Analysis of Buffet’s Letter

Buffet starts the letter by highlighting its economic performance from 1979 to 1980. From the letter, it is clear that the company increased its operating earnings by $5.9 million. However, its return on equity did not record the same positive change as it fell by 0.8%.  The structure of the letter is quite interesting; Buffet starts by highlighting the accounting rules on how organizations that own, manage or invest in other firms should report the earnings from the investment. The letter discusses three types of ownerships; the first one that is highlighted is the more than 50% ownership. The other two ownerships presented in the letter are 20% to 50% and less than 20% categories (Buffett, 1981). In the first ownership, the organization has to include the income and expense revenue in the company’s Consolidated Statement of Earnings. The companies also need to include the full consolidations of sales and taxes of business holdings.  The second category is different as revenue and expenses are not listed in the report. Rather it includes the proportional share of total income. The third category the companies only include the dividends received from the holdings.

Nevertheless, the ownership of Berkshire Hathaway does not determine its retained earnings; instead what is important is their usage and level of earnings that is brought about by their usage. According to Buffet, the actor during the entire process does not matter rather what is important is the act. In this case, he does not care if the returned earnings are included on the balance sheet or not.  He also maintains that it is important for any company to make sound investment decisions (Buffett, 1981). However, he argues that another usage of the retained earning can be the repurchase of the own shares.  Concerning the long-term Corporate Results, it appears that the organization has made various mistakes. However, this has not stopped it from achieving its goals. Berkshire Hathaway has come up with a policy that has enabled it to survive despite the mistakes. According to the letter, Buffet is optimistic that its investors will continue making massive investments. The approach will mean that the organization’s long-term returns will continue recording positive growth.

Additionally, Buffet argues that reported earnings cannot determine the performance of the business owners. Instead, he maintains that the firm owners should focus on the gains in purchasing power when determining their performance. Moreover, he argues that inflation generates a tax on capital. Therefore, the double-digit inflation rate makes most business investment ill-advised. He adds that the Return on Equity has drastically increased.  Buffet appears to put emphasis on the fund manager and investor relationship. According to him, excellent fund managers are important to investors. Nevertheless, he argues that organizations with good economics cannot be affected by poor management. Therefore, an investor should not be afraid of investing in it (Buffett, 1981). According to Buffet such organizations can have pricing power that can assist them in keeping up with the inflation and generate abundant free cash flow. However, this does not mean that good fund managers are not important for the investors. Excellent fund managers are important as they make right decisions for the business, which on the other hand are important for the investors. It is significant for investors to find an investment with an excellent management as well as economics.  He also mentions that investors can recognize a good manager when there is a momentary panic or setback.

Buffet highlights the investment approach taken by Berkshires insurance organizations. It appears that the investment decisions have been productive to the organization. Although at times they may have made investment mistakes, it is clear that the organization had its way of getting over their bad choices. The companies only include a small part of their earnings in dividends. Berkshire Hathaway only records a part of their current earning power in its current operating earnings. However, Buffet argues that the investors’ profits do not determine the company’s performance. The investment decisions have been productive as the insurance business has grown. The security markets have also had positive opportunities for the organization. The good results have led to the increasing of the yearly operating earnings of the company (Buffett, 1981). Nevertheless, initially, the investment portfolio threatened the firm’s operations. For instance, the company has made huge investment decisions that have had minimal returns. In some instance, they had invested 100% which they lacked control of their disposition. According to the letter the company control was only theoretical. The company was required to reinvest its earnings so as to save the situation.

However, this never appeared to work as the reinvested earnings did not show any signs of gaining for the organization. Other investment decisions have been effective to the organization.  In some instances, the firm has owned a small part of organizations with great reinvestment possibilities. In this instance, it seems that the investment decisions are important, and they do not depend on the ownership. Rather the best investment decision is measured by the company’s reinvestment possibilities (Buffett, 1981). If a company owns a company with high investment opportunities, they are more likely to generate significant earnings. In this case, it appears that some of the investment decisions made by the company were good. According to Buffet, the company’s value is not affected by the inclusion or non-inclusion. He argues that not many organizations have been able to outrun inflation. Although Berkshire Hathaway has done well in increasing its book value per share, it is one of those organizations that have not been successful in outrunning inflation. The management utilizes nonconventional approaches to evaluating the company’s holdings in other firms. The approach has seen its book value increasing by 20.5% annually.

However, Buffet has not entirely explained the fund manager and investor relationship management. While explaining about GEICO, the letter explains about the organization’s 33% stake in the company. Initially, GEICO was faced with new insurance laws that almost lead it to bankruptcy. The company had to pay for accident damage that it was not involved in plus it was confronted with excessively broad expansion. Nevertheless, the company was in a good position due to its low-cost insurance and invaluable market position. The two remained intact which saved the company from its bankruptcy (Buffett, 1981). According to Buffet, its new management also helped the company as it was able to save the highly undervalued equity. It is also obvious from the report that Berkshire only received $3million in reportable dividends.

 On the other hand, the company’s stakes were valued at $20million, which means that GEICO managed retained $17 million. In this case, it is important for the company to look beyond the numbers. Rather than offering the figures, it would have been important for Buffet to highlight how the fund managers are handling the investors. At times it is good for the fund manager to revise their approaches so as they can accommodate the changing priorities of the investors. The company has to come up with investor-friendly policies, especially during a crisis. Buffet maintains that the best time for investors to choose a business to invest in is when there is a temporary crisis (Buffett, 1981). In this case, have investors friendly policies during such times would be helpful to the fund manager and the entire company. It is would also have been important if Buffet had included information concerning the creation of a strong brand. For any fund manager to survive they need to have a brand that is famous for its good performance. An excellent brand assists the fund managers in building a long-lasting business. It is normal for a fund manager to experience good and bad performance, however, it needs to create trust and exclusivity so that to survive the years.

Buffet uses tables to highlight the total earnings from total earnings of the different business sectors. The table acts as a good way of communicating information, and it is easy to analyze it. Buffet also uses the table as it offers precise values from different entities. It would be easy for any person to have a clear understanding of the data using the information on the table. It is also easy to compare the data. Using the tables, it is also easy for Buffet to show the reader how he has calculated the common stocks. Moreover, a reader can view how the company’s sources of basic earning power are distributed. A person would not understand the distribution of the different entities. Buffet offers an example of Kaiser Aluminum and Alcoa, which shows that total earnings of the two organizations, is about 13% million (Buffett, 1981). It appears that the company is doing well in the Aluminum business than any other entity. It also appears that in future the company’s decisions will most likely affect the performance of the Aluminum business. Buffet then goes ahead to offer an explanation of every entity which further assists a reader to have an understanding of their performance.

Buffet provides information concerning his investment policy. He took a risk and borrowed money during a double-digit inflation which although it seemed like a risky approach it offered the organization financial advantage. The falling fund bonds are offered to holders with a possibility that the issuer will make payments to a custodial account in a periodic manner. The account is important as the money would be utilized to reimburse the holders when they mature (Buffett, 1981). Buffet’s approach that after borrowing the money he was not expected to pay it immediately. Rather he was able to generate money that exceeded the interest payment on his loan. His investment decisions meant that he would make more money for the organization. It is also apparent that he was not in a hurry to make investment decisions. According to Buffet, a company with good economics would be ideal for investment as it can survive a bad period. He continues to maintain that good management is important as the investors can be assured that their assets are well managed.  

References

Buffett, W. E. (1981, February 27). BERKSHIRE HATHAWAY INC. Retrieved September 05,

2016.

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