Warren Buffett Letter #13: 1989
October 14, 2010 4 Comments
And of course this is in spite of Warren’s yearly bluster about the impossibility of any future BRK growth. (He does it even more in 1989, this time predicting an imminent loss in shareholder value.) He’s a fiscal Ralph Kramden: “One of these days, investors… POW! Right in the kisser!”
(Did I just date myself? Reveal that I am actually an 87-year-old man? And did you know Jackie Gleason recorded a Christmas album of “lounge” music? I have a copy.)
Anyway, before we head straight to the moon, four segments in 1989’s letter. Let’s break it down, Berlin-Wall-style:
(Are you humming Jimmy’s “Come to the Moon?” Why not?)
Thank the government for not taxing your paper gains
In a long section re: tax liabilities, Warren details the investor’s benefit of only owing taxes when an asset is sold — it’s effectively an interest-free loan that renders the eventual levy a simple “transfer tax” when funds are moved from one asset to another.
He uses an extreme example to validate the benefit of staying put and taking advantage of this governmental largesse:
- Two scenarios. Both start with $1.
- Scenario One: we pick a winner in year one, double our investment, and promptly sell. We manage to repeat this process every year for 20 years. And each year we pay 34% to Uncle Sam.
- Scenario Two: we pick a single winner that itself manages to double annually for 20 years. Only then do we cash out.
- In Scenario One, we’re left with $25,250 and the government $13,000. Look what you can get for a buck.
- In Scenario Two, we’re left with $1,048,576, and the government with $356,500.
(See what happens when you sell all the time?! This is why we can’t have nice things.)
Warren contends this isn’t why he holds forever, rather that Berkshire finds good people and mates for life. “Like seahorses. Wealthy, wealthy seahorses.”
And he admits that a capable investor could overcome this transfer tax by moving intelligently. But to me — incapable of doing anything intelligently — it reinforces that I should not be selling BP, even though I am a hero in investing circles thanks to the purchase, and I would like a Playstation.*
The usual back-patting and attaboys
Everything’s amazing with Berkshire’s holdings. I won’t bore you like Warren did me with the quantification. The one highlight is the Blumkin Family Schism. Remember the Blumkins? Nebraska Furniture Mart?
Well, see if you believe this. Rose frickin’ quit.
Seriously. 200-year-old Rose quit her own family business — ditching her (presumably) 90-year-old sons. Over a disagreement about the prominence of carpet in the mart!
The best part? She promptly went and opened a competing store.
My guesses on the new store’s name, in decreasing order of likelihood:
- Rose’s Rugs
- Old Lady Carpets
- Come and Sit. And Buy Some Carpet.
Insurance is… insurance-y as ever. Warren adds an aside about Berkshire’s evolving role in catastrophe (CAT) insurance, the business of reinsurance: insuring the insurers (and other insurers who insure the insurers — really). These are short-term contracts against single catastrophic events. And in 1989, in the wake of Hurricane Hugo and the earthquake that killed the frickin’ San Francisco Giants’ momentum, CAT covers were hit hard. Reinsurers had less cash with which to insure, rates went up, and Berkshire jumped in to the tune of $250M.
Why would you insure against catastrophes? Shut up and I’ll tell you:
- Berkshire can afford it. Worst-case, it can absorb a $250M loss. “Though that is far more than Berkshire normally earns in a quarter, the damage would be a blow only to our pride, not to our well-being.”
- Warren can handle it. Unlike most CEOs, he doesn’t fret about single-quarter results. But most company chiefs, with their lizard-like thin skin, “do not want to expose themselves to an embarrassing single-quarter loss, even if the managerial strategy that causes the loss promises, over time, to produce superior results.”
- “When rates carry an expectation of profit, we want to assume as much risk as is prudent. And in our case, that’s a lot.”
Berkshire also invested in Gillette and Coca-Cola this year. Good CEOs and all that. I’m grasping for a combination Coke-and-Mach-3 joke, but nothing comes other than a weak one about shaving while caffeinated, which I’ll spare you. (Half-spare you, I guess.)
I can’t — for both lack of legitimacy and simple energy — do this part justice, but Warren offers forth a fantastic history and overview of the zero-coupon security. Never thought I’d write that phrase.
These are bonds that only pay when due — versus a coupon on a semi- or annual basis — and started off legitimate (e.g., savings bonds) but have been corrupted by certain investment bankers, who use the zero-coupon instrument to accrue debt beyond a company’s real ability to pay. If you’re interested I’d suggest you read it your dang self.
The only item worth highlighting and that I barely understand is Warren’s description of EBITD (earnings before interest, taxes, and depreciation), which has been accepted by many as a measure of a company’s ability to pay interest against issued bonds, as an “abomination” in ignoring depreciation — a very real cost. “Capital expenditures that over time roughly approximate depreciation are a necessity and are every bit as real an expense as labor or utility costs.”
Warren Makes a Mistakes
1989 marks 25 years of what is now known as Berkshire-Hathaway, and Warren ends the letter with a summary of the mistakes he’s made during that time. It’s a good read, not wholly surprising altogether, and his lessons boil down into a series of aphorisms:
- Don’t be a “cigar butt” investor — availing yourself of cheap, but dying, businesses. Warren’s example — of which he claims many — is the Berkshire textile business itself. You may get a puff, but invariably they are dying for a reason, and not worth the risk. (You’ll also get gross germs. Have you seen how dudes smoke cigars? All bitey and spitty. Cigar butts are medical waste.)
- Good people cannot rescue a bad business. (Good people can however rescue a bad swimmer.)
- Difficult business problems are often difficult for a reason. Solve easy ones. “In both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.” (Incidentally: also true for the SAT.)
- Institutional — i.e., corporate — dynamics will trump individual strengths. These include organizational inertia; the oft erratic internal absorption of any excess equity; the de facto support of a leader’s idea by his underlings (no matter how foolish it may be); and the automatic, “mindless” imitation of competitors. (Gillette Mach 3, meet Schick Extreme.)
- Go into business only with people you like, trust, and admire. (And don’t mind the smell of.)
- When writing a blog project about someone’s annual letters, feel free to skip a few years. Who’s counting?
Warren finally puts forth a promise that in 2015 he will reveal his mistakes from the next 25 years. I will be here — probably only on 1994’s letter by then anyway — waiting. Hamana hamana!
* One circle. It includes my children. They would like a Playstation too.