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1987 Shareholder Letter

First published on 29 February 1988

· Value Investing

The original 1987 Shareholder letter can be found here (

Focus on Business Value, not Book Value

Again, WB focuses on looking at the business value per share that has increased, rather than book value: remember, even businesses with a lot of book value on their balance sheet, can go bankrupt. The other extreme also happens: companies may get acquired at a substantial premium to their book value.

What counts, of course, is the rate of gain in per-share business value, not book value. In many cases, a corporation's book value and business value are almost totally unrelated.

This is why it's so important to invest time and effort in learning value investing - the reality is that there are plenty of opportunities out there for the picking, and it's important that we learn how to identify the gems.

Focus on what's real, and what's not.

Too often, CEOs at their annual letter, will tout their fantastic performance, how sales/revenue have increased by XX%, how their people are their best assets etc etc. The reality is, as covered in previous letters, that it's easy to make money if you throw in a lot of debt and retained earnings. What's more impressive (and more difficult) is the ability to generate substantially more revenue without much more capital. Return on Equity, Return on Total Capital etc, these are all very important ratios to look at.

By itself, this figure says nothing about economic performance. To evaluate that, we must know how much total capital - debt and equity - was needed to produce these earnings.

The performance of the business, and the underlying business value, is not correlated to the price that you paid for, when you bought into the business. When you buy shares, most of the time, your money goes to the seller of the share, and not to the business/company. So be careful how you judge the business performance.

Market is irrational

Again and again, WB repeats his point that the markets are generally irrational, paying very little heed to the underlying business value of companies. What we try to achieve in value-investing is: consistent and sustainable growth, most of the times bordering on boring. Boring-ly making money is good; plenty of companies to invest in, no need to invest in the next sexy new thing.

Experience, however, indicates that 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.

Again in this letter, WB talks about Mr. Market, and several oft-repeated quotes: we reproduce them again here, because it's useful to be reminded of them.

Mr. Market is there to serve you, not to guide you

If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.

The market may ignore business success for a while, but eventually will confirm it. As Ben said: "In the short run, the market is a voting machine but in the long run it is a weighing machine."

Later down the letter, WB speaks again of how the market is irrational. The reality nowadays is that the market is mostly made up of institutional investors: fund managers who are managing billions of dollars, and their army of analysts. Even though this letter is >30 years old, the same situation is happening in the stock market today.

We have "professional" investors, those who manage many
billions, to thank for most of this turmoil. Instead of focusing
on what businesses will do in the years ahead, many prestigious money managers now focus on what they expect other money managers to do in the days ahead. For them, stocks are merely tokens in a game, like the thimble and flatiron in Monopoly.

Again, WB, in his inimitable style, gives a very relatable and concrete example.

If you've thought that investment advisors were hired to
invest, you may be bewildered by this technique. After buying a farm, would a rational owner next order his real estate agent to start selling off pieces of it whenever a neighboring property was sold at a lower price? Or would you sell your house to whatever bidder was available at 9:31 on some morning merely because at 9:30 a similar house sold for less than it would have brought on the previous day?

Think like a business owner

Again, this bears repeating: think like a business owner, even when you are only buying one share (and not the whole company). When studying and researching a particular company, make sure to look at it as though (i) you're a trillionaire and (ii) you are buying the whole company. Look at all the transactions, activities, products, balance sheets and income streams, as though it's your very own business, and ask yourself if the exchanges were closed for 5 years, would you be happy holding on to this business? The answer is obviously yes if the underlying business is sound, makes good returns on equity, and is going to grow from year to year.

Eventually, our economic fate will be determined by the economic fate of the business we own, whether our ownership is partial or total.

Don't ask the barber if you need a haircut

Again, this bears repeating (investing ultimately is an emotional game, and nagging and repeating ad nauseam typically works wonders). When you speak to fund managers, your financial advisor friend, or companies that are trying to sell you something, obviously they will tell you whatever it is that suits their agenda: whether it's the efficient market hypothesis, or you can't beat the markets, or investing is risky etc, be logical and rational before you believe any of that. At the end of the day, we are not buying stock ticker symbols, we are buying partial ownership of real-life businesses. You just need to exercise good business acumen and judgement, and you'll most likely be alright.

After all, what witch doctor has ever achieved fame and fortune by simply advising "Take two aspirins"?

Buying businesses at a sensible price

Again, WB repeats the key mantra of buying good businesses at sensible prices, and not outrageous prices simply they are "hot" or "popular". The reality is that your returns in the next 10-15 years will be largely determined by how much you bought the stock for.

Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price. Charlie and I have found that making silk purses out of silk is the best that we can do; with sow's ears, we fail.

Able and Honest Management

Again, another elaboration of a key principle that we practise here in BTS.

we try to buy not only good businesses, but ones run by high-grade, talented and likeable managers.

There's a space for the small investor

Here, WB gives some encouragement to the small investor, but saying that regardless of your individual portfolios' size, as long as the market remains irrational occasionally, then there will always be opportunity to make money.

They are fond of saying that the small investor has no chance in a market now dominated by the erratic behavior of the big boys. This conclusion is dead wrong: Such markets are ideal for any investor - small or large - so long as he sticks to his investment knitting. Volatility caused by money managers who speculate irrationally with huge sums will offer the true investor more chances to make intelligent investment moves. He can be hurt by such volatility only if he is forced, by either financial or psychological pressures, to sell at untoward times.

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