1990 let Nelson Mandela once again greet the world. Saddam decided he wanted to know his Kuwaiti neighbors better. And over in Germany, Helmut Kohl was elected Chancellor in the first free election of a single, unified Germany since 1932. Over at 11 Wall Street, the S&P 500 entered the year near 360 and departed near 330.
At Berkshire, net worth was up by $362 million, or 7.3%. Since 1964, per-share book value has grown from $19.46 to $4,612.06, or at a rate of 23.2% compounded annually. Total after-tax earnings were down to $394.1 million from $447.5 million in 1989.
Of course, Chairman Buffett encourages shareholders to concentrate on Berkshire’s growth in intrinsic value, rather than merely its annual earnings. Given Berkshire’s reinsurance operations, annual earnings figures may look terrible in the short-term. Given Berkshire’s large investments in publicly traded companies, its annual earnings understate Berkshire’s fair share.
For those interested in Berkshire’s earnings, Buffett notes that “the best way… is in terms of “look-through” results, calculated as follows: Take $250 million, which is roughly our share of the 1990 operating earnings retained by our investees; subtract $30 million, for the incremental taxes we would have owed had that $250 million been paid to us in dividends; and add the remainder, $220 million, to our reported operating earnings of $371 million. Thus our 1990 “look-through earnings” were about $590 million.” Ultimately Berkshire aims to grow look-through earnings at about 15% annually, and will do so without leverage—with nearly all major facilities owned, not leased—and with a bevy of businesses not known for spectacular economics: furniture retailing, candy, vacuum cleaners, and even steel warehousing.
As usual, Buffett briefly surveys Berkshire’s wholly-owned businesses, and two themes consistently emerge—either they have rock-bottom operating costs or monopolistic pricing power. At Borsheim’s, operating costs run about 18% of sales (which includes occupancy and buying costs, which other public companies include in “cost of goods sold”), compared to 40% at the typical competitor. At Nebraska Furniture Mart, operating costs ran 15% in 1990 against about 40% for Levitz, the country’s largest furniture retailer, and 25% for Circuit City Stores, the leading discount retailer of electronics and appliances.
At the Buffalo Evening News, unusual pricing power has generated consistently increasing advertising rates; yet, Buffett is quick to note that in recent years, advertising dollars have grown more slowly, as retailers that do little or no media advertising have gradually taken market share in certain merchandise categories. “As a consequence, advertising dollars are more widely dispersed and the pricing power of ad vendors has diminished.” Today, seventeen years later, we see the effects of this trend in many print and television media businesses; as media channels disperse and increase, advertising venues increase, slowly eroding the pricing power that newspapers and network TV stations previously enjoyed.
In the equity markets, Berkshire spent the year acquiring a large stake in Wells Fargo, the largest permitted without the approval of the Federal Reserve Board. Yet, Buffett notes that “the banking business is no favorite of ours. When assets are twenty times equity – a common ratio in this industry – mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks. Most have resulted from… the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In their lending, many bankers played follow-the-leader with lemming-like zeal; now they are experiencing a lemming-like fate.”
Given the ever-present leverage dynamic of banks, Berkshire will never be interested in merely buying cheaply, for cheap banks will ever be in endless supply. Instead, “our only interest is in buying into well-managed banks at fair prices.” Here though Berkshire hit a home run, acquiring a well-managed bank at an unusually cheap price—a 10% interest for $290 million, “less than five times after-tax earnings, and less than three times pre-tax earnings.” Of course, bank stocks were unusually depressed in 1990, as “chaotic markets” followed the weekly disclosures of continuing losses in the industry; no less than 534 banks failed in 1989.
Yet the pessimism that accompanies dire conditions and exceedingly dire prospects provides pricing anomalies. The long-term investors should think of stock prices like food prices, for “knowing they are forever going to be buyers of food, they welcome falling prices and deplore price increases. (It’s the seller of food who doesn’t like declining prices.)”
At Berkshire, this attitude guides their approach to the stock market; since “we will be buying businesses – or small parts of businesses… as long as I live (and longer, if Berkshire’s directors attend the seances I have scheduled)… declining prices for businesses benefit us, and rising prices hurt us… None of this means, however, that a business or stock is an intelligent purchase simply because it is unpopular; a contrarian approach is just as foolish as a follow-the-crowd strategy… Unfortunately, Bertrand Russell’s observation about life in general applies with unusual force in the financial world: “Most men would rather die than think. Many do.””
Disclosure: I, or persons whose accounts I manage, own shares of Berkshire Hathaway at the time of this writing.
[Also, check out our other posts in our Berkshire Hathaway Letters Series.]