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1358 lines
73 KiB
1358 lines
73 KiB
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<HEAD>
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<TITLE>Chairman's Letter - 1993</TITLE>
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<BODY>
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<P ALIGN=CENTER>
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<B>BERKSHIRE HATHAWAY INC.</B>
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</P>
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<PRE>
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<B>To the Shareholders of Berkshire Hathaway Inc.:</B>
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Our per-share book value increased 14.3% during 1993. Over
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the last 29 years (that is, since present management took over)
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book value has grown from $19 to $8,854, or at a rate of 23.3%
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compounded annually.
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During the year, Berkshire's net worth increased by $1.5
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billion, a figure affected by two negative and two positive non-
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operating items. For the sake of completeness, I'll explain them
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here. If you aren't thrilled by accounting, however, feel free
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to fast-forward through this discussion:
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1. The first negative was produced by a change in
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Generally Accepted Accounting Principles (GAAP)
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having to do with the taxes we accrue against
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unrealized appreciation in the securities we
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carry at market value. The old rule said that
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the tax rate used should be the one in effect
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when the appreciation took place. Therefore,
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at the end of 1992, we were using a rate of 34%
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on the $6.4 billion of gains generated after
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1986 and 28% on the $1.2 billion of gains
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generated before that. The new rule stipulates
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that the current tax rate should be applied to
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all gains. The rate in the first quarter of
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1993, when this rule went into effect, was 34%.
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Applying that rate to our pre-1987 gains
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reduced net worth by $70 million.
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2. The second negative, related to the first, came
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about because the corporate tax rate was raised
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in the third quarter of 1993 to 35%. This
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change required us to make an additional charge
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of 1% against all of our unrealized gains, and
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that charge penalized net worth by $75 million.
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Oddly, GAAP required both this charge and the
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one described above to be deducted from the
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earnings we report, even though the unrealized
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appreciation that gave rise to the charges was
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never included in earnings, but rather was
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credited directly to net worth.
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3. Another 1993 change in GAAP affects the value
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at which we carry the securities that we own.
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In recent years, both the common stocks and
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certain common-equivalent securities held by
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our insurance companies have been valued at
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market, whereas equities held by our non-
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insurance subsidiaries or by the parent company
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were carried at their aggregate cost or market,
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whichever was lower. Now GAAP says that <I>all</I>
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common stocks should be carried at market, a
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rule we began following in the fourth quarter
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of 1993. This change produced a gain in
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Berkshire's reported net worth of about $172
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million.
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4. Finally, we issued some stock last year. In a
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transaction described in last year's Annual
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Report, we issued 3,944 shares in early
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January, 1993 upon the conversion of $46
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million convertible debentures that we had
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called for redemption. Additionally, we issued
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25,203 shares when we acquired Dexter Shoe, a
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purchase discussed later in this report. The
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overall result was that our shares outstanding
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increased by 29,147 and our net worth by about
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$478 million. Per-share book value also grew,
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because the shares issued in these transactions
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carried a price above their book value.
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Of course, it's per-share intrinsic value, not book value,
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that counts. Book value is an accounting term that measures the
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capital, including retained earnings, that has been put into a
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business. Intrinsic value is a present-value estimate of the
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cash that can be taken out of a business during its remaining
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life. At most companies, the two values are unrelated.
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Berkshire, however, is an exception: Our book value, though
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significantly below our intrinsic value, serves as a useful
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device for tracking that key figure. In 1993, each measure grew
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by roughly 14%, advances that I would call satisfactory but
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unexciting.
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These gains, however, were outstripped by a much larger gain
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- 39% - in Berkshire's market price. Over time, of course,
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market price and intrinsic value will arrive at about the same
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destination. But in the short run the two often diverge in a
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major way, a phenomenon I've discussed in the past. Two years
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ago, Coca-Cola and Gillette, both large holdings of ours, enjoyed
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market price increases that dramatically outpaced their earnings
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gains. In the 1991 Annual Report, I said that the stocks of
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these companies could not continuously overperform their
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businesses.
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From 1991 to 1993, Coke and Gillette increased their annual
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operating earnings per share by 38% and 37% respectively, but
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their market prices moved up only 11% and 6%. In other words,
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the companies overperformed their stocks, a result that no doubt
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partly reflects Wall Street's new apprehension about brand names.
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Whatever the reason, what will count over time is the earnings
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performance of these companies. If they prosper, Berkshire will
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also prosper, though not in a lock-step manner.
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Let me add a lesson from history: Coke went public in 1919
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at $40 per share. By the end of 1920 the market, coldly
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reevaluating Coke's future prospects, had battered the stock down
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by more than 50%, to $19.50. At yearend 1993, that single share,
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with dividends reinvested, was worth more than $2.1 million. As
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Ben Graham said: "In the short-run, the market is a voting
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machine - reflecting a voter-registration test that requires only
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money, not intelligence or emotional stability - but in the long-
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run, the market is a weighing machine."
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So how should Berkshire's over-performance in the market
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last year be viewed? Clearly, Berkshire was selling at a higher
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percentage of intrinsic value at the end of 1993 than was the
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case at the beginning of the year. On the other hand, in a world
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of 6% or 7% long-term interest rates, Berkshire's market price
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was not inappropriate if - and you should understand that this is
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a huge if - Charlie Munger, Berkshire's Vice Chairman, and I can
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attain our long-standing goal of increasing Berkshire's per-share
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intrinsic value at an average annual rate of 15%. We have not
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retreated from this goal. But we again emphasize, as we have for
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many years, that the growth in our capital base makes 15% an
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ever-more difficult target to hit.
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What we have going for us is a growing collection of good-
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sized operating businesses that possess economic characteristics
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ranging from good to terrific, run by managers whose performance
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ranges from terrific to terrific. You need have no worries about
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this group.
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The capital-allocation work that Charlie and I do at the
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parent company, using the funds that our managers deliver to us,
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has a less certain outcome: It is not easy to find new
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businesses and managers comparable to those we have. Despite
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that difficulty, Charlie and I relish the search, and we are
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happy to report an important success in 1993.
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<B>Dexter Shoe</B>
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What we did last year was build on our 1991 purchase of H.
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H. Brown, a superbly-run manufacturer of work shoes, boots and
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other footwear. Brown has been a real winner: Though we had
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high hopes to begin with, these expectations have been
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considerably exceeded thanks to Frank Rooney, Jim Issler and the
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talented managers who work with them. Because of our confidence
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in Frank's team, we next acquired Lowell Shoe, at the end of
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1992. Lowell was a long-established manufacturer of women's and
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nurses' shoes, but its business needed some fixing. Again,
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results have surpassed our expectations. So we promptly jumped
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at the chance last year to acquire Dexter Shoe of Dexter, Maine,
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which manufactures popular-priced men's and women's shoes.
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Dexter, I can assure you, needs <I>no</I> fixing: It is one of the
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best-managed companies Charlie and I have seen in our business
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lifetimes.
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Harold Alfond, who started working in a shoe factory at 25
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cents an hour when he was 20, founded Dexter in 1956 with $10,000
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of capital. He was joined in 1958 by Peter Lunder, his nephew.
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The two of them have since built a business that now produces over
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7.5 million pairs of shoes annually, most of them made in Maine
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and the balance in Puerto Rico. As you probably know, the
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domestic shoe industry is generally thought to be unable to
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compete with imports from low-wage countries. But someone forgot
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to tell this to the ingenious managements of Dexter and H. H.
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Brown and to their skilled labor forces, which together make the
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U.S. plants of both companies highly competitive against all
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comers.
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Dexter's business includes 77 retail outlets, located
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primarily in the Northeast. The company is also a major
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manufacturer of golf shoes, producing about 15% of U.S. output.
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Its bread and butter, though, is the manufacture of traditional
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shoes for traditional retailers, a job at which it excels: Last
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year both Nordstrom and J.C. Penney bestowed special awards upon
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Dexter for its performance as a supplier during 1992.
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Our 1993 results include Dexter only from our date of
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merger, November 7th. In 1994, we expect Berkshire's shoe
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operations to have more than $550 million in sales, and we would
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not be surprised if the combined pre-tax earnings of these
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businesses topped $85 million. Five years ago we had no thought
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of getting into shoes. Now we have 7,200 employees in that
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industry, and I sing "There's No Business Like Shoe Business" as
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I drive to work. So much for strategic plans.
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At Berkshire, we have no view of the future that dictates
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what businesses or industries we will enter. Indeed, we think
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it's usually poison for a corporate giant's shareholders if it
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embarks upon new ventures pursuant to some grand vision. We
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prefer instead to focus on the economic characteristics of
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businesses that we wish to own and the personal characteristics
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of managers with whom we wish to associate - and then to hope we
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get lucky in finding the two in combination. At Dexter, we did.
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* * * * * * * * * * * *
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And now we pause for a short commercial: Though they owned
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a business jewel, we believe that Harold and Peter (who were not
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interested in cash) made a sound decision in exchanging their
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Dexter stock for shares of Berkshire. What they did, in effect,
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was trade a 100% interest in a single terrific business for a
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smaller interest in a large group of terrific businesses. They
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incurred no tax on this exchange and now own a security that can
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be easily used for charitable or personal gifts, or that can be
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converted to cash in amounts, and at times, of their own
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choosing. Should members of their families desire to, they can
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pursue varying financial paths without running into the
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complications that often arise when assets are concentrated in a
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private business.
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For tax and other reasons, private companies also often find
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it difficult to diversify outside their industries. Berkshire,
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in contrast, can diversify with ease. So in shifting their
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ownership to Berkshire, Dexter's shareholders solved a
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reinvestment problem. Moreover, though Harold and Peter now have
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non-controlling shares in Berkshire, rather than controlling
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shares in Dexter, they know they will be treated as partners and
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that we will follow owner-oriented practices. If they elect to
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retain their Berkshire shares, their investment result from the
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merger date forward will exactly parallel my own result. Since I
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have a huge percentage of my net worth committed for life to
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Berkshire shares - and since the company will issue me neither
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restricted shares nor stock options - my gain-loss equation will
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always match that of all other owners.
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Additionally, Harold and Peter know that at Berkshire we can
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keep our promises: There will be no changes of control or
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culture at Berkshire for many decades to come. Finally, and of
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paramount importance, Harold and Peter can be sure that they will
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get to run their business - an activity they dearly love -
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exactly as they did before the merger. At Berkshire, we do not
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tell .400 hitters how to swing.
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What made sense for Harold and Peter probably makes sense
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for a few other owners of large private businesses. So, if you
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have a business that might fit, let me hear from you. Our
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acquisition criteria are set forth in the appendix on page 22.
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<B>Sources of Reported Earnings</B>
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The table below shows the major sources of Berkshire's
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reported earnings. In this presentation, amortization of
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Goodwill and other major purchase-price accounting adjustments
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are not charged against the specific businesses to which they
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apply, but are instead aggregated and shown separately. This
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procedure lets you view the earnings of our businesses as they
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would have been reported had we not purchased them. I've
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explained in past reports why this form of presentation seems to
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us to be more useful to investors and managers than one utilizing
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GAAP, which requires purchase-price adjustments to be made on a
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business-by-business basis. The total net earnings we show in
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the table are, of course, identical to the GAAP total in our
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audited financial statements.
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<I>
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(000s omitted)
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------------------------------------------
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Berkshire's Share
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of Net Earnings
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(after taxes and
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Pre-Tax Earnings minority interests)
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---------------------- ------------------
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1993 1992 1993 1992
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---------- ---------- -------- --------</I>
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Operating Earnings:
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Insurance Group:
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Underwriting ............... $ 30,876 $(108,961) $ 20,156 $(71,141)
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Net Investment Income ...... 375,946 355,067 321,321 305,763
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H. H. Brown, Lowell,
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and Dexter ............... 44,025* 27,883 28,829 17,340
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Buffalo News ................. 50,962 47,863 29,696 28,163
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Commercial & Consumer Finance 22,695 19,836 14,161 12,664
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Fechheimer ................... 13,442 13,698 6,931 7,267
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Kirby ........................ 39,147 35,653 25,056 22,795
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Nebraska Furniture Mart ...... 21,540 17,110 10,398 8,072
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Scott Fetzer Manufacturing Group 38,196 31,954 23,809 19,883
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See's Candies ................ 41,150 42,357 24,367 25,501
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World Book ................... 19,915 29,044 13,537 19,503
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Purchase-Price Accounting &
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Goodwill Charges ......... (17,033) (12,087) (13,996) (13,070)
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Interest Expense** ........... (56,545) (98,643) (35,614) (62,899)
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Shareholder-Designated
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Contributions ............ (9,448) (7,634) (5,994) (4,913)
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Other ........................ 28,428 67,540 15,094 32,798
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---------- ---------- -------- --------
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Operating Earnings ............. 643,296 460,680 477,751 347,726
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Sales of Securities ............ 546,422 89,937 356,702 59,559
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Tax Accruals Caused by
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New Accounting Rules ........ --- --- (146,332) ---
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---------- ---------- -------- --------
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Total Earnings - All Entities .. $1,189,718 $ 550,617 $688,121 $407,285
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<I>* Includes Dexter's earnings only from the date it was acquired,
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November 7, 1993.
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**Excludes interest expense of Commercial and Consumer Finance
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businesses. In 1992 includes $22.5 million of premiums paid on
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the early redemption of debt.</I>
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A large amount of information about these businesses is given
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on pages 38-49, where you will also find our segment earnings
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reported on a GAAP basis. In addition, on pages 52-59, we have
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rearranged Berkshire's financial data into four segments on a non-
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GAAP basis, a presentation that corresponds to the way Charlie and
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I think about the company. Our intent is to supply you with the
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financial information that we would wish you to give us if our
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positions were reversed.
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<B>"Look-Through" Earnings</B>
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We've previously discussed look-through earnings, which we
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believe more accurately portray the earnings of Berkshire than does
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our GAAP result. As we calculate them, look-through earnings
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consist of: (1) the operating earnings reported in the previous
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section, plus; (2) the retained operating earnings of major
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investees that, under GAAP accounting, are not reflected in our
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profits, less; (3) an allowance for the tax that would be paid by
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Berkshire if these retained earnings of investees had instead been
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distributed to us. The "operating earnings" of which we speak here
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exclude capital gains, special accounting items and major
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restructuring charges.
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Over time, our look-through earnings need to increase at about
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15% annually if our intrinsic value is to grow at that rate. Last
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year, I explained that we had to increase these earnings to about
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$1.8 billion in the year 2000, were we to meet the 15% goal.
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Because we issued additional shares in 1993, the amount needed has
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risen to about $1.85 billion.
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That is a tough goal, but one that we expect you to hold us
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to. In the past, we've criticized the managerial practice of
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shooting the arrow of performance and <I>then</I> painting the target,
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centering it on whatever point the arrow happened to hit. We will
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instead risk embarrassment by painting first and shooting later.
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If we are to hit the bull's-eye, we will need markets that
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allow the purchase of businesses and securities on sensible terms.
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Right now, markets are difficult, but they can - and will - change
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in unexpected ways and at unexpected times. In the meantime, we'll
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try to resist the temptation to do something marginal simply
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because we are long on cash. There's no use running if you're on
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the wrong road.
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The following table shows how we calculate look-through
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earnings, though I warn you that the figures are necessarily <I>very</I>
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rough. (The dividends paid to us by these investees have been
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included in the operating earnings itemized on page 8, mostly
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under "Insurance Group: Net Investment Income.")
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Berkshire's Share
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of Undistributed
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Berkshire's Approximate Operating Earnings
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Berkshire's Major Investees Ownership at Yearend (in millions)
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--------------------------- ----------------------- --------------------
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1993 1992 1993 1992
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------ ------ ------ ------
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Capital Cities/ABC, Inc. ..... 13.0% 18.2% $ 83(2) $ 70
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The Coca-Cola Company ........ 7.2% 7.1% 94 82
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Federal Home Loan Mortgage Corp. 6.8%(1) 8.2%(1) 41(2) 29(2)
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GEICO Corp. .................. 48.4% 48.1% 76(3) 34(3)
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General Dynamics Corp. ....... 13.9% 14.1% 25 11(2)
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The Gillette Company ......... 10.9% 10.9% 44 38
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Guinness PLC ................. 1.9% 2.0% 8 7
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The Washington Post Company .. 14.8% 14.6% 15 11
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Wells Fargo & Company ........ 12.2% 11.5% 53(2) 16(2)
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Berkshire's share of undistributed
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earnings of major investees $439 $298
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Hypothetical tax on these undistributed
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investee earnings(4) (61) (42)
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Reported operating earnings of Berkshire 478 348
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Total look-through earnings of Berkshire $856 $604
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(1) Does not include shares allocable to the minority interest
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at Wesco
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(2) Calculated on average ownership for the year
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(3) Excludes realized capital gains, which have been both
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recurring and significant
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(4) The tax rate used is 14%, which is the rate Berkshire pays
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on the dividends it receives
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We have told you that we expect the undistributed,
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hypothetically-taxed earnings of our investees to produce at least
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equivalent gains in Berkshire's intrinsic value. To date, we have
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far exceeded that expectation. For example, in 1986 we bought
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three million shares of Capital Cities/ABC for $172.50 per share
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and late last year sold one-third of that holding for $630 per
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share. After paying 35% capital gains taxes, we realized a $297
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million profit from the sale. In contrast, during the eight years
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we held these shares, the retained earnings of Cap Cities
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attributable to them - hypothetically taxed at a lower 14% in
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accordance with our look-through method - were only $152 million.
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In other words, we paid a much larger tax bill than our look-
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through presentations to you have assumed and nonetheless realized
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a gain that far exceeded the undistributed earnings allocable to
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these shares.
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We expect such pleasant outcomes to recur often in the future
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and therefore believe our look-through earnings to be a
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conservative representation of Berkshire's true economic earnings.
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<B>Taxes</B>
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As our Cap Cities sale emphasizes, Berkshire is a substantial
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payer of federal income taxes. In aggregate, we will pay 1993
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federal income taxes of $390 million, about $200 million of that
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attributable to operating earnings and $190 million to realized
|
|
capital gains. Furthermore, our share of the 1993 federal and
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|
foreign income taxes paid by our investees is well over $400
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million, a figure you don't see on our financial statements but
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|
that is nonetheless real. Directly and indirectly, Berkshire's
|
|
1993 federal income tax payments will be about 1/2 of 1% of the total
|
|
paid last year by all American corporations.
|
|
|
|
Speaking for our own shares, Charlie and I have absolutely no
|
|
complaint about these taxes. We know we work in a market-based
|
|
economy that rewards our efforts far more bountifully than it does
|
|
the efforts of others whose output is of equal or greater benefit
|
|
to society. Taxation should, and does, partially redress this
|
|
inequity. But we still remain extraordinarily well-treated.
|
|
|
|
Berkshire and its shareholders, in combination, would pay a
|
|
much smaller tax if Berkshire operated as a partnership or "S"
|
|
corporation, two structures often used for business activities.
|
|
For a variety of reasons, that's not feasible for Berkshire to do.
|
|
However, the penalty our corporate form imposes is mitigated -
|
|
though far from eliminated - by our strategy of investing for the
|
|
long term. Charlie and I would follow a buy-and-hold policy even
|
|
if we ran a tax-exempt institution. We think it the soundest way
|
|
to invest, and it also goes down the grain of our personalities. A
|
|
third reason to favor this policy, however, is the fact that taxes
|
|
are due only when gains are realized.
|
|
|
|
Through my favorite comic strip, Li'l Abner, I got a chance
|
|
during my youth to see the benefits of delayed taxes, though I
|
|
missed the lesson at the time. Making his readers feel superior,
|
|
Li'l Abner bungled happily, but moronically, through life in
|
|
Dogpatch. At one point he became infatuated with a New York
|
|
temptress, Appassionatta Van Climax, but despaired of marrying her
|
|
because he had only a single silver dollar and she was interested
|
|
solely in millionaires. Dejected, Abner took his problem to Old
|
|
Man Mose, the font of all knowledge in Dogpatch. Said the sage:
|
|
Double your money 20 times and Appassionatta will be yours (1, 2,
|
|
4, 8 . . . . 1,048,576).
|
|
|
|
My last memory of the strip is Abner entering a roadhouse,
|
|
dropping his dollar into a slot machine, and hitting a jackpot that
|
|
spilled money all over the floor. Meticulously following Mose's
|
|
advice, Abner picked up two dollars and went off to find his next
|
|
double. Whereupon I dumped Abner and began reading Ben Graham.
|
|
|
|
Mose clearly was overrated as a guru: Besides failing to
|
|
anticipate Abner's slavish obedience to instructions, he also
|
|
forgot about taxes. Had Abner been subject, say, to the 35%
|
|
federal tax rate that Berkshire pays, and had he managed one double
|
|
annually, he would after 20 years only have accumulated $22,370.
|
|
Indeed, had he kept on both getting his annual doubles and paying a
|
|
35% tax on each, he would have needed 7 1/2 years more to reach the
|
|
$1 million required to win Appassionatta.
|
|
|
|
But what if Abner had instead put his dollar in a single
|
|
investment and held it until it doubled the same 27 1/2 times? In
|
|
that case, he would have realized about $200 million pre-tax or,
|
|
after paying a $70 million tax in the final year, about $130
|
|
million after-tax. For that, Appassionatta would have crawled to
|
|
Dogpatch. Of course, with 27 1/2 years having passed, how
|
|
Appassionatta would have looked to a fellow sitting on $130 million
|
|
is another question.
|
|
|
|
What this little tale tells us is that tax-paying investors
|
|
will realize a far, far greater sum from a single investment that
|
|
compounds internally at a given rate than from a succession of
|
|
investments compounding at the same rate. But I suspect many
|
|
Berkshire shareholders figured that out long ago.
|
|
|
|
<B>Insurance Operations</B>
|
|
|
|
At this point in the report we've customarily provided you
|
|
with a table showing the annual "combined ratio" of the insurance
|
|
industry for the preceding decade. This ratio compares total
|
|
insurance costs (losses incurred plus expenses) to revenue from
|
|
premiums. For many years, the ratio has been above 100, a level
|
|
indicating an underwriting loss. That is, the industry has taken
|
|
in less money each year from its policyholders than it has had to
|
|
pay for operating expenses and for loss events that occurred during
|
|
the year.
|
|
|
|
Offsetting this grim equation is a happier fact: Insurers get
|
|
to hold on to their policyholders' money for a time before paying
|
|
it out. This happens because most policies require that premiums
|
|
be prepaid and, more importantly, because it often takes time to
|
|
resolve loss claims. Indeed, in the case of certain lines of
|
|
insurance, such as product liability or professional malpractice,
|
|
many years may elapse between the loss event and payment.
|
|
|
|
To oversimplify the matter somewhat, the total of the funds
|
|
prepaid by policyholders and the funds earmarked for incurred-but-
|
|
not-yet-paid claims is called "the float." In the past, the
|
|
industry was able to suffer a combined ratio of 107 to 111 and
|
|
still break even from its insurance writings because of the
|
|
earnings derived from investing this float.
|
|
|
|
As interest rates have fallen, however, the value of float has
|
|
substantially declined. Therefore, the data that we have provided
|
|
in the past are no longer useful for year-to-year comparisons of
|
|
industry profitability. A company writing at the same combined
|
|
ratio now as in the 1980's today has a far less attractive business
|
|
than it did then.
|
|
|
|
Only by making an analysis that incorporates both underwriting
|
|
results and the current risk-free earnings obtainable from float
|
|
can one evaluate the true economics of the business that a
|
|
property-casualty insurer writes. Of course, the <I>actual</I> investment
|
|
results that an insurer achieves from the use of both float and
|
|
stockholders' funds is also of major importance and should be
|
|
carefully examined when an investor is assessing managerial
|
|
performance. But that should be a separate analysis from the one
|
|
we are discussing here. The value of float funds - in effect,
|
|
their transfer price as they move from the insurance operation to
|
|
the investment operation - should be determined simply by the risk-
|
|
free, long-term rate of interest.
|
|
|
|
On the next page we show the numbers that count in an
|
|
evaluation of Berkshire's insurance business. We calculate our
|
|
float - which we generate in exceptional amounts relative to our
|
|
premium volume - by adding loss reserves, loss adjustment reserves
|
|
and unearned premium reserves and then subtracting agent's
|
|
balances, prepaid acquisition costs and deferred charges applicable
|
|
to assumed reinsurance. Our cost of float is determined by our
|
|
underwriting loss or profit. In those years when we have had an
|
|
underwriting profit, which includes 1993, our cost of float has
|
|
been negative, and we have determined our insurance earnings by
|
|
adding underwriting profit to float income.
|
|
|
|
(1) (2) Yearend Yield
|
|
Underwriting Approximate on Long-Term
|
|
Loss Average Float Cost of Funds Govt. Bonds
|
|
------------ ------------- --------------- -------------
|
|
(In $ Millions) (Ratio of 1 to 2)
|
|
|
|
1967 profit $ 17.3 less than zero 5.50%
|
|
1968 profit 19.9 less than zero 5.90%
|
|
1969 profit 23.4 less than zero 6.79%
|
|
1970 $ 0.37 32.4 1.14% 6.25%
|
|
1971 profit 52.5 less than zero 5.81%
|
|
1972 profit 69.5 less than zero 5.82%
|
|
1973 profit 73.3 less than zero 7.27%
|
|
1974 7.36 79.1 9.30% 8.13%
|
|
1975 11.35 87.6 12.96% 8.03%
|
|
1976 profit 102.6 less than zero 7.30%
|
|
1977 profit 139.0 less than zero 7.97%
|
|
1978 profit 190.4 less than zero 8.93%
|
|
1979 profit 227.3 less than zero 10.08%
|
|
1980 profit 237.0 less than zero 11.94%
|
|
1981 profit 228.4 less than zero 13.61%
|
|
1982 21.56 220.6 9.77% 10.64%
|
|
1983 33.87 231.3 14.64% 11.84%
|
|
1984 48.06 253.2 18.98% 11.58%
|
|
1985 44.23 390.2 11.34% 9.34%
|
|
1986 55.84 797.5 7.00% 7.60%
|
|
1987 55.43 1,266.7 4.38% 8.95%
|
|
1988 11.08 1,497.7 0.74% 9.00%
|
|
1989 24.40 1,541.3 1.58% 7.97%
|
|
1990 26.65 1,637.3 1.63% 8.24%
|
|
1991 119.59 1,895.0 6.31% 7.40%
|
|
1992 108.96 2,290.4 4.76% 7.39%
|
|
1993 profit 2,624.7 less than zero 6.35%
|
|
|
|
As you can see, in our insurance operation last year we had
|
|
the use of $2.6 billion at no cost; in fact we were paid $31
|
|
million, our underwriting profit, to hold these funds. This sounds
|
|
good - is good - but is far from as good as it sounds.
|
|
|
|
We temper our enthusiasm because we write a large volume of
|
|
"super-cat" policies (which other insurance and reinsurance
|
|
companies buy to recover part of the losses they suffer from mega-
|
|
catastrophes) and because last year we had no losses of consequence
|
|
from this activity. As that suggests, the truly catastrophic
|
|
Midwestern floods of 1993 did not trigger super-cat losses, the
|
|
reason being that very few flood policies are purchased from
|
|
private insurers.
|
|
|
|
It would be fallacious, however, to conclude from this single-
|
|
year result that the super-cat business is a wonderful one, or even
|
|
a satisfactory one. A simple example will illustrate the fallacy:
|
|
Suppose there is an event that occurs 25 times in every century.
|
|
If you annually give 5-for-1 odds against its occurrence <I>that</I> year,
|
|
you will have many more winning years than losers. Indeed, you may
|
|
go a straight six, seven or more years without loss. You also will
|
|
eventually go broke.
|
|
|
|
At Berkshire, we naturally believe we are obtaining adequate
|
|
premiums and giving more like 3 1/2-for-1 odds. But there is no way
|
|
for us - or anyone else - to calculate the true odds on super-cat
|
|
coverages. In fact, it will take decades for us to find out
|
|
whether our underwriting judgment has been sound.
|
|
|
|
What we do know is that when a loss comes, it's likely to be a
|
|
lulu. There may well be years when Berkshire will suffer losses
|
|
from the super-cat business equal to three or four times what we
|
|
earned from it in 1993. When Hurricane Andrew blew in 1992, we
|
|
paid out about $125 million. Because we've since expanded our
|
|
super-cat business, a similar storm today could cost us $600
|
|
million.
|
|
|
|
So far, we have been lucky in 1994. As I write this letter,
|
|
we are estimating that our losses from the Los Angeles earthquake
|
|
will be nominal. But if the quake had been a 7.5 instead of a 6.8,
|
|
it would have been a different story.
|
|
|
|
Berkshire is ideally positioned to write super-cat policies.
|
|
In Ajit Jain, we have by far the best manager in this business.
|
|
Additionally, companies writing these policies need enormous
|
|
capital, and our net worth is ten to twenty times larger than that
|
|
of our main competitors. In most lines of insurance, huge
|
|
resources aren't that important: An insurer can diversify the
|
|
risks it writes and, if necessary, can lay off risks to reduce
|
|
concentration in its portfolio. That isn't possible in the super-
|
|
cat business. So these competitors are forced into offering far
|
|
smaller limits than those we can provide. Were they bolder, they
|
|
would run the risk that a mega-catastrophe - or a confluence of
|
|
smaller catastrophes - would wipe them out.
|
|
|
|
One indication of our premier strength and reputation is that
|
|
each of the four largest reinsurance companies in the world buys
|
|
very significant reinsurance coverage from Berkshire. Better than
|
|
anyone else, these giants understand that the test of a reinsurer
|
|
is its ability and willingness to pay losses under trying
|
|
circumstances, not its readiness to accept premiums when things
|
|
look rosy.
|
|
|
|
One caution: There has recently been a substantial increase
|
|
in reinsurance capacity. Close to $5 billion of equity capital has
|
|
been raised by reinsurers, almost all of them newly-formed
|
|
entities. Naturally these new entrants are hungry to write
|
|
business so that they can justify the projections they utilized in
|
|
attracting capital. This new competition won't affect our 1994
|
|
operations; we're filled up there, primarily with business written
|
|
in 1993. But we are now seeing signs of price deterioration. If
|
|
this trend continues, we will resign ourselves to much-reduced
|
|
volume, keeping ourselves available, though, for the large,
|
|
sophisticated buyer who requires a super-cat insurer with large
|
|
capacity and a sure ability to pay losses.
|
|
|
|
In other areas of our insurance business, our homestate
|
|
operation, led by Rod Eldred; our workers' compensation business,
|
|
headed by Brad Kinstler; our credit-card operation, managed by the
|
|
Kizer family; and National Indemnity's traditional auto and general
|
|
liability business, led by Don Wurster, all achieved excellent
|
|
results. In combination, these four units produced a significant
|
|
underwriting profit and substantial float.
|
|
|
|
All in all, we have a first-class insurance business. Though
|
|
its results will be highly volatile, this operation possesses an
|
|
intrinsic value that exceeds its book value by a large amount -
|
|
larger, in fact, than is the case at any other Berkshire business.
|
|
|
|
<B>Common Stock Investments</B>
|
|
|
|
Below we list our common stockholdings having a value of over
|
|
$250 million. A small portion of these investments belongs to
|
|
subsidiaries of which Berkshire owns less than 100%.
|
|
<I>
|
|
12/31/93
|
|
Shares Company Cost Market</I>
|
|
------ ------- ---------- ----------
|
|
(000s omitted)
|
|
2,000,000 Capital Cities/ABC, Inc. ............. $ 345,000 $1,239,000
|
|
93,400,000 The Coca-Cola Company. ............... 1,023,920 4,167,975
|
|
13,654,600 Federal Home Loan Mortgage Corp.
|
|
("Freddie Mac") ................... 307,505 681,023
|
|
34,250,000 GEICO Corp. .......................... 45,713 1,759,594
|
|
4,350,000 General Dynamics Corp. ............... 94,938 401,287
|
|
24,000,000 The Gillette Company ................. 600,000 1,431,000
|
|
38,335,000 Guinness PLC ......................... 333,019 270,822
|
|
1,727,765 The Washington Post Company. ......... 9,731 440,148
|
|
6,791,218 Wells Fargo & Company ................ 423,680 878,614
|
|
|
|
Considering the similarity of this year's list and the last,
|
|
you may decide your management is hopelessly comatose. But we
|
|
continue to think that it is usually foolish to part with an
|
|
interest in a business that is both understandable and durably
|
|
wonderful. Business interests of that kind are simply too hard to
|
|
replace.
|
|
|
|
Interestingly, corporate managers have no trouble
|
|
understanding that point when they are focusing on a business they
|
|
operate: A parent company that owns a subsidiary with superb long-
|
|
term economics is not likely to sell that entity regardless of
|
|
price. "Why," the CEO would ask, "should I part with my crown
|
|
jewel?" Yet that same CEO, when it comes to running his personal
|
|
investment portfolio, will offhandedly - and even impetuously -
|
|
move from business to business when presented with no more than
|
|
superficial arguments by his broker for doing so. The worst of
|
|
these is perhaps, "You can't go broke taking a profit." Can you
|
|
imagine a CEO using this line to urge his board to sell a star
|
|
subsidiary? In our view, what makes sense in business also makes
|
|
sense in stocks: An investor should ordinarily hold a small piece
|
|
of an outstanding business with the same tenacity that an owner
|
|
would exhibit if he owned all of that business.
|
|
|
|
Earlier I mentioned the financial results that could have been
|
|
achieved by investing $40 in The Coca-Cola Co. in 1919. In 1938,
|
|
more than 50 years after the introduction of Coke, and long after
|
|
the drink was firmly established as an American icon, <I>Fortune</I> did
|
|
an excellent story on the company. In the second paragraph the
|
|
writer reported: "Several times every year a weighty and serious
|
|
investor looks long and with profound respect at Coca-Cola's
|
|
record, but comes regretfully to the conclusion that he is looking
|
|
too late. The specters of saturation and competition rise before
|
|
him."
|
|
|
|
Yes, competition there was in 1938 and in 1993 as well. But
|
|
it's worth noting that in 1938 The Coca-Cola Co. sold 207 million
|
|
cases of soft drinks (if its gallonage then is converted into the
|
|
192-ounce cases used for measurement today) and in 1993 it sold
|
|
about 10.7 billion cases, a 50-fold increase in physical volume
|
|
from a company that in 1938 was already dominant in its very major
|
|
industry. Nor was the party over in 1938 for an investor: Though
|
|
the $40 invested in 1919 in one share had (with dividends
|
|
reinvested) turned into $3,277 by the end of 1938, a fresh $40 then
|
|
invested in Coca-Cola stock would have grown to $25,000 by yearend
|
|
1993.
|
|
|
|
I can't resist one more quote from that 1938 <I>Fortune</I> story:
|
|
"It would be hard to name any company comparable in size to Coca-
|
|
Cola and selling, as Coca-Cola does, an unchanged product that can
|
|
point to a ten-year record anything like Coca-Cola's." In the 55
|
|
years that have since passed, Coke's product line has broadened
|
|
somewhat, but it's remarkable how well that description still fits.
|
|
|
|
Charlie and I decided long ago that in an investment lifetime
|
|
it's just too hard to make hundreds of smart decisions. That
|
|
judgment became ever more compelling as Berkshire's capital
|
|
mushroomed and the universe of investments that could significantly
|
|
affect our results shrank dramatically. Therefore, we adopted a
|
|
strategy that required our being smart - and not too smart at that
|
|
- only a very few times. Indeed, we'll now settle for one good
|
|
idea a year. (Charlie says it's my turn.)
|
|
|
|
The strategy we've adopted precludes our following standard
|
|
diversification dogma. Many pundits would therefore say the
|
|
strategy must be riskier than that employed by more conventional
|
|
investors. We disagree. We believe that a policy of portfolio
|
|
concentration may well <I>decrease</I> risk if it raises, as it should,
|
|
both the intensity with which an investor thinks about a business
|
|
and the comfort-level he must feel with its economic characteristics
|
|
before buying into it. In stating this opinion, we define risk,
|
|
using dictionary terms, as "the possibility of loss or injury."
|
|
|
|
Academics, however, like to define investment "risk"
|
|
differently, averring that it is the relative volatility of a stock
|
|
or portfolio of stocks - that is, their volatility as compared to
|
|
that of a large universe of stocks. Employing data bases and
|
|
statistical skills, these academics compute with precision the
|
|
"beta" of a stock - its relative volatility in the past - and then
|
|
build arcane investment and capital-allocation theories around this
|
|
calculation. In their hunger for a single statistic to measure
|
|
risk, however, they forget a fundamental principle: It is better
|
|
to be approximately right than precisely wrong.
|
|
|
|
For owners of a business - and that's the way we think of
|
|
shareholders - the academics' definition of risk is far off the
|
|
mark, so much so that it produces absurdities. For example, under
|
|
beta-based theory, a stock that has dropped very sharply compared
|
|
to the market - as had Washington Post when we bought it in 1973 -
|
|
becomes "riskier" at the lower price than it was at the higher
|
|
price. Would that description have then made any sense to someone
|
|
who was offered the entire company at a vastly-reduced price?
|
|
|
|
In fact, the true investor <I>welcomes</I> volatility. Ben Graham
|
|
explained why in Chapter 8 of <I>The Intelligent Investor.</I> There he
|
|
introduced "Mr. Market," an obliging fellow who shows up every day
|
|
to either buy from you or sell to you, whichever you wish. The
|
|
more manic-depressive this chap is, the greater the opportunities
|
|
available to the investor. That's true because a wildly
|
|
fluctuating market means that irrationally low prices will
|
|
periodically be attached to solid businesses. It is impossible to
|
|
see how the availability of such prices can be thought of as
|
|
increasing the hazards for an investor who is totally free to
|
|
either ignore the market or exploit its folly.
|
|
|
|
In assessing risk, a beta purist will disdain examining what a
|
|
company produces, what its competitors are doing, or how much
|
|
borrowed money the business employs. He may even prefer not to
|
|
know the company's name. What he treasures is the price history of
|
|
its stock. In contrast, we'll happily forgo knowing the price
|
|
history and instead will seek whatever information will further our
|
|
understanding of the company's business. After we buy a stock,
|
|
consequently, we would not be disturbed if markets closed for a
|
|
year or two. We don't need a daily quote on our 100% position in
|
|
See's or H. H. Brown to validate our well-being. Why, then, should
|
|
we need a quote on our 7% interest in Coke?
|
|
|
|
In our opinion, the real risk that an investor must assess is
|
|
whether his aggregate after-tax receipts from an investment
|
|
(including those he receives on sale) will, over his prospective
|
|
holding period, give him at least as much purchasing power as he
|
|
had to begin with, plus a modest rate of interest on that initial
|
|
stake. Though this risk cannot be calculated with engineering
|
|
precision, it can in some cases be judged with a degree of accuracy
|
|
that is useful. The primary factors bearing upon this evaluation
|
|
are:
|
|
|
|
1) The certainty with which the long-term economic
|
|
characteristics of the business can be evaluated;
|
|
|
|
2) The certainty with which management can be evaluated,
|
|
both as to its ability to realize the full potential of
|
|
the business and to wisely employ its cash flows;
|
|
|
|
3) The certainty with which management can be counted on
|
|
to channel the rewards from the business to the
|
|
shareholders rather than to itself;
|
|
|
|
4) The purchase price of the business;
|
|
|
|
5) The levels of taxation and inflation that will be
|
|
experienced and that will determine the degree by which
|
|
an investor's purchasing-power return is reduced from his
|
|
gross return.
|
|
|
|
These factors will probably strike many analysts as unbearably
|
|
fuzzy, since they cannot be extracted from a data base of any kind.
|
|
But the difficulty of precisely quantifying these matters does not
|
|
negate their importance nor is it insuperable. Just as Justice
|
|
Stewart found it impossible to formulate a test for obscenity but
|
|
nevertheless asserted, "I know it when I see it," so also can
|
|
investors - in an inexact but useful way - "see" the risks inherent
|
|
in certain investments without reference to complex equations or
|
|
price histories.
|
|
|
|
Is it really so difficult to conclude that Coca-Cola and
|
|
Gillette possess far less business risk over the long term than,
|
|
say, <I>any</I> computer company or retailer? Worldwide, Coke sells about
|
|
44% of all soft drinks, and Gillette has more than a 60% share (in
|
|
value) of the blade market. Leaving aside chewing gum, in which
|
|
Wrigley is dominant, I know of no other significant businesses in
|
|
which the leading company has long enjoyed such global power.
|
|
|
|
Moreover, both Coke and Gillette have actually increased their
|
|
worldwide shares of market in recent years. The might of their
|
|
brand names, the attributes of their products, and the strength of
|
|
their distribution systems give them an enormous competitive
|
|
advantage, setting up a protective moat around their economic
|
|
castles. The average company, in contrast, does battle daily
|
|
without any such means of protection. As Peter Lynch says, stocks
|
|
of companies selling commodity-like products should come with a
|
|
warning label: "Competition may prove hazardous to human wealth."
|
|
|
|
The competitive strengths of a Coke or Gillette are obvious to
|
|
even the casual observer of business. Yet the beta of their stocks
|
|
is similar to that of a great many run-of-the-mill companies who
|
|
possess little or no competitive advantage. Should we conclude
|
|
from this similarity that the competitive strength of Coke and
|
|
Gillette gains them nothing when business risk is being measured?
|
|
Or should we conclude that the risk in owning a piece of a company
|
|
- its stock - is somehow divorced from the long-term risk inherent
|
|
in its business operations? We believe neither conclusion makes
|
|
sense and that equating beta with investment risk also makes no
|
|
sense.
|
|
|
|
The theoretician bred on beta has no mechanism for
|
|
differentiating the risk inherent in, say, a single-product toy
|
|
company selling pet rocks or hula hoops from that of another toy
|
|
company whose sole product is Monopoly or Barbie. But it's quite
|
|
possible for ordinary investors to make such distinctions if they
|
|
have a reasonable understanding of consumer behavior and the
|
|
factors that create long-term competitive strength or weakness.
|
|
Obviously, every investor will make mistakes. But by confining
|
|
himself to a relatively few, easy-to-understand cases, a reasonably
|
|
intelligent, informed and diligent person can judge investment
|
|
risks with a useful degree of accuracy.
|
|
|
|
In many industries, of course, Charlie and I can't determine
|
|
whether we are dealing with a "pet rock" or a "Barbie." We
|
|
couldn't solve this problem, moreover, even if we were to spend
|
|
years intensely studying those industries. Sometimes our own
|
|
intellectual shortcomings would stand in the way of understanding,
|
|
and in other cases the nature of the industry would be the
|
|
roadblock. For example, a business that must deal with fast-moving
|
|
technology is not going to lend itself to reliable evaluations of
|
|
its long-term economics. Did we foresee thirty years ago what
|
|
would transpire in the television-manufacturing or computer
|
|
industries? Of course not. (Nor did most of the investors and
|
|
corporate managers who enthusiastically entered those industries.)
|
|
Why, then, should Charlie and I now think we can predict the
|
|
future of other rapidly-evolving businesses? We'll stick instead
|
|
with the easy cases. Why search for a needle buried in a haystack
|
|
when one is sitting in plain sight?
|
|
|
|
Of course, some investment strategies - for instance, our
|
|
efforts in arbitrage over the years - require wide diversification.
|
|
If significant risk exists in a single transaction, overall risk
|
|
should be reduced by making that purchase one of many mutually-
|
|
independent commitments. Thus, you may consciously purchase a
|
|
risky investment - one that indeed has a significant possibility of
|
|
causing loss or injury - if you believe that your gain, weighted
|
|
for probabilities, considerably exceeds your loss, comparably
|
|
weighted, and if you can commit to a number of similar, but
|
|
unrelated opportunities. Most venture capitalists employ this
|
|
strategy. Should you choose to pursue this course, you should
|
|
adopt the outlook of the casino that owns a roulette wheel, which
|
|
will want to see lots of action because it is favored by
|
|
probabilities, but will refuse to accept a single, huge bet.
|
|
|
|
Another situation requiring wide diversification occurs when
|
|
an investor who does not understand the economics of specific
|
|
businesses nevertheless believes it in his interest to be a long-
|
|
term owner of American industry. That investor should both own a
|
|
large number of equities and space out his purchases. By
|
|
periodically investing in an index fund, for example, the know-
|
|
nothing investor can actually out-perform most investment
|
|
professionals. Paradoxically, when "dumb" money acknowledges its
|
|
limitations, it ceases to be dumb.
|
|
|
|
On the other hand, if you are a know-<I>something</I> investor, able
|
|
to understand business economics and to find five to ten sensibly-
|
|
priced companies that possess important long-term competitive
|
|
advantages, conventional diversification makes no sense for you.
|
|
It is apt simply to hurt your results and increase your risk. I
|
|
cannot understand why an investor of that sort elects to put money
|
|
into a business that is his 20th favorite rather than simply adding
|
|
that money to his top choices - the businesses he understands best
|
|
and that present the least risk, along with the greatest profit
|
|
potential. In the words of the prophet Mae West: "Too much of a
|
|
good thing can be wonderful."
|
|
|
|
<B>Corporate Governance</B>
|
|
|
|
At our annual meetings, someone usually asks "What happens to
|
|
this place if you get hit by a truck?" I'm glad they are still
|
|
asking the question in this form. It won't be too long before the
|
|
query becomes: "What happens to this place if you <I>don't</I> get hit by
|
|
a truck?"
|
|
|
|
Such questions, in any event, raise a reason for me to discuss
|
|
corporate governance, a hot topic during the past year. In
|
|
general, I believe that directors have stiffened their spines
|
|
recently and that shareholders are now being treated somewhat more
|
|
like true owners than was the case not long ago. Commentators on
|
|
corporate governance, however, seldom make any distinction among
|
|
three fundamentally different manager/owner situations that exist
|
|
in publicly-held companies. Though the legal responsibility of
|
|
directors is identical throughout, their ability to effect change
|
|
differs in each of the cases. Attention usually falls on the first
|
|
case, because it prevails on the corporate scene. Since Berkshire
|
|
falls into the second category, however, and will someday fall into
|
|
the third, we will discuss all three variations.
|
|
|
|
The first, and by far most common, board situation is one in
|
|
which a corporation has no controlling shareholder. In that case,
|
|
I believe directors should behave as if there is a single absentee
|
|
owner, whose long-term interest they should try to further in all
|
|
proper ways. Unfortunately, "long-term" gives directors a lot of
|
|
wiggle room. If they lack either integrity or the ability to think
|
|
independently, directors can do great violence to shareholders
|
|
while still claiming to be acting in their long-term interest. But
|
|
assume the board is functioning well and must deal with a
|
|
management that is mediocre or worse. Directors then have the
|
|
responsibility for changing that management, just as an intelligent
|
|
owner would do if he were present. And if able but greedy managers
|
|
over-reach and try to dip too deeply into the shareholders'
|
|
pockets, directors must slap their hands.
|
|
|
|
In this plain-vanilla case, a director who sees something he
|
|
doesn't like should attempt to persuade the other directors of his
|
|
views. If he is successful, the board will have the muscle to make
|
|
the appropriate change. Suppose, though, that the unhappy director
|
|
can't get other directors to agree with him. He should then feel
|
|
free to make his views known to the absentee owners. Directors
|
|
seldom do that, of course. The temperament of many directors would
|
|
in fact be incompatible with critical behavior of that sort. But I
|
|
see nothing improper in such actions, assuming the issues are
|
|
serious. Naturally, the complaining director can expect a vigorous
|
|
rebuttal from the unpersuaded directors, a prospect that should
|
|
discourage the dissenter from pursuing trivial or non-rational
|
|
causes.
|
|
|
|
For the boards just discussed, I believe the directors ought
|
|
to be relatively few in number - say, ten or less - and ought to
|
|
come mostly from the outside. The outside board members should
|
|
establish standards for the CEO's performance and should also
|
|
periodically meet, without his being present, to evaluate his
|
|
performance against those standards.
|
|
|
|
The requisites for board membership should be business savvy,
|
|
interest in the job, and owner-orientation. Too often, directors
|
|
are selected simply because they are prominent or add diversity to
|
|
the board. That practice is a mistake. Furthermore, mistakes in
|
|
selecting directors are particularly serious because appointments
|
|
are so hard to undo: The pleasant but vacuous director need never
|
|
worry about job security.
|
|
|
|
The second case is that existing at Berkshire, where the
|
|
controlling owner is also the manager. At some companies, this
|
|
arrangement is facilitated by the existence of two classes of stock
|
|
endowed with disproportionate voting power. In these situations,
|
|
it's obvious that the board does not act as an agent between owners
|
|
and management and that the directors cannot effect change except
|
|
through persuasion. Therefore, if the owner/manager is mediocre or
|
|
worse - or is over-reaching - there is little a director can do
|
|
about it except object. If the directors having no connections to
|
|
the owner/manager make a unified argument, it may well have some
|
|
effect. More likely it will not.
|
|
|
|
If change does not come, and the matter is sufficiently
|
|
serious, the outside directors should resign. Their resignation
|
|
will signal their doubts about management, and it will emphasize
|
|
that no outsider is in a position to correct the owner/manager's
|
|
shortcomings.
|
|
|
|
The third governance case occurs when there is a controlling
|
|
owner who is not involved in management. This case, examples of
|
|
which are Hershey Foods and Dow Jones, puts the outside directors
|
|
in a potentially useful position. If they become unhappy with
|
|
either the competence or integrity of the manager, they can go
|
|
directly to the owner (who may also be on the board) and report
|
|
their dissatisfaction. This situation is ideal for an outside
|
|
director, since he need make his case only to a single, presumably
|
|
interested owner, who can forthwith effect change if the argument
|
|
is persuasive. Even so, the dissatisfied director has only that
|
|
single course of action. If he remains unsatisfied about a
|
|
critical matter, he has no choice but to resign.
|
|
|
|
Logically, the third case should be the most effective in
|
|
insuring first-class management. In the second case the owner is
|
|
not going to fire himself, and in the first case, directors often
|
|
find it very difficult to deal with mediocrity or mild over-
|
|
reaching. Unless the unhappy directors can win over a majority of
|
|
the board - an awkward social and logistical task, particularly if
|
|
management's behavior is merely odious, not egregious - their hands
|
|
are effectively tied. In practice, directors trapped in situations
|
|
of this kind usually convince themselves that by staying around
|
|
they can do at least some good. Meanwhile, management proceeds
|
|
unfettered.
|
|
|
|
In the third case, the owner is neither judging himself nor
|
|
burdened with the problem of garnering a majority. He can also
|
|
insure that outside directors are selected who will bring useful
|
|
qualities to the board. These directors, in turn, will know that
|
|
the good advice they give will reach the right ears, rather than
|
|
being stifled by a recalcitrant management. If the controlling
|
|
owner is intelligent and self-confident, he will make decisions in
|
|
respect to management that are meritocratic and pro-shareholder.
|
|
Moreover - and this is critically important - he can readily
|
|
correct any mistake he makes.
|
|
|
|
At Berkshire we operate in the second mode now and will for as
|
|
long as I remain functional. My health, let me add, is excellent.
|
|
For better or worse, you are likely to have me as an owner/manager
|
|
for some time.
|
|
|
|
After my death, all of my stock will go to my wife, Susie,
|
|
should she survive me, or to a foundation if she dies before I do.
|
|
In neither case will taxes and bequests require the sale of
|
|
consequential amounts of stock.
|
|
|
|
When my stock is transferred to either my wife or the
|
|
foundation, Berkshire will enter the third governance mode, going
|
|
forward with a vitally interested, but non-management, owner and
|
|
with a management that must perform for that owner. In preparation
|
|
for that time, Susie was elected to the board a few years ago, and
|
|
in 1993 our son, Howard, joined the board. These family members
|
|
will not be managers of the company in the future, but they will
|
|
represent the controlling interest should anything happen to me.
|
|
Most of our other directors are also significant owners of
|
|
Berkshire stock, and each has a strong owner-orientation. All in
|
|
all, we're prepared for "the truck."
|
|
|
|
<B>Shareholder-Designated Contributions</B>
|
|
|
|
About 97% of all eligible shares participated in Berkshire's
|
|
1993 shareholder-designated contributions program. Contributions
|
|
made through the program were $9.4 million and 3,110 charities were
|
|
recipients.
|
|
|
|
Berkshire's practice in respect to discretionary philanthropy
|
|
- as contrasted to its policies regarding contributions that are
|
|
clearly related to the company's business activities - differs
|
|
significantly from that of other publicly-held corporations.
|
|
There, most corporate contributions are made pursuant to the wishes
|
|
of the CEO (who often will be responding to social pressures),
|
|
employees (through matching gifts), or directors (through matching
|
|
gifts or requests they make of the CEO).
|
|
|
|
At Berkshire, we believe that the company's money is the
|
|
owners' money, just as it would be in a closely-held corporation,
|
|
partnership, or sole proprietorship. Therefore, if funds are to be
|
|
given to causes unrelated to Berkshire's business activities, it is
|
|
the charities favored by our owners that should receive them.
|
|
We've yet to find a CEO who believes he should personally fund the
|
|
charities favored by his shareholders. Why, then, should they foot
|
|
the bill for his picks?
|
|
|
|
Let me add that our program is easy to administer. Last fall,
|
|
for two months, we borrowed one person from National Indemnity to
|
|
help us implement the instructions that came from our 7,500
|
|
registered shareholders. I'd guess that the average corporate
|
|
program in which employee gifts are matched incurs far greater
|
|
administrative costs. Indeed, our entire corporate overhead is
|
|
less than half the size of our charitable contributions. <FONT SIZE="-1"><I>(Charlie,
|
|
however, insists that I tell you that $1.4 million of our $4.9 million overhead is
|
|
attributable to our corporate jet, The Indefensible.)</I></FONT>
|
|
|
|
Below is a list showing the largest categories to which our
|
|
shareholders have steered their contributions.
|
|
|
|
(a) 347 churches and synagogues received 569 gifts
|
|
(b) 283 colleges and universities received 670 gifts
|
|
(c) 244 K-12 schools (about two-thirds secular, one-
|
|
third religious) received 525 gifts
|
|
(d) 288 institutions dedicated to art, culture or the
|
|
humanities received 447 gifts
|
|
(e) 180 religious social-service organizations (split
|
|
about equally between Christian and Jewish) received
|
|
411 gifts
|
|
(f) 445 secular social-service organizations (about 40%
|
|
youth-related) received 759 gifts
|
|
(g) 153 hospitals received 261 gifts
|
|
(h) 186 health-related organizations (American Heart
|
|
Association, American Cancer Society, etc.) received
|
|
320 gifts
|
|
|
|
Three things about this list seem particularly interesting to
|
|
me. First, to some degree it indicates what people choose to give
|
|
money to when they are acting of their own accord, free of pressure
|
|
from solicitors or emotional appeals from charities. Second, the
|
|
contributions programs of publicly-held companies almost never
|
|
allow gifts to churches and synagogues, yet clearly these
|
|
institutions are what many shareholders would like to support.
|
|
Third, the gifts made by our shareholders display conflicting
|
|
philosophies: 130 gifts were directed to organizations that
|
|
believe in making abortions readily available for women and 30
|
|
gifts were directed to organizations (other than churches) that
|
|
discourage or are opposed to abortion.
|
|
|
|
Last year I told you that I was thinking of raising the amount
|
|
that Berkshire shareholders can give under our designated-
|
|
contributions program and asked for your comments. We received a
|
|
few well-written letters opposing the entire idea, on the grounds
|
|
that it was our job to run the business and not our job to force
|
|
shareholders into making charitable gifts. Most of the
|
|
shareholders responding, however, noted the tax efficiency of the
|
|
plan and urged us to increase the designated amount. Several
|
|
shareholders who have given stock to their children or
|
|
grandchildren told me that they consider the program a particularly
|
|
good way to get youngsters thinking at an early age about the
|
|
subject of giving. These people, in other words, perceive the
|
|
program to be an educational, as well as philanthropic, tool. The
|
|
bottom line is that we did raise the amount in 1993, from $8 per
|
|
share to $10.
|
|
|
|
In addition to the shareholder-designated contributions that
|
|
Berkshire distributes, our operating businesses make contributions,
|
|
including merchandise, averaging about $2.5 million annually.
|
|
These contributions support local charities, such as The United
|
|
Way, and produce roughly commensurate benefits for our businesses.
|
|
|
|
We suggest that new shareholders read the description of our
|
|
shareholder-designated contributions program that appears on pages
|
|
50-51. <I>To participate in future programs, you must make sure your
|
|
shares are registered in the name of the actual owner, not in the
|
|
nominee name of a broker, bank or depository. Shares not so
|
|
registered on August 31, 1994 will be ineligible for the 1994
|
|
program.</I>
|
|
|
|
<B>A Few Personal Items</B>
|
|
|
|
Mrs. B - Rose Blumkin - had her 100th birthday on December 3,
|
|
1993. (The candles cost more than the cake.) That was a day on
|
|
which the store was scheduled to be open in the evening. Mrs. B,
|
|
who works seven days a week, for however many hours the store
|
|
operates, found the proper decision quite obvious: She simply
|
|
postponed her party until an evening when the store was closed.
|
|
|
|
Mrs. B's story is well-known but worth telling again. She
|
|
came to the United States 77 years ago, unable to speak English and
|
|
devoid of formal schooling. In 1937, she founded the Nebraska
|
|
Furniture Mart with $500. Last year the store had sales of $200
|
|
million, a larger amount by far than that recorded by any other
|
|
home furnishings store in the United States. Our part in all of
|
|
this began ten years ago when Mrs. B sold control of the business
|
|
to Berkshire Hathaway, a deal we completed without obtaining
|
|
audited financial statements, checking real estate records, or
|
|
getting any warranties. In short, her word was good enough for us.
|
|
|
|
Naturally, I was delighted to attend Mrs. B's birthday party.
|
|
After all, she's promised to attend <I>my</I> 100th.
|
|
|
|
* * * * * * * * * * * *
|
|
|
|
Katharine Graham retired last year as the chairman of The
|
|
Washington Post Company, having relinquished the CEO title three
|
|
years ago. In 1973, we purchased our stock in her company for
|
|
about $10 million. Our holding now garners $7 million a year in
|
|
dividends and is worth over $400 million. At the time of our
|
|
purchase, we knew that the economic prospects of the company were
|
|
good. But equally important, Charlie and I concluded that Kay
|
|
would prove to be an outstanding manager and would treat all
|
|
shareholders honorably. That latter consideration was particularly
|
|
important because The Washington Post Company has two classes of
|
|
stock, a structure that we've seen some managers abuse.
|
|
|
|
All of our judgments about this investment have been validated
|
|
by events. Kay's skills as a manager were underscored this past
|
|
year when she was elected by <I>Fortune's</I> Board of Editors to the
|
|
Business Hall of Fame. On behalf of our shareholders, Charlie and
|
|
I had long ago put her in Berkshire's Hall of Fame.
|
|
|
|
* * * * * * * * * * * *
|
|
|
|
Another of last year's retirees was Don Keough of Coca-Cola,
|
|
although, as he puts it, his retirement lasted "about 14 hours."
|
|
Don is one of the most extraordinary human beings I've ever known -
|
|
a man of enormous business talent, but, even more important, a man
|
|
who brings out the absolute best in everyone lucky enough to
|
|
associate with him. Coca-Cola wants its product to be present at
|
|
the happy times of a person's life. Don Keough, as an individual,
|
|
invariably increases the happiness of those around him. It's
|
|
impossible to think about Don without feeling good.
|
|
|
|
I will edge up to how I met Don by slipping in a plug for my
|
|
neighborhood in Omaha: Though Charlie has lived in California for
|
|
45 years, his home as a boy was about 200 feet away from the house
|
|
where I now live; my wife, Susie, grew up 1 1/2 blocks away; and we
|
|
have about 125 Berkshire shareholders in the zip code. As for Don,
|
|
in 1958 he bought the house directly across the street from mine.
|
|
He was then a coffee salesman with a big family and a small income.
|
|
|
|
The impressions I formed in those days about Don were a factor
|
|
in my decision to have Berkshire make a record $1 billion
|
|
investment in Coca-Cola in 1988-89. Roberto Goizueta had become
|
|
CEO of Coke in 1981, with Don alongside as his partner. The two of
|
|
them took hold of a company that had stagnated during the previous
|
|
decade and moved it from $4.4 billion of market value to $58
|
|
billion in less than 13 years. What a difference a pair of
|
|
managers like this makes, even when their product has been around
|
|
for 100 years.
|
|
|
|
* * * * * * * * * * * *
|
|
|
|
Frank Rooney did double duty last year. In addition to
|
|
leading H. H. Brown to record profits - 35% above the 1992 high -
|
|
he also was key to our merger with Dexter.
|
|
|
|
Frank has known Harold Alfond and Peter Lunder for decades,
|
|
and shortly after our purchase of H. H. Brown, told me what a
|
|
wonderful operation they managed. He encouraged us to get together
|
|
and in due course we made a deal. Frank told Harold and Peter that
|
|
Berkshire would provide an ideal corporate "home" for Dexter, and
|
|
that assurance undoubtedly contributed to their decision to join
|
|
with us.
|
|
|
|
I've told you in the past of Frank's extraordinary record in
|
|
building Melville Corp. during his 23 year tenure as CEO. Now, at
|
|
72, he's setting an even faster pace at Berkshire. Frank has a
|
|
low-key, relaxed style, but don't let that fool you. When he
|
|
swings, the ball disappears far over the fence.
|
|
|
|
<B>The Annual Meeting</B>
|
|
|
|
This year the Annual Meeting will be held at the Orpheum
|
|
Theater in downtown Omaha at 9:30 a.m. on Monday, April 25, 1994.
|
|
A record 2,200 people turned up for the meeting last year, but the
|
|
theater can handle many more. We will have a display in the lobby
|
|
featuring many of our consumer products - candy, spray guns, shoes,
|
|
cutlery, encyclopedias, and the like. Among my favorites slated to
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be there is a See's candy assortment that commemorates Mrs. B's
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|
100th birthday and that features her picture, rather than Mrs.
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|
See's, on the package.
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|
We recommend that you promptly get hotel reservations at one
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|
of these hotels: (1) The Radisson-Redick Tower, a small (88 rooms)
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|
but nice hotel across the street from the Orpheum; (2) the much
|
|
larger Red Lion Hotel, located about a five-minute walk from the
|
|
Orpheum; or (3) the Marriott, located in West Omaha about 100 yards
|
|
from Borsheim's, which is a twenty-minute drive from downtown. We
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|
will have buses at the Marriott that will leave at 8:30 and 8:45
|
|
for the meeting and return after it ends.
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|
An attachment to our proxy material explains how you can
|
|
obtain the card you will need for admission to the meeting. With
|
|
the admission card, we will enclose information about parking
|
|
facilities located near the Orpheum. If you are driving, come a
|
|
little early. Nearby lots fill up quickly and you may have to walk
|
|
a few blocks.
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|
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|
As usual, we will have buses to take you to Nebraska Furniture
|
|
Mart and Borsheim's after the meeting and to take you from there to
|
|
downtown hotels or the airport later. Those of you arriving early
|
|
can visit the Furniture Mart any day of the week; it is open from
|
|
10 a.m. to 5:30 p.m. on Saturdays and from noon to 5:30 p.m. on
|
|
Sundays. Borsheim's normally is closed on Sunday but will be open
|
|
for shareholders and their guests from noon to 6 p.m. on Sunday,
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|
April 24.
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|
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|
In past trips to Borsheim's, many of you have met Susan
|
|
Jacques. Early in 1994, Susan was made President and CEO of the
|
|
company, having risen in 11 years from a $4-an-hour job that she
|
|
took at the store when she was 23. Susan will be joined at
|
|
Borsheim's on Sunday by many of the managers of our other
|
|
businesses, and Charlie and I will be there as well.
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|
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|
On the previous evening, Saturday, April 23, there will be a
|
|
baseball game at Rosenblatt Stadium between the Omaha Royals and
|
|
the Nashville Sounds (which could turn out to be Michael Jordan's
|
|
team). As you may know, a few years ago I bought 25% of the Royals
|
|
(a capital-allocation decision for which I will not become famous)
|
|
and this year the league has cooperatively scheduled a home stand
|
|
at Annual Meeting time.
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|
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|
I will throw the first pitch on the 23rd, and it's a certainty
|
|
that I will improve on last year's humiliating performance. On
|
|
that occasion, the catcher inexplicably called for my "sinker" and
|
|
I dutifully delivered a pitch that barely missed my foot. This
|
|
year, I will go with my high hard one regardless of what the
|
|
catcher signals, so bring your speed-timing devices. The proxy
|
|
statement will include information about obtaining tickets to the
|
|
game. I regret to report that you won't have to buy them from
|
|
scalpers.
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Warren E. Buffett
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March 1, 1994 Chairman of the Board
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