Warren Buffett
1977 Shareholder Letter

This page details the highlights and significant investing points in the Warren Buffett 1977 shareholder letter included in that year's Berkshire Hathaway annual report. The shareholder letter is dated March 14, 1978.

Return on Equity vs. Earnings Per Share Growth

Early on in the Warren Buffett 1977 shareholder letter, Buffett gives a brief explanation of arguably his favorite investing metric - return on equity (ROE) - and why that metric is more accurate than the more popular and more publicized earnings per share (EPS) growth.

He points out that since most companies "customarily add from year to year to their equity base," tracking EPS growth without factoring in how much the equity itself has grown doesn't tell the full story.

As a case in point, he then cites Berkshire's own numbers:

In 1977 our operating earnings on beginning equity capital amounted to 19%, slightly better than last year and above both our own long-term average and that of American industry in aggregate. But, while our operating earnings per share were up 37% from the year before, our beginning capital was up 24%, making the gain in earnings per share considerably less impressive than it might appear at first glance.

Structurally Advantaged Investments

Warren Buffett spends part of his 1977 shareholder letter commenting on the insurance industry in general, and the Berkshire insurance companies in particular. He notes that the pendulum swings both ways when it comes to favorable and unfavorable underwriting environments and points out that:

Insurance companies offer standardized policies which can be copied by anyone. Their only products are promises. It is not difficult to be licensed, and rates are an open book. There are no important advantages from trademarks, patents, location, corporate longevity, raw material sources, etc., and very little consumer differentiation to produce insulation from competition.

But still, what made Berkshire Hathaway what it is today was all that free cash flow (primarily from the insurance companies in the early years) that Warren Buffett was then able to redeploy and invest into other high free cash flow businesses.

And he makes an observation that is classically Buffett, on the surface seemingly simple, but at heart a very profound principle:

It is comforting to be in a business where some mistakes can be made and yet a quite satisfactory overall performance can be achieved. In a sense, this is the opposite case from our textile business where even very good management probably can average only modest results. One of the lessons your management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds.

He makes a critical point that every long term investor should really take the time to appreciate and absorb. This goes to the heart of my constant harping on the importance of investing in only high quality companies.

[And I also think it's this inherrent tailwind effect that explains why the options-oriented long term investing approach I use has been so effective.]

Buying Shares vs. Acquiring Companies

One of the more fascinating sections in the Warren Buffett 1977 shareholder letter is the part where Buffett discusses the advantages of buying shares in a company over acquiring a company outright.

It's interesting because where Berkshire and Buffett are today is 180 degrees from where they were in 1977. Today, Berkshire is so large and produces so much free cash flow that only the acquisition of reasonably large businesses in their entirety is enough to make a measurable impact on Berkshire's operational performance.

But back in 1977, Berkshire was a much smaller company, and in his 1977 letter, Buffett noted what he considered to be a big advantage of purchasing shares in a company (i.e. partial ownership) over the full acquisition of a company:

Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies. Consequently, bargains in business ownership, which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership. When prices are appropriate, we are willing to take very large positions in selected companies, not with any intention of taking control and not foreseeing sell-out or merger, but with the expectation that excellent business results by corporations will translate over the long term into correspondingly excellent market value and dividend results for owners, minority as well as majority.

Buffett's Humor in the 1977 Shareholder Letter

Buffett's wit and humor is second only to his ability to build long term wealth. Here's an example from the Warren Buffett 1977 shareholder letter:

The textile business again had a very poor year in 1977. We have mistakenly predicted better results in each of the last two years. This may say something about our forecasting abilities, the nature of the textile industry, or both.

Tweet

Follow @LeveragedInvest

Download for Free