Thư Buffett Partnership năm 1964

July 8, 1964

July 8, 1964

First Half Performance

The whole family is leaving for California on June 23rd so I am fudging a bit on this report and writing it June 18th. However, for those of you who set your watches by the receipt of our letters. I will maintain our usual chronological symmetry in reporting, leaving a few blanks which Bill will fill in after the final June 30th figures are available.

During the first half of 1964 the Dow-Jones Industrial Average (hereinafter called the “DOW”) advanced from 762.95 to 831.50. If one had owned the Dow during this period, dividends of approximately 14.40 would have been received, bringing the overall return from the Dow during the first half to plus 10.0%. As I write this on June 18th, it appears that our results will differ only insignificantly from those of the Dow. I would feel much better reporting to you that the Dow had broken even, and we had been plus 5%, or better still, that the Dow had been minus 10%, and we had broken even. I have always pointed out, however, that gaining an edge on the Dow is more difficult for us in advancing markets than in static or declining ones.

To bring the record up to date, the following summarizes the performance of the Dow, the performance of the Partnership before allocation to the general partner and the limited partners' results:

          Year               Overall Results From       Partnership Results (2)         Limited Partners’
                                   Dow (1)                                                 Results (3)
           1957                      -8.4%                        10.4%                       9.3%
           1958                     38.5%                         40.9%                      32.2%
           1959                     20.0%                         25.9%                      20.9%
           1960                      -6.2%                        22.8%                      18.6%
           1961                     22.4%                         45.9%                      35.9%
           1962                      -7.6%                        13.9%                      11.9%
           1963                     20.6%                         38.7%                      30.5%
      1st half 1964                 10.9%                         12.0%                      10.5%

  Cumulative results                 116.1%                      521.0%                       354.4%
 Annual compounded                    10.8%                       27.6%                        22.2%
        rate

(See next page for footnotes to table.)

Footnotes to preceding table:

(1) Based on yearly changes in the value of the Dow plus dividends that would have been received through ownership of the Dow during that year. The table includes all complete years of partnership activity.

(2) For 1957-61 consists of combined results of all predecessor limited partnerships operating throughout the entire year after all expenses but before distributions to partners or allocations to the general partner.

(3) For 1957-61 computed on the basis of the preceding column of partnership results allowing for allocation to the general partner based up on the present partnership agreement, but before monthly withdrawals by limited partners.

Buying activities during the first half were quite satisfactory. This is of particular satisfaction to me since I consider the buying end to be about 90% of this business. Our General category now includes three companies where B.P.L. is the largest single stockholder. These stocks have been bought and are continuing to be bought at prices considerably below their value to a private owner. We have been buying one of these situations for approximately eighteen months and both of the others for about a year. It would not surprise me if we continue to do nothing but patiently buy these securities week after week for at least another year, and perhaps even two years or more.

What we really like to see in situations like the three mentioned above is a condition where the company is making substantial progress in terms of improving earnings, increasing asset values, etc., but where the market price of the stock is doing very little while we continue to acquire it. This doesn't do much for our short-term performance, particularly relative to a rising market, but it is a comfortable and logical producer of longer-term profits. Such activity should usually result in either appreciation of market prices from external factors or the acquisition by us of a controlling position in a business at a bargain price. Either alternative suits me.

It is important to realize, however, that most of our holdings in the General category continue to be securities which we believe to be considerably undervalued, but where there is not the slightest possibility that we could have a controlling position. We expect the market to justify our analyses of such situations in a reasonable period of time, but we do not have the two strings to our bow mentioned in the above paragraph working for us in these securities.

Investment Companies

We regularly compare our results with the two largest open-end investment companies (mutual funds) that follow a policy of being typically 95%-100% invested in common stocks, and the two largest diversified closed-end investment companies. These four companies, Massachusetts Investors Trust, Investors Stock Fund, Tri-Continental Corp., and Lehman Corp., manage over $4 billion and are probably typical of most of the $28 billion investment company industry. Their results are shown below. My opinion is that this performance roughly parallels that of the overwhelming majority of other investment advisory organizations which handle, in aggregate, vastly greater sums.

    Year         Mass. Inv.       Investors     Lehman (2)      Tri-Cont.          Dow           Limited
                  Trust (1)       Stock (1)                         (2)                          Partners
1957            -11.4%          -12.4%          -11.4%         -2.4%           -8.4%           9.3%
1958            42.7%           47.5%           40.8%          33.2%           38.5%           32.2%
1959            9.0%            10.3%           8.1%           8.4%            20.0%           20.9%
1960            -1.0%           -0.6%           2.5%           2.8%            -6.2%           18.6%
1961            25.6%           24.9%           23.6%          22.5%           22.4%           35.9%
1962            -9.8%           -13.4%          -14.4%         -10.0%          -7.6%           11.9%
1963            20.0%           16.5%           23.7%          18.3%           20.6%           30.5%
1st half 1964   11.0%           9.5%            9.6%           8.6%            10.9%           10.5%

Cumulative 105.8%               95.5%           98.2%          105.1%          116.1%          354.4%
Results
Annual     10.1%                9.4%            9.6%           10.1%           10.8%           22.2%
Compounded
Rate

(1) Computed from changes in asset value plus any distributions to holders of record during year.

(2) From 1964 Moody's Bank & Finance Manual for 1957-63. Estimated for first half 1964.

These figures continue to show that the most highly paid and respected investment management has difficulty matching the performance of an unmanaged index of blue chip stocks. The results of these companies in some ways resemble the activity of a duck sitting on a pond. When the water (the market) rises, the duck rises; when it falls, back goes the duck. SPCA or no SPCA, I think the duck can only take the credit (or blame) for his own activities. The rise and fall of the lake is hardly something for him to quack about. The water level has been of great importance to B.P.L’s performance as the table on page one indicates. However, we have also occasionally flapped our wings.

I would like to emphasize that I am not saying that the Dow is the only way of measuring investment performance in common stocks. However, I do say that all investment managements (including self-management) should be subjected to objective tests, and that the standards should be selected a priori rather than conveniently chosen retrospectively.

The management of money is big business. Investment managers place great stress on evaluating company managements in the auto industry, steel industry, chemical industry, etc. These evaluations take enormous amounts of work, are usually delivered with great solemnity, and are devoted to finding out which companies are well managed and which companies have management weaknesses. After devoting strenuous efforts to objectively measuring the managements of portfolio companies, it seems strange indeed that similar examination is not applied to the portfolio managers themselves. We feel it is essential that investors and investment managements establish standards of performance and, regularly and objectively, study their own results just as carefully as they study their investments.

We will regularly follow this policy wherever it may lead. It is perhaps too obvious to say that our policy of measuring performance in no way guarantees good results--it merely guarantees objective evaluation. I want to stress the points mentioned in the "Ground Rules" regarding application of the standard--namely that it should be applied on at least a three-year basis because of the nature of our operation and also that during a speculative boom we may lag the field. However, one thing I can promise you. We started out with a 36-inch yardstick and we'll keep it that way. If we don't measure up, we won't change yardsticks. In my opinion, the entire field of investment management, involving hundreds of billions of dollars, would be more satisfactorily conducted if everyone had a good yardstick for measurement of ability and sensibly applied it. This is regularly done by most people in the conduct of their own business when evaluating markets, people, machines, methods, etc., and money management is the largest business in the world.

Taxes

We entered 1964 with net unrealized gains of $2,991,090 which is all attributable to partners belonging during 1963. Through June 30th we have realized capital gains of $2,826,248.76 (of which 96% are long term) so it appears very likely that at least all the unrealized appreciation attributable to your interest and reported to you in our letter of January 25, 1964, (item 3) will be realized this year. I again want to emphasize that this has nothing to do with how we are doing. It is possible that I could have made the above statement, and the market value of your B.P.L. interest could have shrunk substantially since January 1st, so the fact that we have large realized gains is no cause for exultation. Similarly when our realized gains are very small there is not necessarily any reason to be discouraged. We do not play any games to either accelerate or defer taxes. We make investment decisions based on our evaluation of the most profitable combination of probabilities. If this means paying taxes I'm glad the rates on long-term capital gains are as low as they are.

As previously stated in our most recent tax letter of April 1, 1964 the safe course to follow on interim estimates is to pay the same estimated tax for 1964 as your actual tax was for 1963. There can be no penalties if you follow this procedure.

The tax liability for partners who entered January 1st will, of course, be quite moderate, as it always is in the first year for any partner. This occurs because realized capital gains are first attributed to old partners having an interest in unrealized appreciation. This, again, of course, has nothing to do with economic performance. All limited partners, new and old, (except for Bill Scott, Ruth Scott and Susan Buffett per paragraph five of the Partnership Agreement) end up with exactly the same results. As usual, net ordinary income for all partners is nominal to date.

As in past years, we will have a letter out about November 1st (to partners and those who have indicated an interest, to us by that time in becoming partners) with the amendment to the Partnership Agreement, Commitment Letter for 1965, estimate or the 1964 tax situation, etc. In the meantime, keep Bill busy this summer clearing up anything in this letter that comes out fuzzy.

Cordially,

January 18, 1965

January 18, 1965

Our Performance in 1964

Although we had an overall gain of $4,846,312.37 in 1964, it was not one of our better years as judged by our fundamental yardstick, the Dow-Jones Industrial Average (hereinafter called the "Dow"). The overall result for BPL was plus 27.8% compared to an overall plus 18.7% for the Dow. The overall result for limited partners was plus 22.3%. Both the advantage of 9.1 percentage points on a partnership basis and 3.6 points by the limited partners were the poorest since 1959, which was a year of roughly comparable gains for the Dow.

Nevertheless, I am not depressed. It was a strong year for the general market, and it is always tougher for us to outshine the Dow in such a year. We are certain to have years when the Dow gives us a drubbing and, in some respects, I feel rather fortunate that 1964 wasn't the year. Because of the problems that galloping markets pose for us, a Dow repeat in 1965 of 1964 results would make it most difficult for us to match its performance, let alone surpass it by a decent margin.

To bring the record up to date, the following summarizes the year-by-year performance of the Dow, the performance of the Partnership before allocation to the general partner, and the limited partner's results:

          Year              Overall Results From        Partnership Results (2)        Limited Partners’
                                  Dow (1)                                                 Results (3)
          1957                      -8.4%                        10.4%                       9.3%
          1958                     38.5%                         40.9%                      32.2%
          1959                     20.0%                         25.9%                      20.9%
          1960                      -6.2%                        22.8%                      18.6%
          1961                     22.4%                         45.9%                      35.9%
          1962                      -7.6%                        13.9%                      11.9%
          1963                     20.6%                         38.7%                      30.5%
          1964                     18.7%                         27.8%                      22.3%

(1) Based on yearly changes in the value of the Dow plus dividends that would have been received through ownership of the Dow during that year. The table includes all complete years of partnership activity.

(2) For 1957-61 consists of combined results of all predecessor limited partnerships operating throughout the entire year after all expenses, but before distributions to partners or allocations to the general partner.

(3) For 1957-61 computed on the basis of the preceding column of partnership results allowing for allocation to the general partner based upon the present partnership agreement, but before monthly withdrawals by limited partners.

On a cumulative or compounded basis, the results are:

          Year              Overall Results From          Partnership Results          Limited Partners’
                                     Dow                                                    Results
         1957                       -8.4%                        10.4%                       9.3%
       1957 – 58                   26.9%                         55.6%                      44.5%
    1957 – 59                       52.3%                       95.9%                      74.7%
    1957 – 60                       42.9%                      140.9%                     107.2%
    1957 – 61                       74.9%                      251.0%                     181.6%
    1957 – 62                       61.6%                      299.8%                     215.1%
    1957 – 63                       94.9%                      454.5%                     311.2%
    1957 – 64                      131.3%                      608.7%                     402.9%
Annual Compounded                  11.1%                       27.7%                      22.3%
       Rate

Investment Companies

We regularly compare our results with the two largest open-end investment companies (mutual funds) that follow a policy of being typically 95-100% invested in common stock, and the two largest diversified closed-end investment companies. These four companies, Massachusetts Investors Trust, Investors Stock Fund, Tri-Continental Corporation, and Lehman Corporation, manage about $4.5 billion, are owned by about 550,000 shareholders, and are probably typical of most of the $30 billion investment company industry. My opinion is that their results roughly parallel those of the overwhelming majority of other investment advisory organizations which handle, in aggregate, vastly greater sums.

The purpose of this tabulation, which is shown below, is to illustrate that the Dow is no pushover as an index of investment achievement. The advisory talent managing just the four companies shown commands annual fees of over $8 million and this represents a very small fraction of the professional investment management industry. The public batting average of this highly-paid and widely respected talent indicates performance a shade below that of the Dow, an unmanaged index.

YEARLY RESULTS

   Year         Mass. Inv.      Investors      Lehman (2)       Tri-Cont          Dow          Limited
                Trust (1)       Stock (1)                           (2)                        Partners
    1957         -11.4%          -12.4%          -11.4%           -2.4%          -8.4%           9.3%
    1958          42.7%           47.5%           40.8%           33.2%          38.5%          32.2%
    1959           9.0%           10.3%           8.1%             8.4%          20.0%          20.9%
    1960          -1.0%           -0.6%           2.5%             2.8%          -6.2%          18.6%
    1961          25.6%           24.9%           23.6%           22.5%          22.4%          35.9%
    1962          -9.8%          -13.4%          -14.4%          -10.0%          -7.6%          11.9%
    1963          20.0%           16.5%           23.7%           18.3%          20.6%          30.5%
    1964          15.9%           14.3%           13.6%           12.6%          18.7%          22.3%

(1) Computed from changes in asset value plus any distributions to holders of record during year.

(2) From 1964 Moody's Bank & Finance Manual for 1957-63. Estimated for 1964.

COMPOUNDED

Year             Mass. Inv.      Investors     Lehman (2)       Tri-Cont          Dow          Limited
                 Trust (1)       Stock (1)                         (2)                         Partners
    1957          -11.4%          -12.4%          -11.4%         -2.4%           -8.4%           9.3%
  1957 – 58        26.4%           29.2%           24.7%         30.0%           26.9%          44.5%
  1957 – 59        37.8%           42.5%           34.8%         40.9%           52.3%          74.7%
  1957 – 60        36.4%           41.6%           38.2%         44.8%           42.9%          107.2%
 1957 – 61          71.3%           76.9%           70.8%           77.4%           74.9%         181.6%
 1957 – 62          54.5%           53.2%           46.2%           59.7%           61.6%         215.1%
 1957 – 63          85.4%           78.5%           80.8%           88.9%           94.9%         311.2%
 1957 – 64          114.9%         104.0%          105.4%          112.7%          131.3%         402.9%
  Annual            10.0%           9.3%            9.4%            9.9%           11.1%          22.3%
Compounded
   Rate

The repetition of these tables has caused partners to ask: "Why in the world does this happen to very intelligent managements working with (1) bright, energetic staff people, (2) virtually unlimited resources, (3) the most extensive business contacts, and (4) literally centuries of aggregate investment experience?" (The latter qualification brings to mind the fellow who applied for a job and stated he had twenty years of experience - which was corrected by the former employer to read “one year's experience -twenty times.”)

This question is of enormous importance, and you would expect it to be the subject of considerable study by investment managers and substantial investors. After all, each percentage point on $30 billion is $300 million per year. Curiously enough, there is practically nothing in the literature of Wall Street attracting this problem, and discussion of it is virtually absent at security analyst society meetings, conventions, seminars, etc. My opinion is that the first job of any investment management organization is to analyze its own techniques and results before pronouncing judgment on the managerial abilities and performance of the major corporate entities of the United States.

In the great majority of cases the lack of performance exceeding or even matching an unmanaged index in no way reflects lack of either intellectual capacity or integrity. I think it is much more the product of: (1) group decisions - my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations; (3) an institutional framework whereby average is "safe" and the personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4) an adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.

Perhaps the above comments are unjust. Perhaps even our statistical comparisons are unjust. Both our portfolio and method of operation differ substantially from the investment companies in the table. However, I believe both our partners and their stockholders feel their managements are seeking the same goal - the maximum long-term average return on capital obtainable with the minimum risk of permanent loss consistent with a program of continuous investment in equities. Since we should have common goals, and most partners, as an alternative to their interest in BPL, would probably have their funds invested in media producing results comparable with these investment companies, I feel their performance record is meaningful in judging our own results.

There is no question that an important service is provided to investors by investment companies, investment advisors, trust departments, etc. This service revolves around the attainment of adequate diversification, the preservation of a long-term outlook, the ease of handling investment decisions and mechanics, and most importantly, the avoidance of the patently inferior investment techniques which seem to entice some individuals. All but a few of the organizations do not specifically promise to deliver superior investment performance although it is perhaps not unreasonable for the public to draw such an inference from their advertised emphasis on professional management.

One thing I pledge to you as partners - just as I consider the previously stated performance comparison to be meaningful now, so will I in future years, no, matter what tale unfolds. Correspondingly, I ask that you, if you do not feel such a standard to be relevant, register such disagreement now and suggest other standards which can be applied prospectively rather than retrospectively.

One additional thought - I have not included a column in my table for the most widely-used investment advisor in the world - Bell management. People who watch their weight, golf scores, and fuel bills seem to shun quantitative evaluation of their investment management skills although it involves the most important client in the world - themselves. While it may be of academic interest to evaluate the management accomplishments of Massachusetts Investors Trust or Lehman Corporation, it is of enormous dollars-and-cents importance to evaluate objectively the accomplishments of the fellow who is actually handling your money - even if it’s you.

The Question of Conservatism

In looking at the table of investment company performance, the question might be asked: “Yes, but aren't those companies run more conservatively than the Partnership?" If you asked that question of the investment company managements, they, in absolute honesty, would say they were more conservative. If you asked the first hundred security analysts you met, I am sure that a very large majority of them also would answer for the investment companies. I would disagree. I have over 90% of my net worth in BPL, and most of my family have percentages in that area, but of course, that only demonstrates the sincerity of my view - not the validity of it.

It is unquestionably true that the investment companies have their money more conventionally invested than we do. To many people conventionality is indistinguishable from conservatism. In my view, this represents erroneous thinking. Neither a conventional nor an unconventional approach, per se, is conservative.

Truly conservative actions arise from intelligent hypotheses, correct facts and sound reasoning. These qualities may lead to conventional acts, but there have been many times when they have led to unorthodoxy. In some corner of the world they are probably still holding regular meetings of the Flat Earth Society.

We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don't. A public opinion poll is no substitute for thought. When we really sit back with a smile on our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course of action obvious. In that case - whether other conventional or unconventional - whether others agree or disagree - we feel - we are progressing in a conservative manner.

The above may seem highly subjective. It is. You should prefer an objective approach to the question. I do. My suggestion as to one rational way to evaluate the conservativeness of past policies is to study performance in declining markets. We have only three years of declining markets in our table and unfortunately (for purposes of this test only) they were all moderate declines. In all three of these years we achieved appreciably better investment results than any of the more conventional portfolios.

Specifically, if those three years had occurred in sequence, the cumulative results would have been:

Tri-Continental Corp.                                     -9.7%
Dow                                                       -20.6%
Mass. Investors Trust                                     -20.9%
Lehman Corp.                                              -22.3%
Investors Stock Fund                                      -24.6%
Limited Partners                                          +45.0%

We don’t think this comparison is all important, but we do think it has some relevance. We certainly think it makes more sense than saying “We own (regardless of price) A.T. &T., General Electric, IBM and General Motors and are therefore conservative.” In any event, evaluation of the conservatism of any investment program or management (including self-management) should be based upon rational objective standards, and I suggest performance in declining markets to be at least one meaningful test.

The Joys of Compounding

Readers of our early annual letters registered discontent at a mere recital of contemporary investment experience, but instead hungered for the intellectual stimulation that only could be provided by a depth study of investment strategy spanning the centuries. Hence, this section.

Our last two excursions into the mythology of financial expertise have revealed that purportedly shrewd investments by Isabella (backing the voyage of Columbus) and Francis I (original purchase of Mona Lisa) bordered on fiscal lunacy. Apologists for these parties have presented an array of sentimental trivia. Through it all, our compounding tables have not been dented by attack.

Nevertheless, one criticism has stung a bit. The charge has been made that this column has acquired a negative tone with only the financial incompetents of history receiving comment. We have been challenged to record on these pages a story of financial perspicacity which will be a bench mark of brilliance down through the ages.

One story stands out. This, of course, is the saga of trading acumen etched into history by the Manhattan Indians when they unloaded their island to that notorious spendthrift, Peter Minuit in 1626. My understanding is that they received $24 net. For this, Minuit received 22.3 square miles which works out to about 621,688,320 square feet. While on the basis of comparable sales, it is difficult to arrive at a precise appraisal, a $20 per square foot estimate seems reasonable giving a current land value for the island of $12,433,766,400 ($12 1/2 billion). To the novice, perhaps this sounds like a decent deal. However, the Indians have only had to achieve a 6 1/2% return (The tribal mutual fund representative would have promised them this.) to obtain the last laugh on Minuit. At 6 1/2%, $24 becomes $42,105,772,800 ($42 billion) in 338 years, and if they just managed to squeeze out an extra half point to get to 7%, the present value becomes $205 billion.

So much for that.

Some of you may view your investment policies on a shorter term basis. For your convenience, we include our usual table indicating the gains from compounding $100,000 at various rates:

                              4%                     8%                    12%                    16%
10 Years                        $48,024               $115,892               $210,584               $341,143
20 Years                       $119,111               $366,094               $864,627              $1,846,060
30 Years                       $224,337               $906,260              $2,895,970             $8,484,940

This table indicates the financial advantages of:

(1) A long life (in the erudite vocabulary of the financial sophisticate this is referred to as the Methusalah Technique)

(2) A high compound rate

(3) A combination of both (especially recommended by this author)

To be observed are the enormous benefits produced by relatively small gains in the annual earnings rate. This explains our attitude which while hopeful of achieving a striking margin of superiority over average investment results, nevertheless, regards every percentage point of investment return above average as having real meaning.

Our Goal

You will note that there are no columns in the preceding table for the 27.7% average of the Partnership during its eight-year lifespan or the 22.3% average of the limited partners. Such figures are nonsensical for the long term for several reasons: (Don't worry about me "holding back" to substantiate this prophecy.)

(1) Any significant sums compounded at such rates take on national debt proportions at alarming speed.

(2) During our eight-year history a general revaluation of securities has produced average annual rates of overall gain from the whole common stock field which I believe unattainable in future decades. Over a span of 20 or 30 years, I would expect something more like 6% - 7% overall annual gain from the Dow instead of the 11.1% during our brief history. This factor alone would tend to knock 4 points or so off of our annual compounding rate. It would only take a minus 20.5% year in 1965 for the Dow to bring it down to a 7% average figure for the nine years. Such years (or worse) should definitely be expected from time to time by those holding equity investments. If a 20% or 30% drop in the market value of your equity holdings (such as BPL) is going to produce emotional or financial distress, you should simply avoid common stock type investments. In the words of the poet - Harry Truman – “If you can’t stand the heat, stay out of the kitchen. It is preferable, of course, to consider the problem before you enter the “kitchen.”

(3) We do not consider it possible on an extended basis to maintain the 16.6 percentage point advantage over the Dow of the Partnership or the 11.2 percentage point edge enjoyed by the limited partners. We have had eight consecutive years in which our pool of money has out-performed the Dow, although the profit allocation arrangement left the limited partners short of Dow results in one of those years. We are certain to have years (note the plural) when the Partnership results fall short of the Dow despite considerable gnashing of teeth by the general partner (I hope not too much by the limited partners). When that happens our average margin of superiority will drop sharply. I might say that I also think we will continue to have some years of very decent margins in our favor. However, to date we have benefited by the fact that we have not had a really mediocre (or worse) year included in our average, and this obviously cannot be expected to be a permanent experience.

So what can we expect to achieve? Of course, anything I might say is largely guesswork, and my own investment philosophy has developed around the theory that prophecy reveals far more of the frailties of the prophet than it reveals of the future.

Nevertheless, you, as partners, are entitled to know my expectations, tenuous as they may be. I am hopeful that our longer term experience will unfold along the following basis:

(1) An overall gain from the Dow (including dividends, of course) averaging in the area of 7% per annum, exhibiting customarily wide amplitudes in achieving this average -- say, on the order or minus 40% to plus 50% at the extremes with the majority of years in the minus 10% to plus 20% range;

(2) An average advantage of ten percentage points per annum for BPL before allocation to the general partner - again with large amplitudes in the margin from perhaps 10 percentage points worse than the Dow in a bad year to 25 percentage points better when everything clicks; and

(3) The product of these two assumptions gives an average of 17% to BPL or about 14% to limited partners. This figure would vary enormously from year to year; the final amplitudes, of course, depending, on the interplay of the extremes hypothesized in (1) and (2).

I would like to emphasize that the above is conjecture, perhaps heavily influenced by self-interest, ego, etc. Anyone with a sense of financial history knows this sort of guesswork is subject to enormous error. It might better be left out of this letter, but it is a question frequently and legitimately asked by partners. Long-range expectable return is the primary consideration of all of us belonging to BPL, and it is reasonable that I should be put on record, foolish as that may later make me appear. My rather puritanical view is that any investment manager, whether operating as broker, investment counselor, trust department, Investment Company, etc., should be willing to state unequivocally what he is going to attempt to accomplish and how he proposes to measure the extent to which he gets the job done.

Our Method of Operation

In past annual letters I have always utilized three categories to describe investment operations we conduct. I now feel that a four-category division is more appropriate. Partially, the addition of a new section - "Generals Relatively Undervalued" - reflects my further consideration of essential differences that have always existed to a small extent with our "Generals" group. Partially, it reflects the growing importance of what once was a very small sub-category but is now a much more significant part of our total portfolio. This increasing importance has been accompanied by excellent results to date justifying significant time and effort devoted to finding additional opportunities in this area. Finally, it partially reflects the development and implementation of a new and somewhat unique investment technique designed to improve the expectancy and consistency of operations in this category. Therefore, our four present categories are:

1. “Generals -Private Owner Basis” - a category of generally undervalued stocks, determined by quantitative standards, but with considerable attention also paid to the qualitative factor. There is often little or nothing to indicate immediate market improvement. The issues lack glamour or market sponsorship. Their main qualification is a bargain price; that is, an overall valuation of the enterprise substantially below what careful analysis indicates its value to a private owner to be. Again, let me emphasize that while the quantitative comes first and is essential, the qualitative is important. We like good management - we like a decent industry - we like a certain amount of “ferment” in a previously dormant management or stockholder group. But, we demand value.

1. “Thông thường – Góc nhìn chủ sở hữu tư nhân” (Generals - Private Owner Basis) - một nhóm gồm các cổ phiếu nhìn chung bị định giá thấp, được xác định theo các tiêu chuẩn định lượng, nhưng cũng có sự chú ý đáng kể dành cho yếu tố định tính. Thường có rất ít hoặc không có gì cho thấy giá thị trường sẽ cải thiện ngay lập tức. Các chứng khoán này thiếu sự hào nhoáng hay sự hậu thuẫn của thị trường (market sponsorship). Điều kiện chủ yếu của chúng là một mức giá hời; nghĩa là, mức định giá tổng thể của doanh nghiệp thấp hơn đáng kể so với giá trị của doanh nghiệp đối với một chủ sở hữu tư nhân mà phân tích cẩn thận chỉ ra. Một lần nữa, tôi xin nhấn mạnh rằng mặc dù yếu tố định lượng đứng đầu và là thiết yếu, yếu tố định tính vẫn quan trọng. Chúng ta thích ban quản lý giỏi - chúng ta thích một ngành tử tế - chúng ta thích một mức độ “xáo động” nhất định trong một ban quản lý hoặc nhóm cổ đông trước đó vốn im lìm. Nhưng, chúng ta đòi hỏi giá trị.

Many times in this category we have the desirable "two strings to our bow" situation where we should either achieve appreciation of market prices from external factors or from the acquisition of a controlling position in a business at a bargain price. While the former happens in the overwhelming majority of cases, the latter represents an insurance policy most investment operations don't have. We have continued to enlarge the positions in the three companies described in our 1964 midyear report where we are the largest stockholder. All three companies are increasing their fundamental value at a very satisfactory rate, and we are completely passive in two situations and active only on a very minor scale in the third. It is unlikely that we will ever take a really active part in policy-making in any of these three companies, but we stand ready if needed.

2. "Generals -Relatively Undervalued" - this category consists of securities selling at prices relatively cheap compared to securities of the same general quality. We demand substantial discrepancies from current valuation standards, but (usually because of large size) do not feel value to a private owner to be a meaningful concept. It is important in this category, of course, that apples be compared to apples - and not to oranges, and we work hard at achieving that end. In the great majority of cases we simply do not know enough about the industry or company to come to sensible judgments -in that situation we pass.

2. "Thông thường – Bị định giá thấp tương đối" (Generals - Relatively Undervalued) - nhóm này bao gồm các chứng khoán được bán ở mức giá tương đối rẻ so với các chứng khoán có cùng chất lượng chung. Chúng ta đòi hỏi những chênh lệch đáng kể so với các tiêu chuẩn định giá hiện hành, nhưng (thường là do quy mô lớn) không cảm thấy giá trị đối với một chủ sở hữu tư nhân là một khái niệm có ý nghĩa. Dĩ nhiên, trong nhóm này, điều quan trọng là táo phải được so sánh với táo - chứ không phải với cam, và chúng ta nỗ lực hết sức để đạt được mục đích đó. Trong tuyệt đại đa số các trường hợp, chúng ta đơn giản là không hiểu đủ về ngành hoặc công ty để đi đến những nhận định hợp lý - trong tình huống đó, chúng ta bỏ qua.

As mentioned earlier, this new category has been growing and has produced very satisfactory results. We have recently begun to implement a technique, which gives promise of very substantially reducing the risk from an overall change in valuation standards; e.g. I we buy something at 12 times earnings when comparable or poorer quality companies sell at 20 times earnings, but then a major revaluation takes place so the latter only sell at 10 times.

This risk has always bothered us enormously because of the helpless position in which we could be left compared to the "Generals -Private Owner" or "Workouts" types. With this risk diminished, we think this category has a promising future.

3. "Workouts" - these are the securities with a timetable. They arise from corporate activity - sell-outs, mergers, reorganizations, spin-offs, etc. In this category we are not talking about rumors or "inside information" pertaining to such developments, but to publicly announced activities of this sort. We wait until we can read it in the paper. The risk pertains not primarily to general market behavior (although that is sometimes tied in to a degree), but instead to something upsetting the applecart so that the expected development does not materialize. Such killjoys could include anti-trust or other negative government action, stockholder disapproval, withholding of tax rulings, etc. The gross profits in many workouts appear quite small. It's a little like looking for parking meters with some time left on them. However, the predictability coupled with a short holding period produces quite decent average annual rates of return after allowance for the occasional substantial loss. This category produces more steady absolute profits from year to year than generals do. In years of market decline it should usually pile up a big edge for us; during bull markets it will probably be a drag on performance. On a long-term basis, I expect the workouts to achieve the same sort of margin over the Dow attained by generals.

3. "Theo sự kiện" (Workouts) - đây là những chứng khoán có lịch trình thời gian. Chúng phát sinh từ hoạt động doanh nghiệp - các thương vụ bán toàn bộ doanh nghiệp, sáp nhập, tổ chức lại doanh nghiệp (reorganizations), tách công ty (spin-offs), v.v. Trong nhóm này, chúng ta không nói về tin đồn hay "thông tin nội bộ" liên quan đến những diễn biến như vậy, mà về những hoạt động thuộc loại này đã được công bố công khai. Chúng ta chờ cho đến khi có thể đọc được tin đó trên báo. Rủi ro chủ yếu không liên quan đến diễn biến của thị trường chung (dù đôi khi cũng gắn với điều đó ở một mức độ nào đó), mà thay vào đó là việc có điều gì đó làm hỏng chuyện khiến diễn biến được kỳ vọng không thành hiện thực. Những kẻ phá đám như vậy có thể bao gồm hành động chống độc quyền hoặc hành động bất lợi khác của chính phủ, sự phản đối của cổ đông, việc không cấp văn bản xác nhận về thuế (tax rulings), v.v. Mức lãi gộp của thương vụ ở nhiều khoản đầu tư theo sự kiện trông khá nhỏ. Việc này hơi giống như đi tìm những chiếc đồng hồ tính tiền đỗ xe vẫn còn dư chút thời gian. Tuy nhiên, khả năng dự đoán được cùng với thời gian nắm giữ ngắn mang lại tỷ suất sinh lời bình quân hằng năm khá tốt sau khi đã trừ hao cho khoản lỗ lớn thỉnh thoảng xảy ra. Nhóm này tạo ra lợi nhuận tuyệt đối ổn định hơn qua từng năm so với nhóm thông thường. Trong những năm thị trường đi xuống, nhóm này thường được kỳ vọng sẽ tích lũy cho chúng ta một lợi thế lớn; trong thị trường giá lên, nhóm này có lẽ sẽ là lực kéo lùi thành tích. Xét về dài hạn, tôi kỳ vọng các khoản đầu tư theo sự kiện đạt được mức vượt trội so với chỉ số Dow tương tự như mức mà nhóm thông thường đạt được.

4. "Controls" - these are rarities, but when they occur they are likely to be of significant size. Unless we start off with the purchase of a sizable block of stock, controls develop from the general - private owner category. They result from situations where a cheap security does nothing pricewise for such an extended period of time that we are able to buy a significant percentage of the company's stock. At that point we are probably in a position to assume a degree of or perhaps complete control of the company's activities. Whether we become active or remain relatively passive at this point depends upon our assessment of the company's future and the managements capabilities.

4. "Kiểm soát" (Controls) - đây là những trường hợp hiếm hoi, nhưng khi xảy ra thì chúng thường có quy mô đáng kể. Trừ khi chúng ta khởi đầu bằng việc mua một khối cổ phiếu lớn, các khoản đầu tư kiểm soát phát triển từ nhóm thông thường – góc nhìn chủ sở hữu tư nhân. Chúng hình thành từ những tình huống mà một chứng khoán rẻ không có chuyển động gì về giá trong một khoảng thời gian dài đến mức chúng ta có thể mua được một tỷ lệ đáng kể cổ phiếu của công ty. Vào thời điểm đó, có lẽ chúng ta đã ở vị thế có thể nắm một mức độ kiểm soát nào đó, hoặc có thể là toàn bộ quyền kiểm soát, đối với các hoạt động của công ty. Việc chúng ta trở nên chủ động hay vẫn tương đối thụ động vào thời điểm này phụ thuộc vào đánh giá của chúng ta về tương lai của công ty và năng lực của ban quản lý.

We do not want to get active merely for the sake of being active. Everything else being equal, I would much rather let others do the work. However, when an active role is necessary to optimize the employment of capital, you can be sure we will not be standing in the wings.

Active or passive, in a control situation there should be a built-in profit. The sine qua non of this operation is an attractive purchase price. Once control is achieved, the value of our investment is determined by the value of the enterprise, not the oftentimes irrationalities of the market place.

Any of the three situations where we are now the largest stockholders mentioned under Generals - Private Owner could, by virtue of the two-way stretch they possess, turn into controls. That would suit us fine, but it also suits us if they advance in the market to a price more in line with intrinsic value enabling us to sell them, thereby completing a successful generals - private owner operation.

Investment results in the control category have to be measured on the basis of at least several years. Proper buying takes time. If needed, strengthening management, redirecting the utilization of capital, perhaps effecting a satisfactory sale or merger, etc., are also all factors that make this a business to be measured in years rather than months. For this reason, in controls, we are looking for wide margins of profit -if it appears at all close, we quitclaim.

Controls in the buying stage move largely in sympathy with the Dow. In the later stages their behavior is geared more to that of workouts.

You might be interested to know that the buyers of our former control situation, Dempster Mill Manufacturing, seem to be doing very well with it. This fulfills our expectation and is a source of satisfaction. An investment operation that depends on the ultimate buyer making a bum deal (in Wall Street they call this the "Bigger Fool Theory") is tenuous indeed. How much more satisfactory it is to buy at really bargain prices so that only an average disposition brings pleasant results.

As I have mentioned in the past, the division of our portfolio among categories is largely determined by the accident of availability. Therefore, in any given year the mix between generals, workouts, or controls is largely a matter of chance, and this fickle factor will have a great deal to do with our performance relative to the Dow. This is one of many reasons why single year's performance is of minor importance and good or bad, should never be taken too seriously.

To give an example of just how important the accident of division between these categories is, let me cite the example of the past three years. Using an entirely different method of calculation than that used to measure the performance of BPL in entirety, whereby the average monthly investment at market value by category is utilized, borrowed money and office operating expenses excluded, etc., (this gives the most accurate basis for intergroup comparisons but does not reflect overall BPL results) the generals (both present categories combined), workouts, and the Dow, shape up as follows:

          Year                     Generals                    Workouts                       Dow
          1962                      -1.0%                       14.6%                        -8.6%
          1963                      20.5%                       30.6%                        18.4%
          1964                      27.8%                       10.3%                        16.7%

Obviously the workouts (along with controls) saved the day in 1962, and if we had been light in this category that year, our final result would have been much poorer, although still quite respectable considering market conditions during the year. We could just as well have had a much smaller percentage of our portfolio in workouts that year; availability decided it, not any notion on my part as to what the market was going to do. Therefore, it is important to realize that in 1962 we were just plain lucky regarding mix of categories.

In 1963 we had one sensational workout which greatly influenced results, and generals gave a good account of themselves, resulting in a banner year. If workouts had been normal, (say, more like 1962) we would have looked much poorer compared to the Dow. Here it wasn't our mix that did much for us, but rather excellent situations.

Finally, in 1964 workouts were a big drag on performance. This would be normal in any event during a big plus year for the Dow such as 1964, but they were even a greater drag than expected because of mediocre experience. In retrospect it would have been pleasant to have been entirely in generals, but we don’t play the game in retrospect.

I hope the preceding table drives home the point that results in a given year are subject to many variables - some regarding which we have little control or insight. We consider all categories to be good businesses and we are very happy we have several to rely on rather than just one. It makes for more discrimination within each category and reduces the chance we will be put completely out of operation by the elimination of opportunities in a single category.

Taxes

We have had a chorus of groans this year regarding partners' tax liabilities. Of course, we also might have had a few if the tax sheet had gone out blank.

More investment sins are probably committed by otherwise quite intelligent people because of "tax considerations" than from any other cause. One of my friends - a noted West Coast philosopher maintains that a majority of life's errors are caused by forgetting what one is really trying to do. This is certainly the case when an emotionally supercharged element like taxes enters the picture (I have another friend -a noted East Coast philosopher who says it isn't the lack of representation he minds -it's the taxation).

Let's get back to the West Coast. What is one really trying to do in the investment world? Not pay the least taxes, although that may be a factor to be considered in achieving the end. Means and end should not be confused, however, and the end is to come away with the largest after-tax rate of compound. Quite obviously if two courses of action promise equal rates of pre-tax compound and one involves incurring taxes and the other doesn't the latter course is superior. However, we find this is rarely the case.

It is extremely improbable that 20 stocks selected from, say, 3000 choices are going to prove to be the optimum portfolio both now and a year from now at the entirely different prices (both for the selections and the alternatives) prevailing at that later date. If our objective is to produce the maximum after-tax compound rate, we simply have to own the most attractive securities obtainable at current prices, And, with 3,000 rather rapidly shifting variables, this must mean change (hopefully “tax-generating” change).

It is obvious that the performance of a stock last year or last month is no reason, per se, to either own it or to not own it now. It is obvious that an inability to "get even" in a security that has declined is of no importance. It is obvious that the inner warm glow that results from having held a winner last year is of no importance in making a decision as to whether it belongs in an optimum portfolio this year.

If gains are involved, changing portfolios involves paying taxes. Except in very unusual cases (I will readily admit there are some cases), the amount of the tax is of minor importance if the difference in expectable performance is significant. I have never been able to understand why the tax comes as such a body blow to many people since the rate on long-term capital gain is lower than on most lines of endeavor (tax policy indicates digging ditches is regarded as socially less desirable than shuffling stock certificates).

I have a large percentage of pragmatists in the audience so I had better get off that idealistic kick. There are only three ways to avoid ultimately paying the tax: (1) die with the asset - and that's a little too ultimate for me even the zealots would have to view this "cure" with mixed emotions; (2) give the asset away - you certainly don't pay any taxes this way, but of course you don't pay for any groceries, rent, etc., either; and (3) lose back the gain if your mouth waters at this tax-saver, I have to admire you -you certainly have the courage of your convictions.

So it is going to continue to be the policy of BPL to try to maximize investment gains, not minimize taxes. We will do our level best to create the maximum revenue for the Treasury -at the lowest rates the rules will allow.

An interesting sidelight on this whole business of taxes, vis-à-vis investment management, has appeared in the last few years. This has arisen through the creation of so-called "swap funds" which are investment companies created by the exchange of the investment company's shares for general market securities held by potential investors. The dominant sales argument has been the deferment (deferment, when pronounced by an enthusiastic salesman, sometimes comes very close phonetically to elimination) of capital gains taxes while trading a single security for a diversified portfolio. The tax will only finally be paid when the swap fund's shares are redeemed. For the lucky ones, it will be avoided entirely when any of those delightful alternatives mentioned two paragraphs earlier eventuates.

The reasoning implicit in the swapee's action is rather interesting. He obviously doesn't really want to hold what he is holding or he wouldn't jump at the chance to swap it (and pay a fairly healthy commission - usually up to $100,000) for a grab-bag of similar hot potatoes held by other tax-numbed investors. In all fairness, I should point out that after all offerees have submitted their securities for exchange and had a chance to review the proposed portfolio they have a chance to back out but I understand a relatively small proportion do so.

There have been twelve such funds (that I know of) established since origination of the idea in 1960, and several more are currently in the works. The idea is not without appeal since sales totaled well over $600 million. All of the funds retain an investment manager to whom they usually pay 1/2 of 1% of asset value. This investment manager faces an interesting problem; he is paid to manage the fund intelligently (in each of the five largest funds this fee currently ranges from $250,000 to $700,000 per year), but because of the low tax basis inherited from the contributors of securities, virtually his every move creates capital gains tax liabilities. And, of course, he knows that if he incurs such liabilities, he is doing so for people who are probably quite sensitive to taxes or they wouldn't own shares in the swap fund in the first place.

I am putting all of this a bit strongly, and I am sure there are some cases where a swap fund may be the best answer to an individual's combined tax and investment problems. Nevertheless, I feel they offer a very interesting test-tube to measure the ability of some of the most respected investment advisors when they are trying to manage money without paying (significant) taxes.

The three largest swap funds were all organized in 1961, and combined have assets now of about $300 million. One of these, Diversification Fund, reports on a fiscal year basis which makes extraction of relevant data quite difficult for calendar year comparisons. The other two, Federal Street Fund and Westminster Fund (respectively first and third largest in the group) are managed by investment advisors who oversee at least $2 billion of institutional money.

Here's how they shape up for all full years of existence:

        Year                     Federal Street               Westminster                       Dow
        1962                        -19.0%                      -22.5%                         -7.6%
        1963                         17.0%                       18.7%                         20.6%
        1964                         13.8%                       12.3%                         18.7%
 Annual Compounded                   2.6%                        1.1%                           9.8%
        Rate

This is strictly the management record. No allowance has been made for the commission in entering and any taxes paid by the fund on behalf of the shareholders have been added back to performance.

Anyone for taxes?

Miscellaneous

In the December 21st issue of AUTOMOTIVE NEWS it was reported that Ford Motor Co. plans to spend $700 million in 1965 to add 6,742,000 square feet to its facilities throughout the world. Buffett Partnership, Ltd., never far behind, plans to add 227 1/4 square feet to its facilities in the spring of 1965.

Our growth in net assets from $105,100 (there's no prize for guessing who put in the $100) on May 5, 1956 when the first predecessor limited partnership.(Buffett Associates, Ltd. ) was organized, to $26,074,000 on 1/1/65 creates the need for an occasional reorganization in internal routine. Therefore, roughly contemporaneously with the bold move from 682 to 909 ¼ square feet, a highly capable is going to join our organization with responsibility for the administrative (and certain other) functions. This move will particularly serve to free up more of Bill Scott's time for security analysis which is his forte. I’ll have more to report on this in the midyear letter.

Bill (who continues to do a terrific job) and his wife have an investment in the Partnership of $298,749, a very large majority of their net worth. Our new associate (his name is being withheld until his present employer has replaced him), along with his wife and children, has made an important investment in the Partnership. Susie and I presently have an interest of $3,406,700 in BPL which represents virtually our entire net worth, with the exception of our continued holding of Mid-Continent Tab Card Co., a local company into which I bought in 1960 when it had less than 10 stockholders. Additionally, my relatives, consisting of three children, mother , two sisters, two brothers-in-law, father-in-Law, four aunts, four cousins and six nieces and nephews, have interests in BPL, directly or indirectly, totaling $1,942,592. So we all continue to eat home cooking.

We continue to represent the ultimate in seasonal businesses --open one day a year. This creates real problems in keeping the paper flowing smoothly, but Beth and Donna continue to do an outstanding job of coping with this and other problems.

Peat, Marwick, Mitchell has distinguished itself in its usual vital role of finding out what belongs to whom. We continue to throw impossible deadlines at them --and they continue to perform magnificently. You will note in their certificate this year that they have implemented the new procedure whereby they now pounce on us unannounced twice a year in addition to the regular yearend effort.

Finally -and most sincerely -let me thank you partners who cooperate magnificently in getting things to us promptly and properly and thereby maximize the time we can spend working where we should be -by the cash register. I am extremely fortunate in being able to spend the great majority of my time thinking about where our money should be invested, rather than getting bogged down in the minutiae that seems to overwhelm so many business entities. We have an organizational structure which makes this efficiency a possibility, and more importantly, we have a group of partners that make it a reality. For this, I am most appreciative and we are all wealthier.

Our past policy has been to admit close relatives of present partners without a minimum capital limitation. This year a flood of children, grandchildren, etc., appeared which called this policy into question; therefore, I have decided to institute a $25,000 minimum on interests of immediate relatives of present partners.

Within the coming two weeks you will receive:

(1) A tax letter giving you all BPL information needed for your 1964 federal income tax return. This letter is the only item that counts for tax purposes.

(2) An audit from Peat, Marwick, Mitchell & Co. for 1964, setting forth the operations and financial position of BPL as well as your own capital account.

(3) A letter signed by me setting forth the status of your BPL interest on 111165. This is identical with the figure developed in the audit.

(4) Schedule “A” to the partnership agreement listing all partners.

Let Bill or me know if anything needs clarifying. Even with our splendid staff our growth means there is more chance of missing letters, overlooked instructions, a name skipped over, a figure transposition, etc., so speak up if you have any question at all that we might have erred. My next letter will be about July 15th" summarizing the first half of this year.

Cordially,