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1992 Shareholder Letter

Published on 1 March 1993

· Value Investing

The original 1992 Shareholder letter can be found here (

Focus on Intrinsic Business Value

Again and again, WB focuses on "Intrinsic Value" as the true north of understanding the actual worth of a company. While he says that the Book Value of Berkshire serves as a good proxy for Berkshire's intrinsic value, he also says that it's not necessarily the case for a lot of other companies. Regardless, the goal of any investor is to investigate the current state of the intrinsic value of target companies, understand whether it's going to grow steadily for the next 10 years, and determine a good price for it currently. As always, WB's personal target annual growth rate is 15% per year.

It is clear that stocks cannot forever overperform their underlying businesses, as they have so dramatically done for some time, and that fact makes us quite confident of our forecast that the rewards from investing in stocks over the next decade will be significantly smaller than they were in the last.

Focus on quality of business

Different from Ben Graham, WB has gradually shifted his thinking, to that of getting a stake into great companies at fair prices (probably no longer at a margin of safety of 50%, but perhaps 20%).

buy good businesses at fair prices rather than fair businesses at good prices.

Focus on what's real

Here, WB reiterates his preference for judging whether the business is doing well or not, via looking at operating earnings. This is an important fact because many investors like to look at EBIDTA. WB provides his own calculations for "look-through" earnings (quoted below), but it's important to understand the difference between operating earnings, and EBIDTA.

We've previously discussed look-through earnings, which consist of: (1) the operating earnings reported in the previous section, plus; (2) the retained operating earnings of major investees that, under GAAP accounting, are not reflected in our profits, less; (3) an allowance for the tax that would be paid by Berkshire if these retained earnings of investees had instead been distributed to us.

Lower down the letter, WB emphasizes again the need for investors to come to their own conclusions on how well the business is doing, instead of relying solely on what the management is saying.

Managers thinking about accounting issues should never forget one of Abraham Lincoln's favorite riddles: "How many legs does a dog have if you call his tail a leg?" The answer: "Four, because calling a tail a leg does not make it a leg." It behooves managers to remember that Abe's right even if an auditor is willing to certify that the tail is a leg.

Long term = short term

As you continue to look for good businesses at good prices, over years, you will realise that your short-term returns should be as good as your long-term prospects, because you have been consistently trying to evaluate the intrinsic business value of companies. The converse is also true:

If plantings made confidently are repeatedly followed by disappointing harvests, something is wrong with the farmer. (Or perhaps with the farm: Investors should understand that for certain companies, and even for some industries, there simply is no good long-term strategy.)

Explanation of value-investing

In this particular year, WB goes on a long exposition on what value-investing is about, with several important gems.

Our equity-investing strategy remains little changed from what it was fifteen years ago, when we said in the 1977 annual report: "We select our marketable equity securities in much the way we would evaluate a business for acquisition in its entirety. We want the business to be one (a) that we can understand; (b) with favorable long-term prospects; (c) operated by honest and competent people; and (d) available at a very attractive price." We have seen cause to make only one change in this creed: Because of both market conditions and our size, we now substitute "an attractive price" for "a very attractive price."

These are the exact 4 principles that we teach regularly at BTS. Whatever you do in the purchase of any assets (including property), it's useful to look at these 4 principles and consider them carefully. Of course the exact details may differ, in the sense that you may want to look at EBIDTA rather than operating earnings, but overall you should have convince yourself of all 4 principles before you proceed.

we try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we're not smart enough to predict future cash flows. Incidentally, that shortcoming doesn't bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. An investor needs to do very few things right as long as he or she avoids big mistakes.

Again, this is a particularly important point, because a lot of people tend to go into businesses which they use, but perhaps don't quite understand. Being a user of the product doesn't necessarily mean that you understand how the company makes money, and vice versa. In investing, what's important is that you understand how the company makes money, and that you understand the industry enough such that you are reasonably confident of what the future holds.

Second, and equally important, we insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we're not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success.

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