving difficult problems. Here are a few examples of how we apply Charlie's thinking at Berkshire. Charlie and I avoid businesses, this is the first one, Charlie and I avoid businesses whose futures we can't evaluate no matter how exciting their products may be. In the past it required no brilliance for people to foresee the fabulous growth that awaited such industries as automobiles in 1910,

aircraft in 1930, and television sets in 1950. But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding. So he's saying there's no way to predict which one to invest in. Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and return on capital will be as a host of competitors battle for supremacy. At Berkshire, we will stick with businesses whose profit pictures for decades to come

seems reasonably predictable. Even then, we will make plenty of mistakes. Here's another example. We will never become too dependent on the kindness of strangers. Too big to fail is not a fallback position of Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. He's talking about his margin of safety again.

Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses. Next page. We tend to let many of our subsidiaries operate on their own without our supervising and monitoring them to any degree. That means we are sometimes late in spotting, he's talking about the downside to it, but what's the trade-off?

Why is he doing that? He's discussing the trade-off he's making. That means we are sometimes late in spotting management problems that are both operating and capital decisions are occasionally made with which Charlie and I would have disagreed had we been consulted. Most of our managers, however, use the independence we grant them magnificently, rewarding our confidence by maintaining an owner-orienting attitude that is invaluable and too seldom found in huge organizations.

We would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from decisions made too slowly or not at all because of a stifling bureaucracy. So he's saying, hey, we would rather suffer visible costs, a few bad decisions than incur the invisible costs that come with moving too slow. And then this is the impact that Charlie has had on Warren and Berkshire. From my perspective, though, Charlie's most important architectural feat was the design of today's Berkshire.

The blueprint he gave me was simple. Forget what you know about buying fair businesses at wonderful prices and instead buy wonderful businesses at fair prices. This was allowed them to scale. Altering my behavior is not an easy task, asked my family. I had enjoyed reasonable success without Charlie's input, so why should I listen to a lawyer who had never spent a day in business school when I, ahem, had attended three?

So he's being a little tongue-in-cheek there. But Charlie never tired of repeating his maxims about business investing to me, and his logic was irrefutable. Consequently, Berkshire has been built to Charlie's blueprint. My role has been that of general contractor, with the CEOs of Berkshire subsidiaries doing the real work as subcontractors. And then he closes the section saying, listening to Charlie has paid off.

And then the note I left myself and the one I want to say to you is like, if Warren has benefited from listening to Charlie, why wouldn't you? Or put another way, that's why I do so many podcasts on Charlie Munger. He's very interesting. And now we get writing on Munger or from Munger on Buffett. So he says, what was Buffett aiming at as he designed the Berkshire system? Well, over the years, I diagnosed several important themes. Now he's going to give us some ideas we can steal

and take in our own lives. Number one, he particularly wanted continuous maximization of the rationality, skills, and devotion of the most important people in the system, starting with himself. Number two, he wanted win-win results everywhere, in gaining loyalty by giving it, for instance. Number three, he wanted decisions that maximize long-term results, seeking these from decision makers who usually stayed long enough

in place to bear the consequences of decisions. So skin in the game again. Number four, he wanted to minimize the bad effects that would almost inevitably come from a large bureaucracy at headquarters. Repeated that again. Number five, he wanted to personally contribute, like Professor Ben Graham, to the spread of wisdom. And then now he's going to go into what I referenced earlier, like what others call obsession, Buffett calls focus. So this is Munger still writing about what he's observed in how Buffett's built his business. He says, in particular, Buffett's decision to limit his activities to a few kinds and to maximize his attention to them and to keep doing so for 50 years was a lollapalooza. Buffett succeeded for the same reason Roger Federer became good at tennis. Buffett was,

in effect, using the winning method of the famous basketball coach John Wooden. John Wooden won most regularly after he had learned to assign virtually all playing time to his seven best players. That way, opponents always faced his best players instead of his second best. And with the extra playing time, the best players improve more than normal. So I had this virtuous cycle again. And Buffett much outwitted Wooden because in his case,

the exercise of skill was concentrated in one person, not seven. And his skill improved and improved as he got older and older during 50 years instead of deteriorating like the skill of a basketball player. And Munger closes out this section on Buffett. He says, Berkshire's had a big task ahead, turning a tiny stash into a large and useful company, or had a big, he's talking about the beginning. And it solved that problem by avoiding bureaucracy

and relying much on one thoughtful leader for a long, long time as he kept improving and brought in more people like himself. Compare this to a typical big corporation system with much bureaucracy at headquarters and a long succession of CEOs who come in at about age 59, pause little thereafter for a quiet thought, and are soon forced out by a fixed retirement age. I believe that versions of the Berkshire system should be tried more often elsewhere, meaning he wants us to take these ideas in our own life, and that the worst attributes of bureaucracy should much more often be treated like the cancers they so much resemble. A good example of bureaucracy fixing was created by George Marshall

when he helped win World War two by getting from Congress the right to ignore seniority in choosing generals. And finally this is the last section I'm gonna cover it's called the American Tailwind. It's like kind of like a basically an essay in the middle of the the last available shareholder letter that we have. So this is on March 11th. It will be 77 years since I first invested in it.

Now we're back to Buffett, by the way. Since I first invested in American business. The year was 1942, and I was 11. I went all in, investing $114 that I had been accumulating since age six. What I bought was three shares of city service preferred stock. I had become a capitalist and it felt good. Now let's travel back through the two 77 years periods that preceded my purchase. So from today, 77 years ago, the time he bought his first stock. Now he's going two other 77 years back, right? That leaves us starting in the year 1788,

a year prior to George Washington's installation as our first president. Could anyone have imagined what their new country would accomplish in only three 77-year lifetimes? It's an interesting way to look at it. During the two 77-year periods prior to 1942, the United States had grown from 4 million people, about one-half of 1% of the world's population, into the most powerful country on Earth. Those are the first two 77-year periods. In that spring of 1942, though it faced a crisis, the U.S. and its allies were suffering heavy losses in a war that we had entered only three months earlier.

Bad news arrived daily. Despite the alarming headlines, almost all Americans believed that on March 11th that the war would be won, nor was their optimism limited to that victory. Leaving aside congenital pessimists, Americans believed that their children and generations beyond would live far better lives than they themselves had. The nation's citizens understood, of course, that the road ahead would not be a smooth ride. It never has been. Early in its history, our country was tested by a civil war that killed 4% of all American males

and led President Lincoln to openly ponder whether, quote, a nation so conceived and so dedicated could long endure. In the 1930s, Americans suffered through the Great Depression, a punishing period of massive unemployment. Nevertheless, in 1942, when I made my purchase, the nation expected post-war growth, a belief that proved to be well-founded. In fact, the nation's achievement can best be described as breathtaking.

Let's put my numbers to that claim. If my $114 had been invested in a no-fee S&P 500 index fund and all dividends had been reinvested, my stake would have been grown to be worth, pre-taxes, $606,000. That is a gain of $5,288 for one. Meanwhile, a million-dollar investment by a tax-free institution of that time, say a pension fund or college endowment, would have grown to about $5.3 billion. Let me add one additional calculation that I believe will shock you. If that hypothetical institution had only paid 1% of assets annually to various quote-unquote helpers, and he obviously doesn't think they're helping, such as investment managers and consultants,

its gain would have been cut in half to $2.6 billion. That's what happens over 77 years when the 11% annual return actually achieved by the S&P 500 is recalculated down to 10%. Those who regularly preach doom because of government budget deficits, as I regularly did myself for many years, might note that our country's national debt has increased roughly 400-fold during the last of my 77-year period. That's 40,000%.

Suppose you had foreseen this increase and panicked at the prospect of runaway deficits and of a worthless currency. This is, he's talking about something he learned. To protect yourself, you might have eschewed stocks and opted instead to buy gold. And what would your protection have delivered you? You would now have an asset worth about $4,200 or less than 1% what would have been realized from a simple unmanaged investment in American business. And this is kind of the next statement is what Warren Buffett has staked his entire career on. You got to have some kind of beliefs that you're willing to bet on. The magical medal was no match for the American medal. our country's almost unbelievable prosperity has been gained in a bipartisan manner since 1942 we've had seven republican presidents and seven democrats

in the years they serve the country contended at various times with a long period of viral inflation a 21 prime rate several controversial and costly wars the resignation of a president a pervasive collapse in home values, a paralyzing financial panic, and a host of other problems. All engendered scary headlines. All now history. In 1788, to go back to our starting point, there really wasn't much here except for a small band of ambitious people and an embryonic governing framework aimed at turning their dreams into reality. Today, the Federal Reserve estimates our household wealth at $108 trillion, an amount almost impossible to comprehend. Remember earlier in this letter how I described

retained earnings as having been the key to Berkshire's prosperity, so it has been with America. In the nation's accounting, the comparable item is labeled savings, and save we have. If our forefathers had instead consumed all they produce, there would have been no investment, no productivity games, and no leap in living standards. Charlie and I happily acknowledge that much of Berkshire's success has simply been a product of what I think should be called the American tailwind. It is beyond arrogance for American businesses or individuals to boast that they have done it all alone. The tidy rows of simple white crosses at Normandy should shame those who make such claims. There are many other countries around the world that have bright futures.

About that we should rejoice. Americans will be both more prosperous and safer if all nations thrive. For 54 years, Charlie and I have loved our jobs. Daily, we do what we find interesting, working with people we like and trust. And now our new management structure has made our lives even more enjoyable. With the whole ensemble, that is with Ajit, that's somebody that they hired, and Greg running operations, a great collection of businesses, a Niagara of cash generation, a cadre of talented managers, and a rock-solid culture, your company is in good shape for whatever the future brings.

Warren Buffett, February 23, 2019. And that is where I'll leave the story. February 23rd, 2019. And that is where I'll leave the story. If for some reason you want to read all of them, a lot of them are available for free online. You can go year by year. I think some of them back in like the 60s and 70s are only, you'd have to write to them. But I paid, if you want the hardcover,

I guess it's paperback, but the paperback version, which is this giant book that's in my hands. It's 760-something pages. It goes from 1965 to 2014. I think I paid like $35 for this one. Honestly, it really up to you, but I would just opt for the Kindle version because I paid $2.99 for it, and it covers all the way up to 2018. And it's really helpful to be able to search and have more organization around your notes.

But anyways, if you're interested in buying that and supporting the podcast at the same time, I'll leave a link in the show notes, and it's the Amazon affiliate link. So if you use that to purchase, Amazon will send me a small percentage of the sale for directing you their way at no additional cost to you.

So it's a great way to support the podcast. Thank you very much for supporting it already. And I will be back next week with another biography of an entrepreneur.