WARREN BUFFETT’S LETTER – 1990-91

WB Letter 1990

Mr. Buffett mentioned that we need to thoroughly analyze earnings and accounting numbers; we should not focus on the big auditor names.

WB 1990 01

Low prices and low cost of operations for their Jewelry and furniture business creates huge volume growth. Such a low cost of operation is difficult to adopt by competitors.

While we are analyses an insurance company then we check combined ratio for the measuring profitability of the insurance company but with it, we need to check –

WB 1990 02

WB 1990 03

Mr. Buffett mentioned that the majority of the companies follows what their peers are doing though they seem foolish.

WB 1990 04

Example of PSUs & Private Bank

i) PSU Bank

PSU

ii) Private Bank

Private

We should not focus on the buying an only a cheap companies without knowing the quality of assets on which they seem cheap. We can see that PSUs banks have majorly traded at discount compare too few private banks which have a quality of books. PSUs banks seem cheap on the basis of Price to Book Value but the quality of books is questionable, which we have already experienced.

WB 1990 05

Mr. Buffett has mentioned some of the qualities of management which we also can check when we make any investment.

WB 1990 06

As an investor, we need to always focus on the Margin of Safety which is mentioned by the Ben Graham. The margin of Safety provides us a safeguard against any errors occurs by us.

WB 1990 07

WB Letter 1991

In long run, our investment returns will occur through the stock prices but stock prices are derivatives of the future earnings of the business. If a business is not performing well, earnings not grown in future then stock prices also not given us return in long run. So that we need to keep a focus on the business performance, earnings growth driver of business rather keep a focus on the stock price performance.

WB 1991 01

When we talk about the strong franchise of business then we should focus on the criterion into the business which mentioned by Mr. Buffett. All businesses do not fall under the mentioned criterion but those businesses fall under mentioned criterion those can earn a higher return on capital for the longer period of time through price it’s product/services aggressively. If business having a strong franchise then we does not require a strong management to run the business.

WB 1991 02

Liquor is a desired of people and customers does not have any close substitute (legal) of it but in India, the price of liquor is regulated so that we cannot say that liquor business has a strong economic franchise. Watching movies at the multiplex is a desired of people, no close substitute is available for it and also a price of the ticket is not regulated.

Whereas those businesses which do not have strong franchises then those businesses can only earn decent from a low-cost production of products/services or a shortage of products/services. And shortage does not stay for a longer period of time. Shortage of particular product with huge industry size invite more players into the industry which reduces the profitability. Continuously remaining low-cost producer, business needs to be run by the strong management or else business will not sustain as a low-cost producer for the long period of time.

WB 1991 03

We generally provide difference valuations to the businesses where we can foresee constant earning with the lower capital requirement and where we cannot foresee earning with cyclical business nature. Mr. Buffett has explained this concept by mentioning Media business and steel business. He mentioned that we believe that media business having a constant revenue and steel business having a cyclical business nature but when media business has started to getting deteriorate then we revise our way to value media business.

See’s Candy

Berkshire Hathway had bought See’s Candy through Bluechip stamp in the year 1972. A company owned $7 million of tangible net worth with $10 million of excess cash. A seller had asked $30 million (cash adjusted) for the 100% ownership of See’s candy. Buffett and Charlie were ready to pay only $25 million for See’s. Buffett and Charlie have been experienced a pricing power to the business and they felt lucky that seller agreed to sell See’s at $25 million to Berkshire. See’s sales grown from $29 million to $196 million and pre-tax profit has grown from $4.2 million in the year 1972 to $42.4 million in the year 1990.

H.H.Brown

Berkshire has made an investment in the H.H.Brown company, which is a shoe manufacturing business. H.H.Brown is a leading manufacturer of work shoes and boots in North America. Mr. Buffett knows that shoe business is tough to perform due to higher inventories and receivables but he has experienced that H.H.Brown has done well in the leadership of Frank and Mr. Heffernan.

WB 1991 04

If we got a good business which is run by a good manager in the bad industry then we should check such business as an investment candidate.

Berkshire Hathway earns from holding policyholders fund which Mr. Buffett called as “Float”.

WB 1991 05

WB 1991 06

Berkshire Hathway has beat government bond in 20 years from 25 years till the year 1991 and cost of the fund remains satisfactory which help Berkshire Hathway to grow well. Insurance business of the company sustain well, increases float. Lower cost of float and Berkshire has compound it in a good manner which is a major strength of the company for being an out-performer.

Mr. Buffett has mentioned that they don’t like to trade business to business. He considers that He & Charlie are not as much smart to earn well by buying and selling businesses for a longer period of time. He likes to buy a business which has a long-term economic characteristic, run by quality people and available at a sensible price.

Mistake Du Jour

In this section, Mr. Buffett has written about the mistakes which he has incurred. He believes that people cannot able to see mistakes incurred by Berkshire, that does not reduce the cost associated with mistakes. Berkshire has missed few opportunities such as esoteric invention (such as Xerox), high-technology (Apple), or even brilliant merchandising (Wal-Mart) but they do not consider it as their mistake. Such type of the businesses does not fall under their competence area to understand so they have missed it. Few mistakes which they have occurred from their competence area.

In the year 1988, they decided to purchase 30 million shares of Federal National Mortgage Association (Fannie Mae). They owned stocks since earlier years and also understand the business. But when they have bought 7 million shares and the stock price has started moving upside and they have stopped buying it. They do not want to repeat mistakes which they occurred while buying shares of Coca-Cola, they have to keep on buying shares of Coca-Cola though the price has moving upward. But here, they sold 7 million shares which they hold due to a small position. Such a mistake has cost to Berkshire is about $1.40 billion.

Warren Buffett’s Letters 1957 – 2012

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