Chairman's letter 1987
Severe change and exceptional returns usually don't mix. Most investors, of course, behave as if just
the opposite were true. That is, they usually confer the highest price-earnings ratios on exotic-sounding businesses that hold out the promise of feverish change. That prospect lets investors fantasize about future profitability rather than face today's business realities.
The best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago
Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a
fortress-like business franchise. Such a franchise is usually the key to sustained high returns.
That makes no sense to us. We neither understand the adding of unneeded people or activities because profits are booming, nor the cutting of essential people or activities because profitability is shrinking. That kind of yo-yo approach is neither business-like nor humane
The insurance industry is cursed with a set of dismal economic characteristics that make for a poor long-term outlook: hundreds of competitors, ease of entry, and a product that cannot be differentiated in any meaningful way. In such a commodity-like business, only a very low-cost operator or someone operating in a protected, and usually small, niche can sustain high profitability levels.
When shortages exist, however, even commodity businesses flourish.
Three conditions that prevail in insurance, but not in most businesses, allow us our flexibility. First, market share is not an important determinant of profitability: In this business, in contrast to the newspaper or grocery businesses, the economic rule is not survival of the fattest. Second, in many sectors of insurance, including most of those in which we operate, distribution channels are not proprietary and can be easily entered: Small volume this year does not preclude huge volume next year. Third, idle capacity - which in this industry largely
means people - does not result in intolerable costs. In a way that industries such as printing or steel cannot, we can operate at quarter-speed much of the time and still enjoy long-term prosperity.
We look at the economic prospects of the business, the people in charge of running it, and the price we
must pay. We do not have in mind any time or price for sale. Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate. When investing, we view ourselves as business analysts - not as market analysts, not as macroeconomic analysts,
and not even as security analysts.
Unlike many in the business world, we prefer to finance in anticipation of need rather than in reaction to it. A business obtains the best financial results possible by managing both sides of its balance sheet well. This means obtaining the highest-possible return on assets and the lowest-possible cost on liabilities. It would be convenient if opportunities for intelligent action on both fronts coincided. However, reason tells us that just the opposite is likely to be the case: Tight money conditions, which translate into high costs for liabilities, will create the best opportunities for acquisitions, and cheap money will cause assets to be bid to the sky. Our conclusion: Action on the liability side should sometimes be taken independent of any action on the asset side.
Chairman letters 1988
If
voters insist that auto insurance be priced below cost,
it eventually must be sold by government. Stockholders can
subsidize policyholders for a short period, but only taxpayers
can subsidize them over the long term
To evaluate arbitrage situations you must answer four questions: (1) How likely is it that the promised event will indeed occur? (2) How long will your money be tied up? (3) What chance is there that something still better will transpire - a competing takeover bid, for example? and (4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?
Chairman letters 1989
First, data from the past were analyzed and then used to set new "corrected" rates, which were subsequently put into effect by virtually all insurers. Second, the fact that almost all policies were then issued for a one-to three-year term - which meant that it took a considerable time for mispriced policies to expire - delayed the impact of new rates on revenues. These two lagged responses made
combined ratios behave much like alternating current. Meanwhile, the absence of significant price competition guaranteed that industry profits, averaged out over the cycle, would be satisfactory.
Good profits will be realized only when there is a shortage of capacity.
we simply don't care what
earnings we report quarterly, or even annually, just as long as
the decisions leading to those earnings (or losses) were reached
intelligently.
Arbitrage positions are a substitute for short-term cash
equivalents
To these issuers, zero (or
PIK) bonds offer one overwhelming advantage: It is impossible to
default on a promise to pay nothing
Time
is the friend of the wonderful business, the enemy of the
mediocre.
Chairman letters 1990
The reason media businesses have been so outstanding in the past was not
physical growth, but rather the unusual pricing power that most participants
wielded. Now, however, advertising dollars are growing slowly. In addition,
retailers that do little or no media advertising (though they sometimes use the
Postal Service) have gradually taken market share in certain merchandise
categories. Most important of all, the number of both print and electronic
advertising channels has substantially increased. As a consequence, advertising
dollars are more widely dispersed and the pricing power of ad vendors has
diminished. These circumstances materially reduce the intrinsic value of our
major media investments and also the value of our operating unit, Buffalo News -
though all remain fine businesses.
"institutional imperative:" the tendency of executives to mindlessly imitate the
behavior of their peers, no matter how foolish it may be to do so,
Even though we had bought some shares at the prices prevailing before the fall,
we welcomed the decline because it allowed us to pick up many more shares at the
new, panic prices.
Investors who expect to be ongoing buyers of investments throughout
their lifetimes should adopt a similar attitude toward market fluctuations
The most common cause of low prices is pessimism - some times pervasive, some
times specific to a company or industry. We
want to do business in such
an environment, not because we like pessimism but because we like the prices it
produces.
It's optimism that is the enemy of the rational buy
Chairman letters 1991
An
economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation.
The existence of all three conditions will be demonstrated by a company's ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise's profitability, but they cannot inflict mortal damage.
In contrast, "
a business" earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight. Tightness in supply usually does not last long. With
superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike
a franchise, can be killed by poor management
