Discover the insights from Warren Buffett’s 1977 annual shareholder letter, where he shares timeless principles of value investing. Uncover key strategies and lessons that can enhance your value investing approach today!
Perhaps no other writings by any investor are as eagerly anticipated or analyzed as Warren Buffett’s annual letters to Berkshire Hathaway shareholders. Just as important as annual texts of this sort have become, the 1977 letter shines with much insight regarding Buffett’s investment philosophy, business acumen, and long-term strategic thinking. The analysis of this seminal document can offer some valuable lessons for investors and business leaders.
Table of Contents
The True Measure of Corporate Performance
Buffett prefaces the subject, by challenging conventional wisdom in the reporting of earnings. While many companies have been trumpeting “record earnings” as their earnings per-share continue to rise, Buffett argues that the same measure is often misleading. Buffett argues that a better measure of managerial economic performance is “Return on Equity Capital.”
In 1977, Berkshire Hathaway achieved a 19% return on its starting equity capital, significantly exceeding both its own long-term average and the overall performance of American industry. Once more, he emphasis on return on equity, underscores efficient capital allocation and his success at generating superior returns without either excessive leverage or capital input.
What we need to learn: We need to shift focus beyond headline earnings numbers to a company’s ability to generate profits from its equity base.
The Textile Business: A Case Study of Strategic Choice
The most fascinating part of the 1977 letter is the openness in which Buffett discusses Berkshire’s textile business, which he describes as underperformer with long-term prospects that were “at best suspect.” He gives below 3 reasons for a business to retain:
- Employment-related and social considerations
- Management’s cooperative work and previous investment
- Chances of reasonable future payback
This letter can be used to view corporate decisions from a financial lens while keeping in mind other considerations such as ethics and strategic value. It also marks the long-term thinking of Buffett and his gamble on companies in times of peak probability of being rescued.
Business decisions cannot be considered purely, with the intent of short-run profit generation. Other parameters, also such as social and strategic value need to be taken into consideration.
Insurance Operations: The Growth Engine of Berkshire
The insurance operations of Berkshire, form one of the best examples of identifying and nurturing the next big business. Buffett exhaustively outlines the phenomenal growth, his insurance business had undergone, from just $22 million in premium volume back in 1967 to $151 million in 1977.
A few salient points emerge from this part:
- The strength of strategic acquisitions & internal growth.
- The importance of good management in the insurance business.
- The cycle of insurance underwriting profits.
- The brilliance of “float” in the insurance business model.
Buffett’s exposition for these ideas gives readers a penetrating glimpse into the insurance business as well as Berkshire’s competitive advantage within that business.
There always exists a business that have sustainable competitive advantages and very good management, such that long-term results are likely to be extraordinary.
Investment Philosophy: The Art of Value Investing
Perhaps the most useful part of the letter is Buffett’s articulation of his investment philosophy. He describes four fundamental selection criteria for marketable equity securities:
- Businesses that have a good understanding model
- Long term prospects are favorable
- Management is honest and capable
- Price is attractive
He further drives home that this is not unlike the way he would approach evaluating a business as a whole to invest. This mentality-the thinking of buying stocks as a partial buy of a business itself, rather than just some ticker symbol-is a cornerstone of value investing.
In addition, Buffett explains his counterintuitive view on market volatility. Instead of fearing losses in the markets, he welcomes low prices as opportunities to buy more of a good business at a better price. He takes a long-term, business-centric focus that significantly contrasts with the short-term trading mentality that dominates so many investment circles.
What we can learn: The businessperson mindset is required when investing, which is to look at the value investing behind companies and not the short-term movement of the market. Where value investing always prevails!
Blue Chip Stamps & See’s Candies: Effective Management
The letter contains news about Blue Chip Stamps and its subsidiary, See’s Candies. The performance of See’s Candies, alone, is illustrative of the power of a good brand and capable management in building value. Since being purchased by Harvey’s in 1972, See’s had expanded pre-tax operating earnings from $4.2 million to $12.6 million on very little added capital investment.
This example demonstrates that Buffett can buy great businesses and, not least, keep great managers free to operate autonomously.
An excellent business acquired at the appropriate price with smart managers left to themselves to manage their businesses can turn out to be extremely profitable in the long term.
Value investing and more…
The shareholder letter of Warren Buffett in 1977 is treasure trove of investment and business wisdom. It is insight-providing, today with all the depth that it yielded decades ago.
In return on equity and long-term thinking, capital allocation insights and value investments, the letter provides a framework for thoughtful, principled investing and business management.
In the midst of today’s shocking economic curveballs, the principles in this letter remain as timeless as ever for the entrepreneur or investor looking to create enduring value in the business/investing world.
Stay tuned for the continuation of the next analysis, where we will dive deep into every annual letter, which unfolds how Buffett’s thinking in the following years evolved and how his fundamental principles stood the test of time. Following posts will eventually get much better!
Until then share your thoughts in comments because as usual it is free!
