value-investors-tts/annual-letters/bpl-1963b.txt

BUFFETT PARTNERSHIP, LTD.
810 KIEWIT PLAZA
OMAHA 31, NEBRASKA
July 10, 1963
First Half Performance
During the first half of 1963, the Dow Jones Industrial Average (hereinafter called the "Dow") advanced from
652.10 to 706.88. If one had owned the Dow during this period, dividends of $10.66 would have been received,
bringing the overall return from the Dow during the first half to plus 10.0%.
Our incantation has been: (1) that short-term results (less than three years) have little meaning, particularly in
reference to an investment operation such as ours that devotes a portion of resources to control situations, and;
(2) That our results relative to the Dow and other common-stock-form media, will be better in declining markets
and may well have a difficult time just matching such media in bubbling markets.
Nevertheless, our first-half performance, excluding any change in Dempster valuation (and its valuation did
change --I'm saving this for dessert later in the letter) was plus 14%. This 14% is computed on total net assets
(not non-Dempster assets) and is after expenses, but before monthly payments (to those who take them) to
partners and allocation to the General Partner. Such allocations are academic on an interim basis, but if we were
also plus 14% at yearend, the first 6% would be allocated to partners according to their capital, plus three-
quarters of the balance of 8% (14% -6%), or an additional 6%, giving the limited partners a plus 12%
performance.
Despite the relatively pleasant results of the first half the admonitions stated two paragraphs earlier hold in full
force. At plus 14% versus plus 10% for the Dow, this six months has been a less satisfactory period than the first
half of 1962 when we were minus 7.5% versus minus 21.7% for the Dow. You should completely understand
our thinking in this regard which has been emphasized in previous letters.
During the first half we had an average net investment in "generals" (long positions in generals minus short
positions in generals) of approximately $5,275,000. Our overall gain from this net investment in generals (for a
description of our investment categories see the last annual letter) was about $1,100,000 for a percentage gain
from this category of roughly 21%. This again illustrates the extent to which the allocation of our resources
among various categories affects short-term results. In 1962 the generals were down for the year and only an
outstanding performance by both of the other two categories, "work-outs" and "controls," gave us our unusually
favorable results for that year.
Now this year, our work-outs have done poorer than the Dow and have been a drag on performance, as they are
expected to be in rising markets. While it would be very nice to be 100% in generals in advancing markets and
100% in work-outs in declining markets, I make no attempt to guess the course of the stock market in such a
manner. We consider all three of our categories to be good businesses on a long-term basis, although their short-
term price behavior characteristics differ substantially in various types of markets. We consider attempting to
gauge stock market fluctuations to be a very poor business on a long-term basis and are not going to be in it,
either directly or indirectly through the process of trying to guess which of our categories is likely to do best in
the near future.
Investment Companies
Shown below are the usual statistics on a cumulative basis for the Dow and Buffett Partnership. Ltd. (including
predecessor partnerships) as well as for the two largest open-end (mutual funds) and two largest closed-end
investment companies following a diversified common-stock investment policy:
Year Dow Mass.Inv. Trust
(1)
Investors Stock
(1)
Tri-Cont. (2)
1957 -8.4% -11.4% -12.4% -2.4%
1957 – 58 26.9% 26.4% 29.2% 30.0%
1957 – 59 52.3% 37.8% 42.5% 40.9%
1957 – 60 42.9% 36.4% 41.6% 44.8%
1957 – 61 74.9% 71.3% 76.9% 77.4%
1957 – 62 61.6% 54.5% 53.2% 59.7%
1957 – 6/30/63 77.8% 72.4% 69.3% 75.7%
Annual
Compounded Rate
9.3% 8.7% 8.4% 9.1%
Year Lehman (2) Partnership (3) Limited Partners
(4)
1957 -11.4% 10.4% 9.3%
1957 – 58 24.7% 55.6% 44.5%
1957 – 59 34.8% 95.9% 74.7%
1957 – 60 38.2% 140.6% 107.2%
1957 – 61 70.8% 251.0% 181.6%
1957 – 62 46.2% 299.8% 215.1%
1957 – 6/30/63 60.8% 355.8% 252.9%
Annual
Compounded Rate
7.6% 26.3% 21.4%
Footnotes :
(1) Computed from changes in asset value plus any distributions to holders of record during year.
(2) From 1963 Moody's Bank & Finance Manual for 1957-62. Estimated for first half 1963.
(3) For 1957-61 consists of combined results of all predecessor limited partnerships operating throughout
entire year after all expenses but before distributions to partners or allocations to the general partner.
(4) For 1957-61 computed on basis of preceding column of partnership results allowing for allocation to
general partner based upon present partnership agreement.
The results continue to show that the most highly paid and respected investment advice has difficulty matching
the performance of an unmanaged index of blue-chip stocks. This in no sense condemns these institutions or the
investment advisers and trust departments whose methods, reasoning, and results largely parallel such
investment companies. These media perform a substantial service to millions of investors in achieving adequate
diversification, providing convenience and peace of mind, avoiding issues of inferior quality, etc. However,
their services do not include (and in the great majority of cases, are not represented to include) the compounding
of money at a rate greater than that achieved by the general market.
Our partnership's fundamental reason for existence is to compound funds at a better-than-average rate with less
exposure to long-term loss of capital than the above investment media. We certainly cannot represent that we
will achieve this goal. We can and do say that if we don't achieve this goal over any reasonable period excluding
an extensive speculative boom, we will cease operation.
Dempster Mill Manufacturing Company
In our most recent annual letter, I described Harry Bottle as the “man of the year”. If this was an understatement.
Last year Harry did an extraordinary job of converting unproductive assets into cash which we then, of course,
began to invest in undervalued securities. Harry has continued this year to turn under-utilized assets into cash,
but in addition, he has made the remaining needed assets productive. Thus we have had the following
transformation in balance sheets during the last nineteen months:
November 30, 1961 (000’s omitted)
Assets Book Figure Valued @ Adjusted
Valuation
Liabilities
Cash $166 100% $166 Notes Payable $1,230
Accts. Rec.
(net)
$1,040 85% $884 Other
Liabilities
$1,088
Inventory $4,203 60% $2,522
Ppd. Exp. Etc. $82 25% $21 Total
Liabilities
$2,318
Current Assets $5,491 $3,593 Net Worth:
Per Books $4,601
Cash Value
Life ins., etc.
$45 100% $45 As adjusted to
quickly
realizable
values
$2,120
Net Plant &
equipment
$1,383 Est. Net
Auction Value
$800
Total Assets $6,919 $4,438 Share
outstanding
60,146. Adj.
Value per
Share
$35.25
Buffett Partnership Letters 1957 to 1970
www.csinvesting.wordpress.com studying/teaching/investing Page 45
November 30, 1962 (000’s omitted)
Assets Book Figure Valued @ Adjusted
Valuation
Liabilities
Cash $60 100% $60 Notes payable $0
Marketable
Securities
$758 Mkt. 12/31/62 $834 Other
liabilities
$346
Accts. Rec.
(net)
$796 85% $676 Total liabilities $346
Inventory $1,634 60% $981
Cash value life
ins.
$41 100% $41 Net Worth:
Recoverable
income tax
$170 100% $170 Per books $4,077
Ppd. Exp. Etc $14 25% $4 As adjusted to
quickly
realizable
values
$3,125
Add: proceeds
from potential
exercise of
option to
Harry Bottle
$60
Current Assets $3,473 $2,766 $3,185
Shares
Outstanding
60,146
Misc. Invest. $5 100% $5 Add: shs.
Potentially
outstanding
under option:
2,000
Total shs.
62,146
Net plant &
equipment
$945 Est. net
auction value
$700 Adj. Value per
Share
$51.26
Total Assets $4,423 $3,471

November 30, 1963 (000’s omitted)
Assets Book Figure Valued @ Adjusted
Valuation
Liabilities
Cash $144 100% $144 Notes payable
(paid 7/3/63)
$125
Marketable
Securities
$1,772 Mkt. 6/30/63 $2,029 Other
liabilities
$394
Accts. Rec.
(net)
$1,262 85% $1,073 Total
Liabilities
$519
Inventory $977 60% $586
Ppd. Exp. Etc $12 25% $3 Net Worth:
Per books $4,582
Current Assets $4,167 $3,835 As adjusted to
quickly
realizable
values
$4,028
Misc. Invest $62 100% $62 Shares
outstanding
62,146
Net plant &
equip.
$872 Est. net
auction value
$650 Adj. Value per
share
$64.81
Total assets $5,101 $4,547
I have included above the conversion factors we have previously used in valuing Dempster for B.P.L. purposes
to reflect estimated immediate sale values of non-earning assets.
As can be seen, Harry has converted the assets at a much more favorable basis than was implied by my
valuations. This largely reflects Harry's expertise and, perhaps, to a minor degree my own conservatism in
valuation.
As can also be seen, Dempster earned a very satisfactory operating profit in the first half (as well as a substantial
unrealized gain in securities) and there is little question that the operating business, as now conducted, has at
least moderate earning power on the vastly reduced assets needed to conduct it. Because of a very important-
seasonal factor and also the presence of a tax carry forward, however, the earning power is not nearly what
might be inferred simply by a comparison of the 11/30/62 and 6/30/63 balance sheets. Partly because of this
seasonality, but more importantly, because of possible developments in Dempster before 1963 yearend, we have
left our Dempster holdings at the same $51.26 valuation used at yearend 1962 in our figures for B.P.L’s first
half. However, I would be very surprised if it does not work out higher than this figure at yearend.
One sidelight for the fundamentalists in our group: B.P.L. owns 71.7% of Dempster acquired at a cost of
$1,262,577.27. On June 30, 1963 Dempster had a small safe deposit box at the Omaha National Bank containing
securities worth $2,028,415.25. Our 71.7% share of $2,028,415.25 amounts to $1,454,373.70. Thus, everything
above ground (and part of it underground) is profit. My security analyst friends may find this a rather primitive
method of accounting, but I must confess that I find a bit more substance in this fingers and toes method than in
any prayerful reliance that someone will pay me 35 times next year's earnings.

Advance Payments and Advance Withdrawals
We accept advance payments from partners and prospective partners at 6% interest from date of receipt until the
end of the year. While there is no obligation to convert the payment to a partnership interest at the end of the
year, this should be the intent at the time of payment.
Similarly, we allow partners to withdraw up to 20% of their partnership account prior to yearend and charge
them 6% from date of withdrawal until yearend when it is charged against their capital account. Again, it is not
intended that partners use US like a bank, but that they use the withdrawal right for unanticipated need for
funds.
The willingness to both borrow and lend at 6% may seem "un-Buffett-like.” We look at the withdrawal right as
a means of giving some liquidity for unexpected needs and, as a practical matter, are reasonably sure it will be
far more than covered by advance payments.
Why then the willingness to pay 6% for advance payment money when we can borrow from commercial banks
at substantially lower rates? For example, in the first half we obtained a substantial six-month bank loan at 4%.
The answer is that we expect on a long-term basis to earn better than 6% (the general partner's allocation is zero
unless we do although it is largely a matter of chance whether we achieve the 6% figure in any short period.
Moreover, I can adopt a different attitude in the investment of money that can be expected to soon be a part of
our equity capital than I can on short-term borrowed money. The advance payments have the added advantage to
us of spreading the investment of new money over the year, rather than having it hit us all at once in January. On
the other hand, 6% is more than can be obtained in short-term dollar secure investments by our partners, so I
consider it mutually profitable. On June 30, 1963 we had advance withdrawals of $21,832.00 and advance
payments of $562,437.11.
Taxes
There is some possibility that we may have fairly substantial realized gains this year. Of course, this may not
materialize at all and actually does not have anything to do with our investment performance this year. I am an
outspoken advocate of paying large amounts of income taxes -- at low rates. A tremendous number of fuzzy,
confused investment decisions are rationalized through so-called "tax considerations.”
My net worth is the market value of holdings less the tax payable upon sale. The liability is just as real as the
asset unless the value of the asset declines (ouch), the asset is given away (no comment), or I die with it. The
latter course of action would appear to at least border on a Pyrrhic victory.
Investment decisions should be made on the basis of the most probable compounding of after-tax net worth with
minimum risk. Any isolation of low-basis securities merely freezes a portion of net worth at a compounding
factor identical with the assets isolated. While this may work out either well or badly in individual cases, it is a
nullification of investment management. The group experience holding various low basis securities will
undoubtedly approximate group experience on securities as a whole, namely compounding at the compounding
rate of the Dow. We do not consider this the optimum in after-tax compounding rates.
I have said before that if earnings from the partnership can potentially amount to a sizable portion of your total
taxable income, the safe thing to do is to estimate this year the same tax you incurred last year. If you do this,
you cannot run into penalties. In any event, tax liabilities for those who entered the partnership on 1/1/63 will be
minimal because of the terms of our partnership agreement first allocating capital gains to those having an
interest in unrealized appreciation.

As in past years, we will have a letter out about November 1st (to partners and those who have indicated an
interest to me by that time in becoming partners) with the amendment to the partnership agreement, commitment
letter for 1964, estimate of the 1963 tax situation, etc.
My closing plea for questions regarding anything not clear always draws a blank. Maybe no one reads this far.
Anyway, the offer is still open.
Cordially,
Warren E. Buffett