Warren Buffett’s Letter – 1978
Dec 4th, 2005 by Martin Lee
The letter started with some notes about accounting. When a subsidiary of a company exceeds a certain percentage, it’s sales, expenses, receivables, inventories, debt, etc has to be fully consolidated into the company’s account.
Such a grouping of Balance Sheet and Earnings items – some wholly owned, some partly owned – is actually quite useless as it contains figures from many diverse businesses and does not enable investors to evaluate the performance of the individual businesses.
Thankfully, Berkshire still provides separate financial information and commentary on the various segments of the business.
There is a reminder that while capital gains or losses should not be used to evaluate the performance of a company over a single year, they are still an important component over the long term. It is also furtile to try to predict short term stock price movements.
The textiles continued to underperform. This only helped to reinforce the fact that producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.
Back to the criteria for buying over businesses (as stated in the 1977 letter). It is often possible to find a few businesses fulfilling (1), (2) and (3), but (4) often prevents action.
Nevertheless, the stock market still offers an opportunity to obtain portions of outstanding businesses at prices that might be dramatically cheaper than the whole businesses bought over on negotiated sales.
If you were a net buyer of securities, would you prefer that prices go up or stay low? Many people get this part wrong.
A last note about retained earnings. If a company can utilize internally those funds at attractive rates, it makes sense for them to keep them. On the other hand, if management has a record of using capital for projects of low profitability; then earnings should be paid out or used to repurchase shares.