1980 Letter to Berkshire Shareholders
BERKSHIRE HATHAWAY INC.
To the Shareholders of Berkshire Hathaway Inc.:
Operating earnings improved to 36.0 million in 1979, but return on beginning equity capital (with securities valued at cost) declined to 17.8% from 18.6%. We believe this latter figure to be the more meaningful measure of performance. New equity capital was added during the year, making the percentage gain in earnings per share somewhat less impressive than it might appear at first glance.
Much of the gain in earnings came from insurance underwriting. However, as indicated in last year’s report, we expect insurance underwriting results to deteriorate significantly in 1981. Indeed, we expect that industry underwriting results in 1981 will be the poorest in many years.
Measuring Long-Term Performance
We continue to feel that the ratio of operating earnings (before securities gains or losses) to beginning equity capital is the most appropriate measure of single-year managerial performance. It is important, however, to understand the limitations of this measure. We have discussed those limitations in past reports, but believe they are sufficiently important to warrant repetition.
First, securities values can change significantly, producing large changes in equity capital. Such changes can significantly affect the denominator in our ratio without any change in operating earnings. For example, a large increase in securities values will produce a large increase in equity capital, thereby reducing the ratio of operating earnings to equity capital even though operating earnings remain unchanged. Conversely, a large decrease in securities values will reduce equity capital and increase the ratio even though operating earnings remain unchanged.
Second, the ratio reflects results of a single year and, therefore, can be distorted by factors peculiar to that year. For example, insurance underwriting results are highly volatile and should be measured over a period of several years. A single-year ratio can be materially affected by unusual insurance underwriting results for that year.
Third, the ratio can be distorted by unusual debt-equity ratios. Such distortion is especially applicable to financial institutions, including insurance companies. Most financial institutions operate with very high debt-equity ratios, often 20:1 or more. Thus, even a very small positive spread between the rate earned on assets and the cost of liabilities can produce a very high return on equity. However, a very small negative spread can wipe out equity.
We believe that meaningful measurement of operating performance must reflect both the return on equity and the level of risk inherent in the business operation. The risk factor largely reflects the degree of leverage. We have attempted to reflect both return and risk in the measurement of our insurance operations by adjusting equity to reflect unrealized appreciation or depreciation in equity securities. This adjustment produces an equity figure that better reflects the true equity underlying the operations and produces a return figure that more accurately reflects the risk level.
Fourth, the ratio excludes capital gains or losses, both realized and unrealized. We feel that inclusion of such items, particularly on a single-year basis, would produce a distorted picture of operating results. Capital gains often are realized in years following the period in which the value increase actually occurred. Thus, inclusion in a single-year figure would reflect events and decisions of earlier years.
For reasons discussed above, we believe that measurement of operating performance on a single-year basis is inherently imperfect. Such measurement should be viewed only as an approximate indicator of performance and should be supplemented by consideration of results over a longer period. We believe that measurement of performance over a period of five years or more provides a much more meaningful picture of managerial economic performance.
We also believe that measurement of performance should reflect the economic reality of the business operation rather than the accounting presentation. We have discussed in past reports the distortions that can arise from adherence to conventional accounting presentations. We continue to believe that such presentations often do not reflect economic reality and can produce misleading measurements of performance.
Sources of Reported Earnings
The table below shows the sources of Berkshire’s reported earnings. Major segments of business activity are shown separately, along with supplemental figures regarding insurance operations. Blue Chip Stamps is shown on an equity basis and, therefore, its earnings are included in Berkshire’s reported earnings to the extent of our approximate 60% ownership interest.
| Pre-Tax Earnings | Pre-Tax Earnings | After-Tax Earnings | |
|---|---|---|---|
| 1980 | 1979 | 1980 | |
| Operating Earnings: | |||
| Insurance Group: | |||
| Underwriting | ($3.4) | ($2.2) | ($1.9) |
| Net Investment Income | 19.7 | 16.8 | 17.0 |
| Blue Chip Stamps - Equity Basis | 7.8 | 5.6 | 4.2 |
| Illinois National Bank | 4.5 | 4.1 | 2.4 |
| Retail Operations | 2.6 | 2.7 | 1.4 |
| Textile Operations | (1.2) | (1.8) | (0.7) |
| Total Operating Earnings | 30.0 | 25.2 | 22.4 |
| Securities Gains: | |||
| Insurance Group | 8.8 | 7.8 | 4.9 |
| Blue Chip Stamps | 2.7 | 2.6 | 1.5 |
| Berkshire Hathaway Inc. | 1.4 | 0.4 | 0.8 |
| Total Securities Gains | 12.9 | 10.8 | 7.2 |
| Total Reported Earnings | 42.9 | 36.0 | 29.6 |
Note: All figures in millions of dollars.
The insurance underwriting loss of $3.4 million was substantially larger than anticipated. As indicated in last year’s report, we expected a deterioration in insurance underwriting results in 1980. However, the actual deterioration was worse than expected. The industry experienced significant deterioration, and our results were affected by industry trends as well as by certain problems peculiar to our operations.
Insurance Underwriting
The insurance industry experienced a significant deterioration in underwriting results during 1980. Industry combined ratios are estimated to have increased to approximately 103 from approximately 101 in 1979. We expect further deterioration in 1981, with industry combined ratios increasing to approximately 106 or higher.
Our insurance subsidiaries, in aggregate, had a combined ratio of approximately 103.3 in 1980. This compares with 100.7 in 1979. The deterioration reflects the adverse trends in the insurance industry discussed in last year’s report, as well as certain problems peculiar to our operations.
Phil Liesche’s operation at National Indemnity Company produced a combined ratio of approximately 103 in 1980. This compares with 94 in 1979. The deterioration reflects the fact that we maintained our pricing discipline in an increasingly competitive market, accepting a significant reduction in premium volume. Premium volume at National Indemnity declined from 67 million in 1980. We believe this reduction in volume to be appropriate given market conditions, even though it produced a deterioration in underwriting results. We continue to believe that maintenance of underwriting standards and pricing discipline is essential to long-term profitability in the insurance business.
The homestate insurance operation had a combined ratio of approximately 108 in 1980, compared with 104 in 1979. John Ringwalt’s operation experienced significant problems in certain lines of business, and we expect further deterioration in 1981.
Home and Automobile Insurance Company had a combined ratio of approximately 106 in 1980, compared with 101 in 1979. John Seward’s operation also experienced significant problems, reflecting industry trends.
Our reinsurance operation, managed by George Young, had a combined ratio of approximately 112 in 1980, compared with 107 in 1979. The reinsurance market continues to be highly competitive, and we expect continued difficult conditions.
We continue to believe that the insurance business offers significant opportunities for profit over the long term. However, we also believe that the industry is experiencing significant adverse trends that will produce difficult conditions for most operators during the next few years. Our goal is to maintain our underwriting standards and pricing discipline, even if it means accepting a significant reduction in premium volume and temporary deterioration in underwriting results.
Insurance Investments
Our insurance subsidiaries had investments at cost (excluding the investment in Blue Chip Stamps) of approximately 302 million at yearend 1979. Net investment income approximated 16.8 million in 1979.
We realized capital gains of 42 million. Our equity holdings at yearend 1980 with a market value over $5 million were:
| No. of Shares | Company | Cost ($000) | Market ($000) |
|---|---|---|---|
| 1,871,692 | American Broadcasting Companies, Inc. | 8,533 | 27,335 |
| 1,294,308 | Government Employees Insurance Co. Common Stock | 4,116 | 8,150 |
| 592,650 | The Interpublic Group of Companies, Inc. | 4,531 | 10,710 |
| 451,720 | SAFECO Corporation | 7,929 | 10,890 |
| 280,150 | The Washington Post Company Class B | 3,266 | 8,400 |
| Total | 28,375 | 65,485 | |
| All Other Holdings | 84,925 | 106,588 | |
| Total Equities | 113,300 | 172,073 |
Our equity investments remain concentrated in a relatively few companies. We continue to believe that meaningful positions in a few outstanding businesses are preferable to small positions in many mediocre businesses.
During 1980 we purchased approximately 8% of R.J. Reynolds Industries (now RJR Nabisco) for approximately $29 million. This purchase reflects our investment philosophy described in past reports. We believe RJR Nabisco to be a good business with favorable long-term prospects, operated by competent people, and available at an attractive price.
We also increased our investment in GEICO Corporation during 1980. GEICO continues to operate under difficult conditions, but we believe it to have excellent long-term prospects. We have great admiration for Jack Byrne, GEICO’s chief executive officer, who has brought the company through a very difficult period and has positioned it for long-term success.
Banking
The Illinois National Bank continued its outstanding record in 1980, achieving earnings of approximately $4.5 million. The bank remains one of the most profitable banks of its size in the United States, achieving a return on assets substantially above industry averages. Peter Jeffrey continues to manage the bank with great skill.
Gene Abegg, now 81, continues as Chairman. We are fortunate to have both Gene and Peter managing this operation.
Retail Operations
Associated Retail Stores, Inc. had a good year in 1980, although earnings declined slightly from 1979. Ben Rosner continues to manage this operation effectively. This business produces good results with minimal capital requirements.
Blue Chip Stamps
We owned approximately 60% of Blue Chip Stamps at yearend 1980. Blue Chip had operating earnings of approximately 2.7 million.
See’s Candies, a wholly-owned subsidiary of Blue Chip Stamps, had an excellent year with pre-tax earnings of approximately 13 million in 1979. Chuck Huggins continues to manage See’s effectively. Since acquisition in 1972, See’s earnings have grown from 14 million with minimal additional capital investment.
Wesco Financial Corporation, an 80%-owned subsidiary of Blue Chip Stamps, continues to be managed effectively by Louis Vincenti.
Shareholders of Berkshire Hathaway may obtain the annual report of Blue Chip Stamps by writing to Mr. Robert H. Bird, Blue Chip Stamps, 5801 South Eastern Avenue, Los Angeles, California 90040.
Geo. W. Jones & Sons, Inc.
In late 1980 we acquired Geo. W. Jones & Sons, Inc., a small newspaper in Decatur, Illinois. We purchased this business because we believe it to have favorable long-term prospects and because we like newspapers as businesses. This acquisition was small, but we expect it to be profitable.
We have long believed that newspapers, when operated in towns with a strong sense of community, have excellent business characteristics. Such newspapers have a natural monopoly in their market, since they are the primary source of local news and information. We believe that Geo. W. Jones & Sons fits this pattern.
Warren E. Buffett, Chairman February 27, 1981
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