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1404 lines
75 KiB
1404 lines
75 KiB
Chairman's Letter - 1995
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BERKSHIRE HATHAWAY INC.
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To the Shareholders of Berkshire Hathaway Inc.:
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Our gain in net worth during 1995 was $5.3 billion, or
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45.0%. Per-share book value grew by a little less, 43.1%,
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because we paid stock for two acquisitions, increasing our shares
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outstanding by 1.3%. Over the last 31 years (that is, since
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present management took over) per-share book value has grown from
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$19 to $14,426, or at a rate of 23.6% compounded annually.
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There's no reason to do handsprings over 1995's gains. This
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was a year in which any fool could make a bundle in the stock
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market. And we did. To paraphrase President Kennedy, a rising
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tide lifts all yachts.
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Putting aside the financial results, there was plenty of
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good news at Berkshire last year: We negotiated three
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acquisitions of exactly the type we desire. Two of these,
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Helzberg's Diamond Shops and R.C. Willey Home Furnishings, are
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included in our 1995 financial statements, while our largest
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transaction, the purchase of GEICO, closed immediately after the
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end of the year. (I'll tell you more about all three
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acquisitions later in the report.)
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These new subsidiaries roughly double our revenues. Even
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so, the acquisitions neither materially increased our shares
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outstanding nor our debt. And, though these three operations
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employ over 11,000 people, our headquarters staff grew only from
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11 to 12. (No sense going crazy.)
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Charlie Munger, Berkshire's Vice Chairman and my partner,
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and I want to build a collection of companies - both wholly- and
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partly-owned - that have excellent economic characteristics and
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that are run by outstanding managers. Our favorite acquisition
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is the negotiated transaction that allows us to purchase 100% of
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such a business at a fair price. But we are almost as happy when
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the stock market offers us the chance to buy a modest percentage
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of an outstanding business at a pro-rata price well below what it
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would take to buy 100%. This double-barrelled approach -
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purchases of entire businesses through negotiation or purchases
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of part-interests through the stock market - gives us an
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important advantage over capital-allocators who stick to a single
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course. Woody Allen once explained why eclecticism works: "The
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real advantage of being bisexual is that it doubles your chances
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for a date on Saturday night."
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Over the years, we've been Woody-like in our thinking,
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attempting to increase our marketable investments in wonderful
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businesses, while simultaneously trying to buy similar businesses
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in their entirety. The following table illustrates our progress
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on both fronts. In the tabulation, we show the marketable
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securities owned per share of Berkshire at ten-year intervals. A
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second column lists our per-share operating earnings (before
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taxes and purchase-price adjustments but after interest and
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corporate overhead) from all other activities. In other words,
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the second column shows what we earned excluding the dividends,
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interest and capital gains that we realized from investments.
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Purchase-price accounting adjustments are ignored for reasons we
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have explained at length in previous reports and which, as an act
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of mercy, we won't repeat. (We'll be glad to send masochists the
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earlier explanations, however.)
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Pre-tax Earnings Per Share
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Marketable Securities Excluding All Income from
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Year Per Share Investments
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---- --------------------- --------------------------
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1965 ................ $ 4 $ 4.08
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1975 ................ 159 (6.48)
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1985 ................ 2,443 18.86
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1995 ................ 22,088 258.20
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Yearly Growth Rate: 1965-95 33.4% 14.7%
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These results have not sprung from some master plan that we
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concocted in 1965. In a general way, we knew then what we hoped
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to accomplish but had no idea what specific opportunities might
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make it possible. Today we remain similarly unstructured: Over
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time, we expect to improve the figures in both columns but have
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no road map to tell us how that will come about.
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We proceed with two advantages: First, our operating
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managers are outstanding and, in most cases, have an unusually
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strong attachment to Berkshire. Second, Charlie and I have had
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considerable experience in allocating capital and try to go at
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that job rationally and objectively. The giant disadvantage we
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face is size: In the early years, we needed only good ideas, but
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now we need good big ideas. Unfortunately, the difficulty of
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finding these grows in direct proportion to our financial
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success, a problem that increasingly erodes our strengths.
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I will have more to say about Berkshire's prospects later in
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this report, when I discuss our proposed recapitalization.
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Acquisitions
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It may seem strange that we exult over a year in which we
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made three acquisitions, given that we have regularly used these
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pages to question the acquisition activities of most managers.
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Rest assured, Charlie and I haven't lost our skepticism: We
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believe most deals do damage to the shareholders of the acquiring
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company. Too often, the words from HMS Pinafore apply: "Things
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are seldom what they seem, skim milk masquerades as cream."
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Specifically, sellers and their representatives invariably
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present financial projections having more entertainment value
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than educational value. In the production of rosy scenarios,
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Wall Street can hold its own against Washington.
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In any case, why potential buyers even look at projections
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prepared by sellers baffles me. Charlie and I never give them a
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glance, but instead keep in mind the story of the man with an
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ailing horse. Visiting the vet, he said: "Can you help me?
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Sometimes my horse walks just fine and sometimes he limps." The
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vet's reply was pointed: "No problem - when he's walking fine,
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sell him." In the world of mergers and acquisitions, that horse
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would be peddled as Secretariat.
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At Berkshire, we have all the difficulties in perceiving the
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future that other acquisition-minded companies do. Like they
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also, we face the inherent problem that the seller of a business
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practically always knows far more about it than the buyer and
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also picks the time of sale - a time when the business is likely
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to be walking "just fine."
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Even so, we do have a few advantages, perhaps the greatest
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being that we don't have a strategic plan. Thus we feel no need
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to proceed in an ordained direction (a course leading almost
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invariably to silly purchase prices) but can instead simply
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decide what makes sense for our owners. In doing that, we always
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mentally compare any move we are contemplating with dozens of
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other opportunities open to us, including the purchase of small
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pieces of the best businesses in the world via the stock market.
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Our practice of making this comparison - acquisitions against
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passive investments - is a discipline that managers focused
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simply on expansion seldom use.
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Talking to Time Magazine a few years back, Peter Drucker got
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to the heart of things: "I will tell you a secret: Dealmaking
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beats working. Dealmaking is exciting and fun, and working is
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grubby. Running anything is primarily an enormous amount of
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grubby detail work . . . dealmaking is romantic, sexy. That's
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why you have deals that make no sense."
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In making acquisitions, we have a further advantage: As
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payment, we can offer sellers a stock backed by an extraordinary
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collection of outstanding businesses. An individual or a family
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wishing to dispose of a single fine business, but also wishing to
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defer personal taxes indefinitely, is apt to find Berkshire stock
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a particularly comfortable holding. I believe, in fact, that
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this calculus played an important part in the two acquisitions
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for which we paid shares in 1995.
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Beyond that, sellers sometimes care about placing their
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companies in a corporate home that will both endure and provide
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pleasant, productive working conditions for their managers. Here
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again, Berkshire offers something special. Our managers operate
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with extraordinary autonomy. Additionally, our ownership
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structure enables sellers to know that when I say we are buying
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to keep, the promise means something. For our part, we like
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dealing with owners who care what happens to their companies and
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people. A buyer is likely to find fewer unpleasant surprises
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dealing with that type of seller than with one simply auctioning
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off his business.
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In addition to the foregoing being an explanation of our
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acquisition style, it is, of course, a not-so-subtle sales pitch.
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If you own or represent a business earning $25 million or more
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before tax, and it fits the criteria listed on page 23, just
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give me a call. Our discussion will be confidential. And if you
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aren't interested now, file our proposition in the back of your
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mind: We are never going to lose our appetite for buying
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companies with good economics and excellent management.
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Concluding this little dissertation on acquisitions, I can't
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resist repeating a tale told me last year by a corporate
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executive. The business he grew up in was a fine one, with a
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long-time record of leadership in its industry. Its main
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product, however, was distressingly glamorless. So several
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decades ago, the company hired a management consultant who -
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naturally - advised diversification, the then-current fad.
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("Focus" was not yet in style.) Before long, the company
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acquired a number of businesses, each after the consulting firm
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had gone through a long - and expensive - acquisition study. And
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the outcome? Said the executive sadly, "When we started, we were
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getting 100% of our earnings from the original business. After
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ten years, we were getting 150%."
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Helzberg's Diamond Shops
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A few years back, management consultants popularized a
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technique called "management by walking around" (MBWA). At
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Berkshire, we've instituted ABWA (acquisitions by walking
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around).
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In May 1994, a week or so after the Annual Meeting, I was
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crossing the street at 58th and Fifth Avenue in New York, when a
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woman called out my name. I listened as she told me she'd been
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to, and had enjoyed, the Annual Meeting. A few seconds later, a
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man who'd heard the woman stop me did so as well. He turned out
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to be Barnett Helzberg, Jr., who owned four shares of Berkshire
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and had also been at our meeting.
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In our few minutes of conversation, Barnett said he had a
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business we might be interested in. When people say that, it
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usually turns out they have a lemonade stand - with potential, of
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course, to quickly grow into the next Microsoft. So I simply
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asked Barnett to send me particulars. That, I thought to myself.
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will be the end of that.
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Not long after, Barnett sent me the financial statements of
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Helzberg's Diamond Shops. The company had been started by his
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grandfather in 1915 from a single store in Kansas City and had
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developed by the time we met into a group with 134 stores in 23
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states. Sales had grown from $10 million in 1974 to $53 million
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in 1984 and $282 million in 1994. We weren't talking lemonade
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stands.
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Barnett, then 60, loved the business but also wanted to feel
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free of it. In 1988, as a step in that direction, he had brought
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in Jeff Comment, formerly President of Wanamaker's, to help him
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run things. The hiring of Jeff turned out to be a homerun, but
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Barnett still found that he couldn't shake a feeling of ultimate
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responsibility. Additionally, he owned a valuable asset that was
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subject to the vagaries of a single, very competitive industry,
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and he thought it prudent to diversify his family's holdings.
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Berkshire was made to order for him. It took us awhile to
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get together on price, but there was never any question in my
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mind that, first, Helzberg's was the kind of business that we
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wanted to own and, second, Jeff was our kind of manager. In
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fact, we would not have bought the business if Jeff had not been
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there to run it. Buying a retailer without good management is
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like buying the Eiffel Tower without an elevator.
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We completed the Helzberg purchase in 1995 by means of a
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tax-free exchange of stock, the only kind of transaction that
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interested Barnett. Though he was certainly under no obligation
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to do so, Barnett shared a meaningful part of his proceeds from
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the sale with a large number of his associates. When someone
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behaves that generously, you know you are going to be treated
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right as a buyer.
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The average Helzberg's store has annual sales of about $2
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million, far more than competitors operating similarly-sized
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stores achieve. This superior per-store productivity is the key
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to Helzberg's excellent profits. If the company continues its
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first-rate performance - and we believe it will - it could grow
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rather quickly to several times its present size.
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Helzberg's, it should be added, is an entirely different
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sort of operation from Borsheim's, our Omaha jewelry business,
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and the two companies will operate independently of each other.
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Borsheim's had an excellent year in 1995, with sales up 11.7%.
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Susan Jacques, its 36-year-old CEO, had an even better year,
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giving birth to her second son at the start of the Christmas
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season. Susan has proved to be a terrific leader in the two
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years since her promotion.
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R.C. Willey Home Furnishings
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It was Nebraska Furniture Mart's Irv Blumkin who did the
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walking around in the case of R.C. Willey, long the leading home
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furnishings business in Utah. Over the years, Irv had told me
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about the strengths of that company. And he had also told Bill
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Child, CEO of R.C. Willey, how pleased the Blumkin family had
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been with its Berkshire relationship. So in early 1995, Bill
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mentioned to Irv that for estate tax and diversification reasons,
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he and the other owners of R.C. Willey might be interested in
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selling.
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From that point forward, things could not have been simpler.
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Bill sent me some figures, and I wrote him a letter indicating
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my idea of value. We quickly agreed on a number, and found our
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personal chemistry to be perfect. By mid-year, the merger was
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completed.
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R.C. Willey is an amazing story. Bill took over the
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business from his father-in-law in 1954 when sales were about
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$250,000. From this tiny base, Bill employed Mae West's
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philosophy: "It's not what you've got - it's what you do with
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what you've got." Aided by his brother, Sheldon, Bill has built
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the company to its 1995 sales volume of $257 million, and it now
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accounts for over 50% of the furniture business in Utah. Like
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Nebraska Furniture Mart, R.C. Willey sells appliances,
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electronics, computers and carpets in addition to furniture.
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Both companies have about the same sales volume, but NFM gets all
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of its business from one complex in Omaha, whereas R.C. Willey
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will open its sixth major store in the next few months.
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Retailing is a tough business. During my investment career,
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I have watched a large number of retailers enjoy terrific growth
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and superb returns on equity for a period, and then suddenly
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nosedive, often all the way into bankruptcy. This shooting-star
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phenomenon is far more common in retailing than it is in
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manufacturing or service businesses. In part, this is because a
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retailer must stay smart, day after day. Your competitor is
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always copying and then topping whatever you do. Shoppers are
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meanwhile beckoned in every conceivable way to try a stream of
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new merchants. In retailing, to coast is to fail.
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In contrast to this have-to-be-smart-every-day business,
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there is what I call the have-to-be-smart-once business. For
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example, if you were smart enough to buy a network TV station
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very early in the game, you could put in a shiftless and backward
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nephew to run things, and the business would still do well for
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decades. You'd do far better, of course, if you put in Tom
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Murphy, but you could stay comfortably in the black without him.
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For a retailer, hiring that nephew would be an express ticket to
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bankruptcy.
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The two retailing businesses we purchased this year are
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blessed with terrific managers who love to compete and have done
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so successfully for decades. Like the CEOs of our other
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operating units, they will operate autonomously: We want them to
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feel that the businesses they run are theirs. This means no
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second-guessing by Charlie and me. We avoid the attitude of the
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alumnus whose message to the football coach is "I'm 100% with you
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- win or tie." Our basic goal as an owner is to behave with our
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managers as we like our owners to behave with us.
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As we add more operations, I'm sometimes asked how many
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people I can handle reporting to me. My answer to that is
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simple: If I have one person reporting to me and he is a lemon,
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that's one too many, and if I have managers like those we now
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have, the number can be almost unlimited. We are lucky to have
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Bill and Sheldon associated with us, and we hope that we can
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acquire other businesses that bring with them managers of similar
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caliber.
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GEICO Corporation
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Right after yearend, we completed the purchase of 100% of
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GEICO, the seventh largest auto insurer in the United States,
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with about 3.7 million cars insured. I've had a 45-year
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association with GEICO, and though the story has been told
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before, it's worth a short recap here.
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I attended Columbia University's business school in 1950-51,
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not because I cared about the degree it offered, but because I
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wanted to study under Ben Graham, then teaching there. The time
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I spent in Ben's classes was a personal high, and quickly induced
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me to learn all I could about my hero. I turned first to Who's
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Who in America, finding there, among other things, that Ben was
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Chairman of Government Employees Insurance Company, to me an
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unknown company in an unfamiliar industry.
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A librarian next referred me to Best's Fire and Casualty
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insurance manual, where I learned that GEICO was based in
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Washington, DC. So on a Saturday in January, 1951, I took the
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train to Washington and headed for GEICO's downtown headquarters.
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To my dismay, the building was closed, but I pounded on the door
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until a custodian appeared. I asked this puzzled fellow if there
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was anyone in the office I could talk to, and he said he'd seen
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one man working on the sixth floor.
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And thus I met Lorimer Davidson, Assistant to the President,
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who was later to become CEO. Though my only credentials were
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that I was a student of Graham's, "Davy" graciously spent four
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hours or so showering me with both kindness and instruction. No
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one has ever received a better half-day course in how the
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insurance industry functions nor in the factors that enable one
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company to excel over others. As Davy made clear, GEICO's method
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of selling - direct marketing - gave it an enormous cost
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advantage over competitors that sold through agents, a form of
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distribution so ingrained in the business of these insurers that
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it was impossible for them to give it up. After my session with
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Davy, I was more excited about GEICO than I have ever been about
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a stock.
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When I finished at Columbia some months later and returned
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to Omaha to sell securities, I naturally focused almost
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exclusively on GEICO. My first sales call - on my Aunt Alice,
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who always supported me 100% - was successful. But I was then a
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skinny, unpolished 20-year-old who looked about 17, and my pitch
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usually failed. Undaunted, I wrote a short report late in 1951
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about GEICO for "The Security I Like Best" column in The
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Commercial and Financial Chronicle, a leading financial
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publication of the time. More important, I bought stock for my
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own account.
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You may think this odd, but I have kept copies of every tax
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return I filed, starting with the return for 1944. Checking
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back, I find that I purchased GEICO shares on four occasions
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during 1951, the last purchase being made on September 26. This
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pattern of persistence suggests to me that my tendency toward
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self-intoxication was developed early. I probably came back on
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that September day from unsuccessfully trying to sell some
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prospect and decided - despite my already having more than 50% of
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my net worth in GEICO - to load up further. In any event, I
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accumulated 350 shares of GEICO during the year, at a cost of
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$10,282. At yearend, this holding was worth $13,125, more than
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65% of my net worth.
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You can see why GEICO was my first business love. Furthermore,
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just to complete this stroll down memory lane, I should add
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that I earned most of the funds I used to buy GEICO shares by
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delivering The Washington Post, the chief product of a
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company that much later made it possible for Berkshire to turn
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$10 million into $500 million.
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Alas, I sold my entire GEICO position in 1952 for $15,259,
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primarily to switch into Western Insurance Securities. This act
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of infidelity can partially be excused by the fact that Western
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was selling for slightly more than one times its current earnings,
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a p/e ratio that for some reason caught my eye. But in the next
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20 years, the GEICO stock I sold grew in value to about $1.3
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million, which taught me a lesson about the inadvisability of
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selling a stake in an identifiably-wonderful company.
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In the early 1970's, after Davy retired, the executives
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running GEICO made some serious errors in estimating their claims
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costs, a mistake that led the company to underprice its policies
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- and that almost caused it to go bankrupt. The company was
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saved only because Jack Byrne came in as CEO in 1976 and took
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drastic remedial measures.
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Because I believed both in Jack and in GEICO's fundamental
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competitive strength, Berkshire purchased a large interest in the
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company during the second half of 1976, and also made smaller
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purchases later. By yearend 1980, we had put $45.7 million into
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GEICO and owned 33.3% of its shares. During the next 15 years,
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we did not make further purchases. Our interest in the company,
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nonetheless, grew to about 50% because it was a big repurchaser
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of its own shares.
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Then, in 1995, we agreed to pay $2.3 billion for the half of
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the company we didn't own. That is a steep price. But it gives
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us full ownership of a growing enterprise whose business remains
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exceptional for precisely the same reasons that prevailed in
|
|
1951. In addition, GEICO has two extraordinary managers: Tony
|
|
Nicely, who runs the insurance side of the operation, and Lou
|
|
Simpson, who runs investments.
|
|
|
|
Tony, 52, has been with GEICO for 34 years. There's no one
|
|
I would rather have managing GEICO's insurance operation. He has
|
|
brains, energy, integrity and focus. If we're lucky, he'll stay
|
|
another 34 years.
|
|
|
|
Lou runs investments just as ably. Between 1980 and 1995,
|
|
the equities under Lou's management returned an average of 22.8%
|
|
annually vs. 15.7% for the S&P. Lou takes the same conservative,
|
|
concentrated approach to investments that we do at Berkshire, and
|
|
it is an enormous plus for us to have him on board. One point
|
|
that goes beyond Lou's GEICO work: His presence on the scene
|
|
assures us that Berkshire would have an extraordinary
|
|
professional immediately available to handle its investments if
|
|
something were to happen to Charlie and me.
|
|
|
|
GEICO, of course, must continue both to attract good
|
|
policyholders and keep them happy. It must also reserve and
|
|
price properly. But the ultimate key to the company's success is
|
|
its rock-bottom operating costs, which virtually no competitor
|
|
can match. In 1995, moreover, Tony and his management team
|
|
pushed underwriting and loss adjustment expenses down further to
|
|
23.6% of premiums, nearly one percentage point below 1994's
|
|
ratio. In business, I look for economic castles protected by
|
|
unbreachable "moats." Thanks to Tony and his management team,
|
|
GEICO's moat widened in 1995.
|
|
|
|
Finally, let me bring you up to date on Davy. He's now 93
|
|
and remains my friend and teacher. He continues to pay close
|
|
attention to GEICO and has always been there when the company's
|
|
CEOs - Jack Byrne, Bill Snyder and Tony - have needed him. Our
|
|
acquisition of 100% of GEICO caused Davy to incur a large tax.
|
|
Characteristically, he still warmly supported the transaction.
|
|
|
|
Davy has been one of my heroes for the 45 years I've known
|
|
him, and he's never let me down. You should understand that
|
|
Berkshire would not be where it is today if Davy had not been so
|
|
generous with his time on a cold Saturday in 1951. I've often
|
|
thanked him privately, but it is fitting that I use this report
|
|
to thank him on behalf of Berkshire's shareholders.
|
|
|
|
Insurance Operations
|
|
|
|
In addition to acquiring GEICO, we enjoyed other favorable
|
|
developments in insurance during 1995.
|
|
|
|
As we've explained in past reports, what counts in our
|
|
insurance business is, first, the amount of "float" we generate
|
|
and, second, its cost to us. Float is money we hold but don't
|
|
own. In an insurance operation, float arises because most
|
|
policies require that premiums be prepaid and, more importantly,
|
|
because it usually takes time for an insurer to hear about and
|
|
resolve loss claims.
|
|
|
|
Typically, the premiums that an insurer takes in do not
|
|
cover the losses and expenses it must pay. That leaves it
|
|
running an "underwriting loss" - and that loss is the cost of
|
|
float. An insurance business is profitable over time if its cost
|
|
of float is less than the cost the company would otherwise incur
|
|
to obtain funds. But the business has a negative value if the
|
|
cost of its float is higher than market rates for money.
|
|
|
|
As the numbers in the following table show, Berkshire's
|
|
insurance business has been a huge winner. For the table, we
|
|
have calculated our float - which we generate in exceptional
|
|
amounts relative to our premium volume - by adding loss reserves,
|
|
loss adjustment reserves, funds held under reinsurance assumed
|
|
and unearned premium reserves, and then subtracting agents'
|
|
balances, prepaid acquisition costs, prepaid taxes 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, such as the last three,
|
|
our cost of float has been negative, which means we have
|
|
calculated 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%
|
|
1994 ...... profit 3,056.6 less than zero 7.88%
|
|
1995 ...... profit 3,607.2 less than zero 5.95%
|
|
|
|
Since 1967, when we entered the insurance business, our float
|
|
has grown at an annual compounded rate of 20.7%. In more years
|
|
than not, our cost of funds has been less than nothing. This
|
|
access to "free" money has boosted Berkshire's performance in a
|
|
major way.
|
|
|
|
Any company's level of profitability is determined by three
|
|
items: (1) what its assets earn; (2) what its liabilities cost;
|
|
and (3) its utilization of "leverage" - that is, the degree to
|
|
which its assets are funded by liabilities rather than by equity.
|
|
Over the years, we have done well on Point 1, having produced high
|
|
returns on our assets. But we have also benefitted greatly - to a
|
|
degree that is not generally well-understood - because our
|
|
liabilities have cost us very little. An important reason for this
|
|
low cost is that we have obtained float on very advantageous terms.
|
|
The same cannot be said by many other property and casualty
|
|
insurers, who may generate plenty of float, but at a cost that
|
|
exceeds what the funds are worth to them. In those circumstances,
|
|
leverage becomes a disadvantage.
|
|
|
|
Since our float has cost us virtually nothing over the years,
|
|
it has in effect served as equity. Of course, it differs from true
|
|
equity in that it doesn't belong to us. Nevertheless, let's assume
|
|
that instead of our having $3.4 billion of float at the end of
|
|
1994, we had replaced it with $3.4 billion of equity. Under this
|
|
scenario, we would have owned no more assets than we did during
|
|
1995. We would, however, have had somewhat lower earnings because
|
|
the cost of float was negative last year. That is, our float threw
|
|
off profits. And, of course, to obtain the replacement equity, we
|
|
would have needed to sell many new shares of Berkshire. The net
|
|
result - more shares, equal assets and lower earnings - would have
|
|
materially reduced the value of our stock. So you can understand
|
|
why float wonderfully benefits a business - if it is obtained at a
|
|
low cost.
|
|
|
|
Our acquisition of GEICO will immediately increase our float
|
|
by nearly $3 billion, with additional growth almost certain. We
|
|
also expect GEICO to operate at a decent underwriting profit in
|
|
most years, a fact that will increase the probability that our
|
|
total float will cost us nothing. Of course, we paid a very
|
|
substantial price for the GEICO float, whereas virtually all of the
|
|
gains in float depicted in the table were developed internally.
|
|
|
|
Our enthusiasm over 1995's insurance results must be tempered
|
|
once again because we had our third straight year of good fortune
|
|
in the super-cat business. In this operation, we sell policies
|
|
that insurance and reinsurance companies buy to protect themselves
|
|
from the effects of mega-catastrophes. Since truly major
|
|
catastrophes occur infrequently, our super-cat business can be
|
|
expected to show large profits in most years but occasionally to
|
|
record a huge loss. In other words, the attractiveness of our
|
|
super-cat business will take many years to measure. We know that
|
|
the results of years like the past three will be at least partially
|
|
offset by some truly terrible year in the future. We just hope
|
|
that "partially" turns out to be the proper adverb.
|
|
|
|
There were plenty of catastrophes last year, but no super-cats
|
|
of the insured variety. The Southeast had a close call when Opal,
|
|
sporting winds of 150 miles per hour, hovered off Florida.
|
|
However, the storm abated before hitting land, and so a second
|
|
Andrew was dodged. For insurers, the Kobe earthquake was another
|
|
close call: The economic damage was huge - perhaps even a record -
|
|
but only a tiny portion of it was insured. The insurance industry
|
|
won't always be that lucky.
|
|
|
|
Ajit Jain is the guiding genius of our super-cat business and
|
|
writes important non-cat business as well. In insurance, the term
|
|
"catastrophe" is applied to an event, such as a hurricane or
|
|
earthquake, that causes a great many insured losses. The other
|
|
deals Ajit enters into usually cover only a single large loss. A
|
|
simplified description of three transactions from last year will
|
|
illustrate both what I mean and Ajit's versatility. We insured: (1)
|
|
The life of Mike Tyson for a sum that is large initially and that,
|
|
fight-by-fight, gradually declines to zero over the next few years;
|
|
(2) Lloyd's against more than 225 of its "names" dying during the
|
|
year; and (3) The launch, and a year of orbit, of two Chinese
|
|
satellites. Happily, both satellites are orbiting, the Lloyd's folk
|
|
avoided abnormal mortality, and if Mike Tyson looked any healthier,
|
|
no one would get in the ring with him.
|
|
|
|
Berkshire is sought out for many kinds of insurance, both
|
|
super-cat and large single-risk, because: (1) our financial
|
|
strength is unmatched, and insureds know we can and will pay our
|
|
losses under the most adverse of circumstances; (2) we can supply a
|
|
quote faster than anyone in the business; and (3) we will issue
|
|
policies with limits larger than anyone else is prepared to write.
|
|
Most of our competitors have extensive reinsurance treaties and
|
|
lay off much of their business. While this helps them avoid shock
|
|
losses, it also hurts their flexibility and reaction time. As you
|
|
know, Berkshire moves quickly to seize investment and acquisition
|
|
opportunities; in insurance we respond with the same exceptional
|
|
speed. In another important point, large coverages don't frighten
|
|
us but, on the contrary, intensify our interest. We have offered a
|
|
policy under which we could have lost $1 billion; the largest
|
|
coverage that a client accepted was $400 million.
|
|
|
|
We will get hit from time to time with large losses. Charlie
|
|
and I, however, are quite willing to accept relatively volatile
|
|
results in exchange for better long-term earnings than we would
|
|
otherwise have had. In other words, we prefer a lumpy 15% to a
|
|
smooth 12%. Since most managers opt for smoothness, we are left
|
|
with a competitive advantage that we try to maximize. We do,
|
|
though, monitor our aggregate exposure in order to keep our "worst
|
|
case" at a level that leaves us comfortable.
|
|
|
|
Indeed, our worst case from a "once-in-a-century" super-cat is
|
|
far less severe - relative to net worth - than that faced by many
|
|
well-known primary companies writing great numbers of property
|
|
policies. These insurers don't issue single huge-limit policies as
|
|
we do, but their small policies, in aggregate, can create a risk of
|
|
staggering size. The "big one" would blow right through the
|
|
reinsurance covers of some of these insurers, exposing them to
|
|
uncapped losses that could threaten their survival. In our case,
|
|
losses would be large, but capped at levels we could easily handle.
|
|
|
|
Prices are weakening in the super-cat field. That is
|
|
understandable considering the influx of capital into the
|
|
reinsurance business a few years ago and the natural desire of
|
|
those holding the capital to employ it. No matter what others may
|
|
do, we will not knowingly write business at inadequate rates. We
|
|
unwittingly did this in the early 1970's and, after more than 20
|
|
years, regularly receive significant bills stemming from the
|
|
mistakes of that era. My guess is that we will still be getting
|
|
surprises from that business 20 years from now. A bad reinsurance
|
|
contract is like hell: easy to enter and impossible to exit.
|
|
|
|
I actively participated in those early reinsurance decisions,
|
|
and Berkshire paid a heavy tuition for my education in the
|
|
business. Unfortunately, reinsurance students can't attend school
|
|
on scholarship. GEICO, incidentally, suffered a similar,
|
|
disastrous experience in the early 1980's, when it plunged
|
|
enthusiastically into the writing of reinsurance and large risks.
|
|
GEICO's folly was brief, but it will be cleaning things up for at
|
|
least another decade. The well-publicized problems at Lloyd's
|
|
further illustrate the perils of reinsurance and also underscore
|
|
how vital it is that the interests of the people who write
|
|
insurance business be aligned - on the downside as well as the
|
|
upside - with those of the people putting up the capital. When
|
|
that kind of symmetry is missing, insurers almost invariably run
|
|
into trouble, though its existence may remain hidden for some time.
|
|
|
|
A small, apocryphal story about an insurance CEO who was
|
|
visited by an analyst tells a lot about this industry. To the
|
|
analyst's questions about his business, the CEO had nothing but
|
|
gloomy answers: Rates were ridiculously low; the reserves on his
|
|
balance sheet weren't adequate for ordinary claims, much less those
|
|
likely to arise from asbestos and environmental problems; most of
|
|
his reinsurers had long since gone broke, leaving him holding the
|
|
sack. But then the CEO brightened: "Still, things could be a lot
|
|
worse," he said. "It could be my money." At Berkshire, it's our
|
|
money.
|
|
|
|
Berkshire's other insurance operations, though relatively
|
|
small, performed magnificently in 1995. National Indemnity's
|
|
traditional business had a combined ratio of 84.2 and developed, as
|
|
usual, a large amount of float compared to premium volume. Over
|
|
the last three years, this segment of our business, run by Don
|
|
Wurster, has had an average combined ratio of 85.6. Our homestate
|
|
operation, managed by Rod Eldred, grew at a good rate in 1995 and
|
|
achieved a combined ratio of 81.4. Its three-year combined ratio
|
|
is an amazing 82.4. Berkshire's California workers' compensation
|
|
business, run by Brad Kinstler, faced fierce price-cutting in 1995
|
|
and lost a great many renewals when we refused to accept inadequate
|
|
rates. Though this operation's volume dropped materially, it
|
|
produced an excellent underwriting profit. Finally, John Kizer, at
|
|
Central States Indemnity, continues to do an extraordinary job.
|
|
His premium volume was up 23% in 1995, and underwriting profit grew
|
|
by 59%. Ajit, Don, Rod, Brad and John are all under 45, an
|
|
embarrassing fact demolishing my theory that managers only hit
|
|
their stride after they reach 70.
|
|
|
|
To sum up, we entered 1995 with an exceptional insurance
|
|
operation of moderate size. By adding GEICO, we entered 1996 with
|
|
a business still better in quality, much improved in its growth
|
|
prospects, and doubled in size. More than ever, insurance is our
|
|
core strength.
|
|
|
|
Sources of Reported Earnings
|
|
|
|
The table below shows the main sources of Berkshire's reported
|
|
earnings. In this presentation, purchase-premium charges are not
|
|
assigned to the specific businesses to which they apply, but are
|
|
instead aggregated and shown separately. This procedure lets you
|
|
view the earnings of our businesses as they would have been
|
|
reported had we not purchased them. This form of presentation
|
|
seems to us to be more useful to investors and managers than one
|
|
utilizing GAAP, which requires purchase-premiums to be charged off,
|
|
business-by-business. The total earnings we show in the table are,
|
|
of course, identical to the GAAP total in our audited financial
|
|
statements.
|
|
|
|
(in millions)
|
|
---------------------------------------
|
|
Berkshire's Share
|
|
of Net Earnings
|
|
(after taxes and
|
|
Pre-Tax Earnings minority interests)
|
|
------------------ ------------------
|
|
1995 1994 1995 1994
|
|
-------- -------- -------- --------
|
|
Operating Earnings:
|
|
Insurance Group:
|
|
Underwriting ............... $ 20.5 $129.9 $ 11.3 $ 80.9
|
|
Net Investment Income ...... 501.6 419.4 417.7 350.5
|
|
Buffalo News ................. 46.8 54.2 27.3 31.7
|
|
Fechheimer ................... 16.9 14.3 8.8 7.1
|
|
Finance Businesses ........... 20.8 22.1 12.6 14.6
|
|
Home Furnishings ............. 29.7(1) 17.4 16.7(1) 8.7
|
|
Jewelry ...................... 33.9(2) ---(3) 19.1(2) ---(3)
|
|
Kirby ........................ 50.2 42.3 32.1 27.7
|
|
Scott Fetzer Manufacturing Group 34.1 39.5 21.2 24.9
|
|
See's Candies ................ 50.2 47.5 29.8 28.2
|
|
Shoe Group ................... 58.4 85.5 37.5 55.8
|
|
World Book ................... 8.8 24.7 7.0 17.3
|
|
Purchase-Price Premium Charges (27.0) (22.6) (23.4) (19.4)
|
|
Interest Expense(4) .......... (56.0) (60.1) (34.9) (37.3)
|
|
Shareholder-Designated
|
|
Contributions ............ (11.6) (10.4) (7.0) (6.7)
|
|
Other ........................ 37.4 35.7 24.4 22.3
|
|
-------- -------- -------- --------
|
|
Operating Earnings ............. 814.7 839.4 600.2 606.2
|
|
Sales of Securities ............ 194.1 91.3 125.0 61.1
|
|
Decline in Value of
|
|
USAir Preferred Stock ...... --- (268.5) --- (172.6)
|
|
--------- -------- -------- --------
|
|
Total Earnings - All Entities $1,008.8 $662.2 $725.2 $494.8
|
|
========= ======== ======== ========
|
|
|
|
(1) Includes R.C. Willey from June 29, 1995.
|
|
(2) Includes Helzberg's from April 30, 1995.
|
|
(3) Jewelry earnings were included in "Other" in 1994.
|
|
(4) Excludes interest expense of Finance Businesses.
|
|
|
|
A large amount of information about these businesses is given
|
|
on pages 41-52, where you will also find our segment earnings
|
|
reported on a GAAP basis. In addition, on pages 57-63, we have
|
|
rearranged Berkshire's financial data into four segments on a non-
|
|
GAAP basis, a presentation that corresponds to the way Charlie and
|
|
I think about the company. Our intent is to supply you with the
|
|
financial information that we would wish you to give us if our
|
|
positions were reversed.
|
|
|
|
At Berkshire, we believe in Charlie's dictum - "Just tell me
|
|
the bad news; the good news will take care of itself" - and that is
|
|
the behavior we expect of our managers when they are reporting to
|
|
us. Consequently, I also owe you - Berkshire's owners - a report
|
|
on three operations that, though they continued to earn decent (or
|
|
better) returns on invested capital, experienced a decline in
|
|
earnings last year. Each encountered a different type of problem.
|
|
|
|
Our shoe business operated in an industry that suffered
|
|
depressed earnings throughout last year, and many of our
|
|
competitors made only marginal profits or worse. That means we at
|
|
least maintained, and in some instances widened, our competitive
|
|
superiority. So I have no doubt that our shoe operations will
|
|
climb back to top-grade earnings in the future. In other words,
|
|
though the turn has not yet occurred, we believe you should view
|
|
last year's figures as reflecting a cyclical problem, not a secular
|
|
one.
|
|
|
|
The Buffalo News, though still doing very well in comparison
|
|
to other newspapers, is another story. In this case, industry
|
|
trends are not good. In the 1991 Annual Report, I explained that
|
|
newspapers had lost a notch in their economic attractiveness from
|
|
the days when they appeared to have a bullet-proof franchise.
|
|
Today, the industry retains its excellent economics, but has lost
|
|
still another notch. Over time, we expect the competitive strength
|
|
of newspapers to gradually erode, though the industry should
|
|
nevertheless remain a fine business for many years to come.
|
|
|
|
Berkshire's most difficult problem is World Book, which
|
|
operates in an industry beset by increasingly tough competition
|
|
from CD-ROM and on-line offerings. True, we are still profitable,
|
|
a claim that perhaps no other print encyclopedia can make. But our
|
|
sales and earnings trends have gone in the wrong direction. At the
|
|
end of 1995, World Book made major changes in the way it
|
|
distributes its product, stepped up its efforts with electronic
|
|
products and sharply reduced its overhead costs. It will take time
|
|
for us to evaluate the effects of these initiatives, but we are
|
|
confident they will significantly improve our viability.
|
|
|
|
All of our operations, including those whose earnings fell
|
|
last year, benefit from exceptionally talented and dedicated
|
|
managers. Were we to have the choice of any other executives now
|
|
working in their industries, there is not one of our managers we
|
|
would replace.
|
|
|
|
Many of our managers don't have to work for a living, but
|
|
simply go out and perform every day for the same reason that
|
|
wealthy golfers stay on the tour: They love both doing what they
|
|
do and doing it well. To describe them as working may be a
|
|
misnomer - they simply prefer spending much of their time on a
|
|
productive activity at which they excel to spending it on leisure
|
|
activities. Our job is to provide an environment that will keep
|
|
them feeling this way, and so far we seem to have succeeded:
|
|
Thinking back over the 1965-95 period, I can't recall that a single
|
|
key manager has left Berkshire to join another employer.
|
|
|
|
Common Stock Investments
|
|
|
|
Below we present our common stock investments. Those with a
|
|
market value of more than $600 million are itemized.
|
|
|
|
12/31/95
|
|
Shares Company Cost Market
|
|
---------- ------- -------- --------
|
|
(dollars in millions)
|
|
49,456,900 American Express Company ............. $1,392.7 $2,046.3
|
|
20,000,000 Capital Cities/ABC, Inc. ............. 345.0 2,467.5
|
|
100,000,000 The Coca-Cola Company ................ 1,298.9 7,425.0
|
|
12,502,500 Federal Home Loan Mortgage Corp.
|
|
("Freddie Mac") ................... 260.1 1,044.0
|
|
34,250,000 GEICO Corp. .......................... 45.7 2,393.2
|
|
48,000,000 The Gillette Company ................. 600.0 2,502.0
|
|
6,791,218 Wells Fargo & Company ................ 423.7 1,466.9
|
|
Others ............................... 1,379.0 2,655.4
|
|
-------- ---------
|
|
Total Common Stocks .................. $5,745.1 $22,000.3
|
|
======== =========
|
|
|
|
We continue in our Rip Van Winkle mode: Five of our six top
|
|
positions at yearend 1994 were left untouched during 1995. The
|
|
sixth was American Express, in which we increased our ownership to
|
|
about 10%.
|
|
|
|
In early 1996, two major events affected our holdings: First,
|
|
our purchase of the GEICO stock we did not already own caused that
|
|
company to be converted into a wholly-owned subsidiary. Second, we
|
|
exchanged our Cap Cities shares for a combination of cash and
|
|
Disney stock.
|
|
|
|
In the Disney merger, Cap Cities shareholders had a choice of
|
|
actions. If they chose, they could exchange each of their Cap
|
|
Cities shares for one share of Disney stock plus $65. Or they
|
|
could ask for - though not necessarily get - all cash or all stock,
|
|
with their ultimate allotment of each depending on the choices made
|
|
by other shareholders and certain decisions made by Disney. For
|
|
our 20 million shares, we sought stock, but do not know, as this
|
|
report goes to press, how much we were allocated. We are certain,
|
|
however, to receive something over 20 million Disney shares. We
|
|
have also recently bought Disney stock in the market.
|
|
|
|
One more bit of history: I first became interested in Disney
|
|
in 1966, when its market valuation was less than $90 million, even
|
|
though the company had earned around $21 million pre-tax in 1965
|
|
and was sitting with more cash than debt. At Disneyland, the $17
|
|
million Pirates of the Caribbean ride would soon open. Imagine my
|
|
excitement - a company selling at only five times rides!
|
|
|
|
Duly impressed, Buffett Partnership Ltd. bought a significant
|
|
amount of Disney stock at a split-adjusted price of 31 per share.
|
|
That decision may appear brilliant, given that the stock now sells
|
|
for $66. But your Chairman was up to the task of nullifying it:
|
|
In 1967 I sold out at 48 per share.
|
|
|
|
Oh well - we're happy to be once again a large owner of a
|
|
business with both unique assets and outstanding management.
|
|
|
|
Convertible Preferred Stocks
|
|
|
|
As many of you will remember, Berkshire made five private
|
|
purchases of convertible preferred stocks during the 1987-91 period
|
|
and the time seems right to discuss their status. Here are the
|
|
particulars:
|
|
|
|
Dividend Year of Market
|
|
Company Rate Purchase Cost Value
|
|
------- -------- -------- ------ --------
|
|
(dollars in millions)
|
|
|
|
Champion International Corp. ... 9 1/4% 1989 $300 $388(1)
|
|
First Empire State Corp. ....... 9% 1991 40 110
|
|
The Gillette Company ........... 8 3/4% 1989 600 2,502(2)
|
|
Salomon Inc .................... 9% 1987 700 728(3)
|
|
USAir Group, Inc. .............. 9 1/4% 1989 358 215
|
|
|
|
(1) Proceeds from sale of common we received through conversion in 1995.
|
|
(2) 12/31/95 value of common we received through conversion in 1991.
|
|
(3) Includes $140 we received in 1995 from partial redemption.
|
|
|
|
In each case we had the option of sticking with these
|
|
preferreds as fixed-income securities or converting them into
|
|
common stock. Initially, their value to us came primarily from
|
|
their fixed-income characteristics. The option we had to convert
|
|
was a kicker.
|
|
|
|
Our $300 million private purchase of American Express "Percs"
|
|
- described in the 1991 Annual Report - is not included in the
|
|
table because that security was a modified form of common stock
|
|
whose fixed-income characteristics contributed only a minor portion
|
|
of its initial value. Three years after we bought them, the Percs
|
|
automatically were converted to common stock. In contrast, the
|
|
five securities in the table were set to become common stocks only
|
|
if we wished them to - a crucial difference.
|
|
|
|
When we purchased our convertible securities, I told you that
|
|
we expected to earn after-tax returns from them that "moderately"
|
|
exceeded what we could earn from the medium-term fixed-income
|
|
securities they replaced. We beat this expectation - but only
|
|
because of the performance of a single issue. I also told you that
|
|
these securities, as a group, would "not produce the returns we can
|
|
achieve when we find a business with wonderful economic prospects."
|
|
Unfortunately, that prediction was fulfilled. Finally, I said
|
|
that "under almost any conditions, we expect these preferreds to
|
|
return us our money plus dividends." That's one I would like to
|
|
have back. Winston Churchill once said that "eating my words has
|
|
never given me indigestion." My assertion, however, that it was
|
|
almost impossible for us to lose money on our preferreds has caused
|
|
me some well-deserved heartburn.
|
|
|
|
Our best holding has been Gillette, which we told you from the
|
|
start was a superior business. Ironically, though, this is also
|
|
the purchase in which I made my biggest mistake - of a kind,
|
|
however, never recognized on financial statements.
|
|
|
|
We paid $600 million in 1989 for Gillette preferred shares
|
|
that were convertible into 48 million (split-adjusted) common
|
|
shares. Taking an alternative route with the $600 million, I
|
|
probably could have purchased 60 million shares of common from the
|
|
company. The market on the common was then about $10.50, and given
|
|
that this would have been a huge private placement carrying
|
|
important restrictions, I probably could have bought the stock at a
|
|
discount of at least 5%. I can't be sure about this, but it's
|
|
likely that Gillette's management would have been just as happy to
|
|
have Berkshire opt for common.
|
|
|
|
But I was far too clever to do that. Instead, for less than
|
|
two years, we received some extra dividend income (the difference
|
|
between the preferred's yield and that of the common), at which
|
|
point the company - quite properly - called the issue, moving to do
|
|
that as quickly as was possible. If I had negotiated for common
|
|
rather than preferred, we would have been better off at yearend
|
|
1995 by $625 million, minus the "excess" dividends of about $70
|
|
million.
|
|
|
|
In the case of Champion, the ability of the company to call
|
|
our preferred at 115% of cost forced a move out of us last August
|
|
that we would rather have delayed. In this instance, we converted
|
|
our shares just prior to the pending call and offered them to the
|
|
company at a modest discount.
|
|
|
|
Charlie and I have never had a conviction about the paper
|
|
industry - actually, I can't remember ever owning the common stock
|
|
of a paper producer in my 54 years of investing - so our choice in
|
|
August was whether to sell in the market or to the company.
|
|
Champion's management had always been candid and honorable in
|
|
dealing with us and wished to repurchase common shares, so we
|
|
offered our stock to the company. Our Champion capital gain was
|
|
moderate - about 19% after tax from a six-year investment - but the
|
|
preferred delivered us a good after-tax dividend yield throughout
|
|
our holding period. (That said, many press accounts have
|
|
overstated the after-tax yields earned by property-casualty
|
|
insurance companies on dividends paid to them. What the press has
|
|
failed to take into account is a change in the tax law that took
|
|
effect in 1987 and that significantly reduced the dividends
|
|
received credit applicable to insurers. For details, see our 1986
|
|
Annual Report.)
|
|
|
|
Our First Empire preferred will be called on March 31, 1996,
|
|
the earliest date allowable. We are comfortable owning stock in
|
|
well-run banks, and we will convert and keep our First Empire
|
|
common shares. Bob Wilmers, CEO of the company, is an outstanding
|
|
banker, and we love being associated with him.
|
|
|
|
Our other two preferreds have been disappointing, though the
|
|
Salomon preferred has modestly outperformed the fixed-income
|
|
securities for which it was a substitute. However, the amount of
|
|
management time Charlie and I have devoted to this holding has been
|
|
vastly greater than its economic significance to Berkshire.
|
|
Certainly I never dreamed I would take a new job at age 60 -
|
|
Salomon interim chairman, that is - because of an earlier purchase
|
|
of a fixed-income security.
|
|
|
|
Soon after our purchase of the Salomon preferred in 1987, I
|
|
wrote that I had "no special insights regarding the direction or
|
|
future profitability of investment banking." Even the most
|
|
charitable commentator would conclude that I have since proved my
|
|
point.
|
|
|
|
To date, our option to convert into Salomon common has not
|
|
proven of value. Furthermore, the Dow Industrials have doubled
|
|
since I committed to buy the preferred, and the brokerage group has
|
|
performed equally as well. That means my decision to go with
|
|
Salomon because I saw value in the conversion option must be graded
|
|
as very poor. Even so, the preferred has continued under some
|
|
trying conditions to deliver as a fixed-income security, and the
|
|
9% dividend is currently quite attractive.
|
|
|
|
Unless the preferred is converted, its terms require
|
|
redemption of 20% of the issue on October 31 of each year, 1995-99,
|
|
and $140 million of our original $700 million was taken on schedule
|
|
last year. (Some press reports labeled this a sale, but a senior
|
|
security that matures is not "sold.") Though we did not elect to
|
|
convert the preferred that matured last year, we have four more
|
|
bites at the conversion apple, and I believe it quite likely that
|
|
we will yet find value in our right to convert.
|
|
|
|
I discussed the USAir investment at length in last year's
|
|
report. The company's results improved in 1995, but it still faces
|
|
significant problems. On the plus side for us is the fact that our
|
|
preferred is structurally well-designed: For example, though we
|
|
have not been paid dividends since June 1994, the amounts owed us
|
|
are compounding at 5% over the prime rate. On the minus side is
|
|
the fact that we are dealing with a weak credit.
|
|
|
|
We feel much better about our USAir preferred than we did a
|
|
year ago, but your guess is as good as mine as to its ultimate
|
|
value. (Indeed, considering my record with this investment, it's
|
|
fair to say that your guess may be better than mine.) At yearend
|
|
we carried our preferred (in which there is no public market) at
|
|
60% of par, though USAir also has outstanding a junior preferred
|
|
that is significantly inferior to ours in all respects except
|
|
conversion price and that was then trading at 82% of par. As I
|
|
write this, the junior issue has advanced to 97% of par. Let's
|
|
hope the market is right.
|
|
|
|
Overall, our preferreds have performed well, but that is true
|
|
only because of one huge winner, Gillette. Leaving aside Gillette,
|
|
our preferreds as a group have delivered us after-tax returns no
|
|
more than equal to those we could have earned from the medium-term
|
|
fixed-income issues that they replaced.
|
|
|
|
A Proposed Recapitalization
|
|
|
|
At the Annual Meeting you will be asked to approve a
|
|
recapitalization of Berkshire, creating two classes of stock. If
|
|
the plan is adopted, our existing common stock will be designated
|
|
as Class A Common Stock and a new Class B Common Stock will be
|
|
authorized.
|
|
|
|
Each share of the "B" will have the rights of 1/30th of an "A"
|
|
share with these exceptions: First, a B share will have 1/200th of
|
|
the vote of an A share (rather than 1/30th of the vote). Second,
|
|
the B will not be eligible to participate in Berkshire's
|
|
shareholder-designated charitable contributions program.
|
|
|
|
When the recapitalization is complete, each share of A will
|
|
become convertible, at the holder's option and at any time, into 30
|
|
shares of B. This conversion privilege will not extend in the
|
|
opposite direction. That is, holders of B shares will not be able
|
|
to convert them into A shares.
|
|
|
|
We expect to list the B shares on the New York Stock Exchange,
|
|
where they will trade alongside the A stock. To create the
|
|
shareholder base necessary for a listing - and to ensure a liquid
|
|
market in the B stock - Berkshire expects to make a public offering
|
|
for cash of at least $100 million of new B shares. The offering
|
|
will be made only by means of a prospectus.
|
|
|
|
The market will ultimately determine the price of the B
|
|
shares. Their price, though, should be in the neighborhood of
|
|
1/30th of the price of the A shares.
|
|
|
|
Class A shareholders who wish to give gifts may find it
|
|
convenient to convert a share or two of their stock into Class B
|
|
shares. Additionally, arbitrage-related conversions will occur if
|
|
demand for the B is strong enough to push its price to slightly
|
|
above 1/30th of the price of A.
|
|
|
|
However, because the Class A stock will entitle its holders to
|
|
full voting rights and access to Berkshire's contributions program,
|
|
these shares will be superior to the Class B shares and we would
|
|
expect most shareholders to remain holders of the Class A - which
|
|
is precisely what the Buffett and Munger families plan to do,
|
|
except in those instances when we ourselves might convert a few
|
|
shares to facilitate gifts. The prospect that most shareholders
|
|
will stick to the A stock suggests that it will enjoy a somewhat
|
|
more liquid market than the B.
|
|
|
|
There are tradeoffs for Berkshire in this recapitalization.
|
|
But they do not arise from the proceeds of the offering - we will
|
|
find constructive uses for the money - nor in any degree from the
|
|
price at which we will sell the B shares. As I write this - with
|
|
Berkshire stock at $36,000 - Charlie and I do not believe it
|
|
undervalued. Therefore, the offering we propose will not diminish
|
|
the per-share intrinsic value of our existing stock. Let me also
|
|
put our thoughts about valuation more baldly: Berkshire is selling
|
|
at a price at which Charlie and I would not consider buying it.
|
|
|
|
What Berkshire will incur by way of the B stock are certain
|
|
added costs, including those involving the mechanics of handling a
|
|
larger number of shareholders. On the other hand, the stock should
|
|
be a convenience for people wishing to make gifts. And those of
|
|
you who have hoped for a split have gained a do-it-yourself method
|
|
of bringing one about.
|
|
|
|
We are making this move, though, for other reasons - having to
|
|
do with the appearance of expense-laden unit trusts purporting to
|
|
be low-priced "clones" of Berkshire and sure to be aggressively
|
|
marketed. The idea behind these vehicles is not new: In recent
|
|
years, a number of people have told me about their wish to create
|
|
an "all-Berkshire" investment fund to be sold at a low dollar
|
|
price. But until recently, the promoters of these investments
|
|
heard out my objections and backed off.
|
|
|
|
I did not discourage these people because I prefer large
|
|
investors over small. Were it possible, Charlie and I would love
|
|
to turn $1,000 into $3,000 for multitudes of people who would find
|
|
that gain an important answer to their immediate problems.
|
|
|
|
In order to quickly triple small stakes, however, we would
|
|
have to just as quickly turn our present market capitalization of
|
|
$43 billion into $129 billion (roughly the market cap of General
|
|
Electric, America's most highly valued company). We can't come
|
|
close to doing that. The very best we hope for is - on average - to
|
|
double Berkshire's per-share intrinsic value every five years, and
|
|
we may well fall far short of that goal.
|
|
|
|
In the end, Charlie and I do not care whether our shareholders
|
|
own Berkshire in large or small amounts. What we wish for are
|
|
shareholders of any size who are knowledgeable about our
|
|
operations, share our objectives and long-term perspective, and are
|
|
aware of our limitations, most particularly those imposed by our
|
|
large capital base.
|
|
|
|
The unit trusts that have recently surfaced fly in the face of
|
|
these goals. They would be sold by brokers working for big
|
|
commissions, would impose other burdensome costs on their
|
|
shareholders, and would be marketed en masse to unsophisticated
|
|
buyers, apt to be seduced by our past record and beguiled by the
|
|
publicity Berkshire and I have received in recent years. The sure
|
|
outcome: a multitude of investors destined to be disappointed.
|
|
|
|
Through our creation of the B stock - a low-denomination
|
|
product far superior to Berkshire-only trusts - we hope to make the
|
|
clones unmerchandisable.
|
|
|
|
But both present and prospective Berkshire shareholders should
|
|
pay special attention to one point: Though the per-share intrinsic
|
|
value of our stock has grown at an excellent rate during the past
|
|
five years, its market price has grown still faster. The stock, in
|
|
other words, has outperformed the business.
|
|
|
|
That kind of market overperformance cannot persist indefinitely,
|
|
neither for Berkshire nor any other stock. Inevitably, there
|
|
will be periods of underperformance as well. The price
|
|
volatility that results, though endemic to public markets, is
|
|
not to our liking. What we would prefer instead is to have the
|
|
market price of Berkshire precisely track its intrinsic value.
|
|
Were the stock to do that, every shareholder would benefit during
|
|
his period of ownership in exact proportion to the progress
|
|
Berkshire itself made in the period.
|
|
|
|
Obviously, the market behavior of Berkshire's stock will never
|
|
conform to this ideal. But we will come closer to this goal than
|
|
we would otherwise if our present and prospective shareholders are
|
|
informed, business-oriented and not exposed to high-commission
|
|
salesmanship when making their investment decisions. To that end,
|
|
we are better off if we can blunt the merchandising efforts of the
|
|
unit trusts - and that is the reason we are creating the B stock.
|
|
|
|
We look forward to answering your questions about the
|
|
recapitalization at the Annual Meeting.
|
|
|
|
Miscellaneous
|
|
|
|
Berkshire isn't the only American corporation utilizing the
|
|
new, exciting ABWA strategy. At about 1:15 p.m. on July 14, 1995,
|
|
Michael Eisner, CEO of The Walt Disney Company, was walking up
|
|
Wildflower Lane in Sun Valley. At the same time, I was leaving a
|
|
lunch at Herbert Allen's home on that street to meet Tom Murphy,
|
|
CEO of Cap Cities/ABC, for a golf game.
|
|
|
|
That morning, speaking to a large group of executives and
|
|
money managers assembled by Allen's investment bank, Michael had
|
|
made a brilliant presentation about Disney, and upon seeing him, I
|
|
offered my congratulations. We chatted briefly - and the subject
|
|
of a possible combination of Disney and Cap Cities came up. This
|
|
wasn't the first time a merger had been discussed, but progress had
|
|
never before been made, in part because Disney wanted to buy with
|
|
cash and Cap Cities desired stock.
|
|
|
|
Michael and I waited a few minutes for Murph to arrive, and in
|
|
the short conversation that ensued, both Michael and Murph
|
|
indicated they might bend on the stock/cash question. Within a few
|
|
weeks, they both did, at which point a contract was put together in
|
|
three very busy days.
|
|
|
|
The Disney/Cap Cities deal makes so much sense that I'm sure
|
|
it would have occurred without that chance encounter in Sun Valley.
|
|
But when I ran into Michael that day on Wildflower Lane, he was
|
|
heading for his plane, so without that accidental meeting the deal
|
|
certainly wouldn't have happened in the time frame it did. I
|
|
believe both Disney and Cap Cities will benefit from the fact that
|
|
we all serendipitously met that day.
|
|
|
|
* * * * * * * * * * * *
|
|
|
|
It's appropriate that I say a few words here about Murph. To
|
|
put it simply, he is as fine an executive as I have ever seen in my
|
|
long exposure to business. Equally important, he possesses human
|
|
qualities every bit the equal of his managerial qualities. He's an
|
|
extraordinary friend, parent, husband and citizen. In those rare
|
|
instances in which Murph's personal interests diverged from those
|
|
of shareholders, he unfailingly favored the owners. When I say
|
|
that I like to be associated with managers whom I would love to
|
|
have as a sibling, in-law, or trustee of my will, Murph is the
|
|
exemplar of what I mean.
|
|
|
|
If Murph should elect to run another business, don't bother to
|
|
study its value - just buy the stock. And don't later be as dumb
|
|
as I was two years ago when I sold one-third of our holdings in Cap
|
|
Cities for $635 million (versus the $1.27 billion those shares
|
|
would bring in the Disney merger).
|
|
|
|
* * * * * * * * * * * *
|
|
|
|
About 96.3% of all eligible shares participated in Berkshire's
|
|
1995 shareholder-designated contributions program. Contributions
|
|
made were $11.6 million and 3,600 charities were recipients. A
|
|
full description of the shareholder-designated contributions
|
|
program appears on pages 54-55.
|
|
|
|
Every year a few shareholders miss out on the program because
|
|
they don't have their shares registered in their own names on the
|
|
prescribed record date or because they fail to get their
|
|
designation form back to us within the 60-day period allowed. That
|
|
second problem pained me especially this year because two good
|
|
friends with substantial holdings missed the deadline. We had to
|
|
deny their requests to be included because we can't make exceptions
|
|
for some shareholders while refusing to make them for others.
|
|
|
|
To participate in future programs, you must own Class A shares
|
|
that are registered in the name of the actual owner, not the
|
|
nominee name of a broker, bank or depository. Shares not so
|
|
registered on August 31, 1996, will be ineligible for the 1996
|
|
program. When you get the form, return it promptly so that it does
|
|
not get put aside or forgotten.
|
|
|
|
* * * * * * * * * * * *
|
|
|
|
|
|
When it comes to our Annual Meetings, Charlie and I are
|
|
managerial oddballs: We thoroughly enjoy the event. So come join
|
|
us on Monday, May 6. At Berkshire, we have no investor relations
|
|
department and don't use financial analysts as a channel for
|
|
disseminating information, earnings "guidance," or the like.
|
|
Instead, we prefer direct manager-to-owner communication and
|
|
believe that the Annual Meeting is the ideal place for this
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interchange of ideas. Talking to you there is efficient for us and
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also democratic in that all present simultaneously hear what we
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have to say.
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Last year, for the first time, we had the Annual Meeting at
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the Holiday Convention Centre and the logistics seemed to work.
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The ballroom there was filled with about 3,200 people, and we had a
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video feed into a second room holding another 800 people. Seating
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in the main room was a little tight, so this year we will probably
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configure it to hold 3,000. This year we will also have two rooms
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for the overflow.
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All in all, we will be able to handle 5,000 shareholders. The
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meeting will start at 9:30 a.m., but be warned that last year the
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main ballroom was filled shortly after 8:00 a.m.
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Shareholders from 49 states attended our 1995 meeting - where
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were you, Vermont? - and a number of foreign countries, including
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Australia, Sweden and Germany, were represented. As always, the
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meeting attracted shareholders who were interested in Berkshire's
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business - as contrasted to shareholders who are primarily
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interested in themselves - and the questions were all good.
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Charlie and I ate lunch on stage and answered questions for about
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five hours.
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We feel that if owners come from all over the world, we should
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try to make sure they have an opportunity to ask their questions.
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Most shareholders leave about noon, but a thousand or so hardcore
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types usually stay to see whether we will drop. Charlie and I are
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in training to last at least five hours again this year.
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We will have our usual array of Berkshire products at the
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meeting and this year will add a sales representative from GEICO.
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At the 1995 meeting, we sold 747 pounds of candy, 759 pairs of
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shoes, and over $17,500 of World Books and related publications.
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In a move that might have been dangerous had our stock been weak,
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we added knives last year from our Quikut subsidiary and sold 400
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sets of these. (We draw the line at soft fruit, however.) All of
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these goods will again be available this year. We don't consider a
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cultural event complete unless a little business is mixed in.
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Because we expect a large crowd for the meeting, we recommend
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that you promptly get both plane and hotel reservations. Those of
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you who like to be downtown (about six miles from the Centre) may
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wish to stay at the Radisson Redick Tower, a small (88 rooms) but
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nice hotel, or at the much larger Red Lion Hotel a few blocks away.
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In the vicinity of the Centre are the Holiday Inn (403 rooms),
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Homewood Suites (118 rooms) and Hampton Inn (136 rooms). Another
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recommended spot is the Marriott, whose west Omaha location is
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about 100 yards from Borsheim's and a ten-minute drive from the
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Centre. There will be buses at the Marriott that will leave at
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7:30, 8:00 and 8:30 for the meeting and return after it ends.
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An attachment to our proxy material explains how you can
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obtain the card you will need for admission to the meeting. A
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good-sized parking area is available at the Centre, while those who
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stay at the Holiday Inn, Homewood Suites and Hampton Inn will be
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able to walk to the meeting. As usual, we will have buses to take
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you to the Nebraska Furniture Mart and Borsheim's after the meeting
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and to take you from there to hotels or the airport later.
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NFM's main store, on its 64-acre site about two miles north of
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the Centre, is open from 10 a.m. to 9 p.m. on weekdays, 10 a.m. to
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6 p.m. on Saturdays, and noon to 6 p.m. on Sundays. Rose Blumkin -
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"Mrs. B" - is now 102, but will be hard at work in Mrs. B's
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Warehouse. She was honored in November at the opening of The Rose,
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a classic downtown theater of the 20's that has been magnificently
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restored, but that would have been demolished had she not saved it.
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Ask her to tell you the story.
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Borsheim's normally is closed on Sunday but will be open for
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shareholders and their guests from 10 a.m. to 6 p.m. on May 5th.
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Additionally, we will have a special opening for shareholders on
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Saturday, the 4th, from 6 p.m. to 9 p.m. Last year, on
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Shareholders Day, we wrote 1,733 tickets in the six hours we were
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open - which is a sale every 13 seconds. Remember, though, that
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records are made to be broken.
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At Borsheim's, we will also have the world's largest faceted
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diamond on display. Two years in the cutting, this inconspicuous
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bauble is 545 carats in size. Please inspect this stone and let it
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guide you in determining what size gem is appropriate for the one
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you love.
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On Saturday evening, May 4, there will be a baseball game at
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Rosenblatt Stadium between the Omaha Royals and the Louisville
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Redbirds. I expect to make the opening pitch - owning a quarter of
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the team assures me of one start per year - but our manager, Mike
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Jirschele, will probably make his usual mistake and yank me
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immediately after. About 1,700 shareholders attended last year's
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game. Unfortunately, we had a rain-out, which greatly disappointed
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the many scouts in the stands. But the smart ones will be back
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this year, and I plan to show them my best stuff.
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Our proxy statement will include information about obtaining
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tickets to the game. We will also offer an information packet this
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year listing restaurants that will be open on Sunday night and
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describing various things that you can do in Omaha on the weekend.
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For years, I've unsuccessfully tried to get my grade school
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classmate, "Pal" Gorat, to open his steakhouse for business on the
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Sunday evening preceding the meeting. But this year he's relented.
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Gorat's is a family-owned enterprise that has thrived for 52
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years, and if you like steaks, you'll love this place. I've told
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Pal he will get a good crowd, so call Gorat's at 402-551-3733 for a
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reservation. You'll spot me there - I'll be the one eating the
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rare T-bone with a double order of hash browns.
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Warren E. Buffett
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March 1, 1996 Chairman of the Board |