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+1957 Letter
+WARREN E. BUFFETT
+5202 Underwood Ave. Omaha, Nebraska
+
+SECOND ANNUAL LETTER TO LIMITED PARTNERS
+
+The General Stock Market Picture in 1957.
+
+In last year's letter to partners, I said the following:
+My view of the general market level is that it is priced above intrinsic value. This view relates to blue-chip
+securities. This view, if accurate, carries with it the possibility of a substantial decline in all stock prices, both
+undervalued and otherwise. In any event I think the probability is very slight that current market levels will be
+thought of as cheap five years from now. Even a full-scale bear market, however, should not hurt the market
+value of our work-outs substantially.
+If the general market were to return to an undervalued status our capital might be employed exclusively in
+general issues and perhaps some borrowed money would be used in this operation at that time. Conversely, if
+the market should go considerably higher our policy will be to reduce our general issues as profits present
+themselves and increase the work-out portfolio.
+All of the above is not intended to imply that market analysis is foremost in my mind. Primary attention is given
+at all times to the detection of substantially undervalued securities.
+The past year witnessed a moderate decline in stock prices. I stress the word "moderate" since casual reading of
+the press or conversing with those who have had only recent experience with stocks would tend to create an
+impression of a much greater decline. Actually, it appears to me that the decline in stock prices has been
+considerably less than the decline in corporate earning power under present business conditions. This means that
+the public is still very bullish on blue chip stocks and the general economic picture. I make no attempt to
+forecast either business or the stock market; the above is simply intended to dispel any notions that stocks have
+suffered any drastic decline or that the general market, is at a low level. I still consider the general market to be
+priced on the high side based on long term investment value.
+Our Activities in 1957
+The market decline has created greater opportunity among undervalued situations so that, generally, our
+portfolio is heavier in undervalued situations relative to work-outs than it was last year. Perhaps an explanation
+of the term "work-out" is in order. A work-out is an investment which is dependent on a specific corporate
+action for its profit rather than a general advance in the price of the stock as in the case of undervalued
+situations. Work-outs come about through: sales, mergers, liquidations, tenders, etc. In each case, the risk is that
+something will upset the applecart and cause the abandonment of the planned action, not that the economic
+picture will deteriorate and stocks decline generally. At the end of 1956, we had a ratio of about 70-30 between
+general issues and work-outs. Now it is about 85-15.
+During the past year we have taken positions in two situations which have reached a size where we may expect
+to take some part in corporate decisions. One of these positions accounts for between 10% and 20% of the
+portfolio of the various partnerships and the other accounts for about 5%. Both of these will probably take in the
+neighborhood of three to five years of work but they presently appear to have potential for a high average annual
+rate of return with a minimum of risk. While not in the classification of work-outs, they have very little
+Buffett Partnership Letters 1957 to 1970
+www.csinvesting.wordpress.com studying/teaching/investing Page 2
+dependence on the general action of the stock market. Should the general market have a substantial rise, of
+course, I would expect this section of our portfolio to lag behind the action of the market.
+Results for 1957
+In 1957 the three partnerships which we formed in 1956 did substantially better than the general market. At the
+beginning of the year, the Dow-Jones Industrials stood at 499 and at the end of the year it was at 435 for a loss
+of 64 points. If one had owned the Averages, he would have received 22 points in dividends reducing the overall
+loss to 42 points or 8.470% for the year. This loss is roughly equivalent to what would have been achieved by
+investing in most investment funds and, to my knowledge, no investment fund invested in stocks showed a gain
+for the year.
+All three of the 1956 partnerships showed a gain during the year amounting to about 6.2%, 7.8% and 25% on
+yearend 1956 net worth. Naturally a question is created as to the vastly superior performance of the last
+partnership, particularly in the mind of the partners of the first two. This performance emphasizes the
+importance of luck in the short run, particularly in regard to when funds are received. The third partnership was
+started the latest in 1956 when the market was at a lower level and when several securities were particularly
+attractive. Because of the availability of funds, large positions were taken in these issues. Whereas the two
+partnerships formed earlier were already substantially invested so that they could only take relatively small
+positions in these issues.
+Basically, all partnerships are invested in the same securities and in approximately the same percentages.
+However, particularly during the initial stages, money becomes available at varying times and varying levels of
+the market so there is more variation in results than is likely to be the case in later years. Over the years, I will
+be quite satisfied with a performance that is 10% per year better than the Averages, so in respect to these three
+partnerships, 1957 was a successful and probably better than average, year.
+Two partnerships were started during the middle of 1957 and their results for the balance of the year were
+roughly the same as the performance of the Averages which were down about 12% for the period since
+inception of the 1957 partnerships. Their portfolios are now starting to approximate those of the 1956
+partnerships and performance of the entire group should be much more comparable in the future.
+Interpretation of results
+To some extent our better than average performance in 1957 was due to the fact that it was a generally poor year
+for most stocks. Our performance, relatively, is likely to be better in a bear market than in a bull market so that
+deductions made from the above results should be tempered by the fact that it was the type of year when we
+should have done relatively well. In a year when the general market had a substantial advance I would be well
+satisfied to match the advance of the Averages.
+I can definitely say that our portfolio represents better value at the end of 1957 than it did at the end of 1956.
+This is due to both generally lower prices and the fact that we have had more time to acquire the more
+substantially undervalued securities which can only be acquired with patience. Earlier I mentioned our largest
+position which comprised 10% to 20% of the assets of the various partnerships. In time I plan to have this
+represent 20% of the assets of all partnerships but this cannot be hurried. Obviously during any acquisition
+period, our primary interest is to have the stock do nothing or decline rather than advance. Therefore, at any
+given time, a fair proportion of our portfolio may be in the sterile stage. This policy, while requiring patience,
+should maximize long term profits.
+Buffett Partnership Letters 1957 to 1970
+www.csinvesting.wordpress.com studying/teaching/investing Page 3
+I have tried to cover points which I felt might be of interest and disclose as much of our philosophy as may be
+imparted without talking of individual issues. If there are any questions concerning any phase of the operation, I
+would welcome hearing from you.
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+Buffett Partnership Letters 1957 to 1970
+1958 Letter
+Warren E Buffett
+5202 Underwood Ave. Omaha, Nebraska
+
+THE GENERAL STOCK MARKET IN 1958
+A friend who runs a medium-sized investment trust recently wrote: "The mercurial temperament, characteristic
+of the American people, produced a major transformation in 1958 and ‘exuberant’ would be the proper word for
+the stock market, at least".
+I think this summarizes the change in psychology dominating the stock market in 1958 at both the amateur and
+professional levels. During the past year almost any reason has been seized upon to justify “Investing” in the
+market. There are undoubtedly more mercurially-tempered people in the stock market now than for a good many
+years and the duration of their stay will be limited to how long they think profits can be made quickly and
+effortlessly. While it is impossible to determine how long they will continue to add numbers to their ranks and
+thereby stimulate rising prices, I believe it is valid to say that the longer their visit, the greater the reaction from
+it.
+I make no attempt to forecast the general market - my efforts are devoted to finding undervalued securities.
+However, I do believe that widespread public belief in the inevitability of profits from investment in stocks will
+lead to eventual trouble. Should this occur, prices, but not intrinsic values in my opinion, of even undervalued
+securities can be expected to be substantially affected.
+
+RESULTS IN 1958.
+In my letter of last year, I wrote:
+“Our performance, relatively, is likely to be better in a bear market than in a bull market so that
+deductions made from the above results should be tempered by the fact that it was the type of year when
+we should have done relatively will. In a year when the general market had a substantial advance, I
+would be well satisfied to match the advance of the averages.”
+The latter sentence describes the type of year we had in 1958 and my forecast worked out. The Dow-Jones
+Industrial average advanced from 435 to 583 which, after adding back dividends of about 20 points, gave an
+overall gain of 38.5% from the Dow-Jones unit. The five partnerships that operated throughout the entire year
+obtained results averaging slightly better than this 38.5%. Based on market values at the end of both years, their
+gains ranged from 36.7% to 46.2%. Considering the fact that a substantial portion of assets has been and still is
+invested in securities, which benefit very little from a fast-rising market, I believe these results are reasonably
+good. I will continue to forecast that our results will be above average in a declining or level market, but it will
+be all we can do to keep pace with a rising market.
+
+TYPICAL SITUATION.
+So that you may better understand our method of operation, I think it would be well to review a specific activity
+of 1958. Last year I referred to our largest holding which comprised 10% to 20% of the assets of the various
+partnerships. I pointed out that it was to our interest to have this stock decline or remain relatively steady, so that
+we could acquire an even larger position and that for this reason such a security would probably hold back our
+comparative performance in a bull market.
+This stock was the Commonwealth Trust Co. of Union City, New Jersey. At the time we started to purchase the
+stock, it had an intrinsic value $125 per share computed on a conservative basis. However, for good reasons, it
+Buffett Partnership Letters 1957 to 1970
+www.csinvesting.wordpress.com studying/teaching/investing Page 5
+paid no cash dividend at all despite earnings of about $10 per share which was largely responsible for a
+depressed price of about $50 per share. So here we had a very well managed bank with substantia1 earnings
+power selling at a large discount from intrinsic value. Management was friendly to us as new stockholders and
+risk of any ultimate loss seemed minimal.
+Commonwealth was 25.5% owned by a larger bank (Commonwealth had assets of about $50 Million – about
+half the size of the First National in Omaha), which had desired a merger for many years. Such a merger was
+prevented for persona1 reasons, but there was evidence that this situation would not continue indefinitely. Thus
+we had a combination of:
+1. Very strong defensive characteristics;
+2. Good solid value building up at a satisfactory pace and;
+3. Evidence to the effect that eventually this value would be unlocked although it might be one year or ten
+years. If the latter were true, the value would presumably have been built up to a considerably larger
+figure, say, $250 per share.
+Over a period of a year or so, we were successful in obtaining about 12% of the bank at a price averaging about
+$51 per share. Obviously it was definitely to our advantage to have the stock remain dormant in price. Our block
+of stock increased in value as its size grew, particularly after we became the second largest stockholder with
+sufficient voting power to warrant consultation on any merger proposa1.
+Commonwealth only had about 300 stockholders and probably averaged two trades or so per month, so you can
+understand why I say that the activity of the stock market generally had very little effect on the price movement
+of some of our holdings.
+Unfortunately we did run into some competition on buying, which railed the price to about $65 where we were
+neither buyer nor seller. Very small buying orders can create price changes of this magnitude in an inactive
+stock, which explains the importance of not having any "Leakage" regarding our portfolio holdings.
+Late in the year we were successful in finding a special situation where we could become the largest holder at an
+attractive price, so we sold our block of Commonwealth obtaining $80 per share although the quoted market was
+about 20% lower at the time.
+It is obvious that we could still be sitting with $50 stock patiently buying in dribs and drabs, and I would be
+quite happy with such a program although our performance relative to the market last year would have looked
+poor. The year when a situation such at Commonwealth results in a realized profit is, to a great extent,
+fortuitous. Thus, our performance for any single year has serious limitations as a basis for estimating long term
+results. However, I believe that a program of investing in such undervalued well protected securities offers the
+surest means of long term profits in securities.
+I might mention that the buyer of the stock at $80 can expect to do quite well over the years. However, the
+relative undervaluation at $80 with an intrinsic value $135 is quite different from a price $50 with an intrinsic
+value of $125, and it seemed to me that our capital could better be employed in the situation which replaced it.
+This new situation is somewhat larger than Commonwealth and represents about 25% of the assets of the
+various partnerships. While the degree of undervaluation is no greater than in many other securities we own (or
+even than some) we are the largest stockholder and this has substantial advantages many times in determining
+the length of time required to correct the undervaluation. In this particular holding we are virtually assured of a
+performance better than that of the Dow-Jones for the period we hold it.
+
+THE CURRENT SITUATION
+The higher the level of the market, the fewer the undervalued securities and I am finding some difficulty in
+ecuring an adequate number of attractive investments. I would prefer to increase the percentage of our assets in
+work-outs, but these are very difficult to find on the right terms.
+To the extent possible, therefore, I am attempting to create my own work-outs by acquiring large positions in
+several undervalued securities. Such a policy should lead to the fulfillment of my earlier forecast – an above
+average performance in a bear market. It is on this basis that I hope to be judged. If you have any questions, feel
+free to ask them.
+WARREN E. BUFFETT 2-11-59