1960
1960 Letter
WARREN E. BUFFETT
5202 Underwood Ave. Omaha, Nebraska
The General Stock Market in 1960:
A year ago, I commented on the somewhat faulty picture presented in 1959 by the Dow-Jones Industrial
Average which had
advanced from 583 to 679, or 16.4%. Although practically all investment companies
showed gains for that year, less than 10% of them were able to match or better the record of the Industrial
Average. The Dow-Jones Utility Average had a small decline and the Railroad Average recorded a substantial
one.
In 1960, the picture was reversed. The Industrial Average declined from 679 to 616, or 9.3%. Adding back the
dividends which would have been received through ownership of the Average still left it with an overall loss of
6.3%. On the other hand, the Utility Average showed a good gain and, while all the results are not now
available, my guess is that about 90% of all investment companies outperformed the Industrial Average.
The
majority of investment companies appear to have ended the year with overall results in the range of plus or
minus 5%. On the New York Stock Exchange, 653 common stocks registered losses for the year while 404
showed gains.
Results in 1960:
My continual objective in managing partnership funds is to achieve a long-term performance record superior to
that of the Industrial Average. I believe this Average, over a period of years, will more or less parallel the results
of leading investment companies. Unless we do achieve this superior performance there is no reason for
existence of the partnerships.
However, I have pointed out that any superior record which we might accomplish should not be expected to be
evidenced by a relatively constant advantage in performance compared to the Average.
Rather it is likely that if
such an advantage is achieved, it will be through better-than-average performance in stable or declining markets
and average, or perhaps even poorer- than-average performance in rising markets.
I would consider a year in which we declined 15% and the Average 30% to be much superior to a year when
both we and the Average advanced 20%. Over a period of time there are going
to be good and bad years; there is
nothing to be gained by getting enthused or depressed about the sequence in which they occur.
The important
thing is to be beating par; a four on a par three hole is not as good as a five on a par five hole and it is unrealistic
to assume we are not going to have our share of both par three's and par five's.
The above dose of philosophy is being dispensed since we have a number of new partners this year and I want to
make sure they understand my objectives, my measure of attainment of these objectives, and some of my known
limitations.
With this background it is not unexpected that 1960 was a better-than-average year for us. As contrasted with an
overall loss of 6.3% for the Industrial Average, we had a 22.8% gain for the seven partnerships operating
throughout the year.
Our results for the four complete years of partnership operation after expenses but before
interest to limited partners or allocation to the general partner are:
Year
Partnerships Operating Entire Year
Partnership Gain
Dow-Jones Gain
1957
3
10.4%
-8.4%
1958
5
40.9%
38.5%
9 1959
6
25.9%
19.9%
1960
7
22.8%
-6.3%
It should be emphasized again that these are the net results to the partnership; the net results to the limited
partners would depend on the partnership agreement that they had selected.
The overall gain or loss is computed on a market to market basis.
After allowing for any money added or
withdrawn, such a method gives results based upon what would have been realized upon liquidation of the
partnership at the beginning, of the year and what would have been realized upon liquidation at year end and is
different, of course, from our tax results, which value securities at cost and realize gains or losses only when
securities are actually sold.
On a compounded basis, the cumulative results have been:
Year
Partnership Gain
Dow-Jones Gain
1957
10.4%
-8.4%
1958
55.6%
26.9%
1959
95.9%
52.2%
1960
140.6%
42.6%
Although four years is entirely too short a period from which to make deductions, what evidence there is points
toward confirming the proposition that our results should be relatively better in moderately declining or static
markets. To the extent that this is true, it indicates that our portfolio may be more conservatively, although
decidedly less conventionally, invested than if we owned "blue-chip" securities.
During a strongly rising market
for the latter, we might have real difficulty in matching their performance.
Multiplicity of Partnerships:
A preceding table shows that the family is growing. There has been no partnership which has had a consistently
superior or inferior record compared to our group average, but there has been some variance each year despite
my efforts to "keep all partnerships invested in the same securities and in about the same proportions. This
variation, of course, could be eliminated by combining the present partnerships into one large partnership. Such
a move would also eliminate much detail and a moderate amount of expense.
Frankly, I am hopeful of doing something along this line in the next few years. The problem is that various
partners have expressed preferences for varying partnership arrangements. Nothing will be done without
unanimous consent of partners.
Advance Payments:
Several partners have inquired about adding money during the year to their partnership.
Although an exception
has been made, it is too difficult to amend partnership agreements during mid-year where we have more than
one family represented among the limited partners. Therefore, in mixed partnerships an additional interest can
only be acquired at the end of the year.
We do accept advance payments during the year toward a partnership interest and pay interest at 6% on this
payment from the time received until the end of the year. At that time, subject to amendment of the agreement
by the partners, the payment plus interest is added to the partnership capital and thereafter participates in profits
and losses.
Sanborn Map:
10 Last year mention was made of an investment which accounted for a very high and unusual proportion (35%) of
our net assets along with the comment that I had some hope this investment would be concluded in 1960. This
hope materialized. The history of an investment of this magnitude may be of interest to you.
Sanborn Map Co.
is engaged in the publication and continuous revision of extremely detailed maps of all cities
of the United States. For example, the volumes mapping Omaha would weigh perhaps fifty pounds and provide
minute details on each structure. The map would be revised by the paste-over method showing new
construction, changed occupancy, new fire protection facilities, changed structural materials, etc. These
revisions would be done approximately annually and a new map would be published every twenty or thirty years
when further pasteovers became impractical. The cost of keeping the map revised to an Omaha customer would
run around $100 per year.
This detailed information showing diameter of water mains underlying streets, location of fire hydrants,
composition of roof, etc., was primarily of use to fire insurance companies. Their underwriting departments,
located in a central office, could evaluate business by agents nationally.
The theory was that a picture was worth
a thousand words and such evaluation would decide whether the risk was properly rated, the degree of
conflagration exposure in an area, advisable reinsurance procedure, etc. The bulk of Sanborn's business was
done with about thirty insurance companies although maps were also sold to customers outside the insurance
industry such as public utilities, mortgage companies, and taxing authorities.
For seventy-five years the business operated in a more or less monopolistic manner, with profits realized in
every year accompanied by almost complete immunity to recession and lack of need for any sales effort.
In the
earlier years of the business, the insurance industry became fearful that Sanborn's profits would become too
great and placed a number of prominent
insurance men on Sanborn's board of directors to act in a watch-dog
capacity.
In the early 1950’s a competitive method of under-writing known as "carding" made inroads on Sanborn’s
business and after-tax profits of the map business fell from an average annual level of over $500,000 in the late
1930's to under $100,000 in 1958 and 1959. Considering the upward bias in the economy during this period, this
amounted to an almost complete elimination of what had been sizable, stable earning power.
However, during the early 1930's Sanborn had begun to accumulate an investment portfolio. There were no
capital requirements to the business so that any retained earnings could be devoted to this project. Over a period
of time, about $2.5 million was invested, roughly half in bonds and half in stocks.
Thus, in the last decade
particularly, the investment portfolio blossomed while the operating map business wilted.
Let me give you some idea of the extreme divergence of these two factors. In 1938 when the Dow-Jones
Industrial Average was in the 100-120 range, Sanborn sold at $110 per share. In 1958 with the Average in the
550 area, Sanborn sold at $45 per share. Yet during that same period the value of the Sanborn investment
portfolio increased from about $20 per share to $65 per share. This means, in effect, that the buyer of Sanborn
stock in 1938 was placing a positive valuation of $90 per share on the map business ($110 less the $20 value of
the investments unrelated to the map business) in a year of depressed business and stock market conditions.
In
the tremendously more vigorous climate of 1958 the same map business was evaluated at a minus $20 with the
buyer of the stock unwilling to pay more than 70 cents on the dollar for the investment portfolio with the map
business thrown in for nothing.
How could this come about? Sanborn in 1958 as well as 1938 possessed a wealth of information of substantial
value to the insurance industry. To reproduce the detailed information they had gathered over the years would
have cost tens of millions of dollars. Despite “carding” over $500 million of fire premiums were underwritten
11 by “mapping” companies. However, the means of selling and packaging Sanborn’s product, information had
remained unchanged throughout the year and finally this inertia was reflected in the earnings.
The very fact that the investment portfolio had done so well served to minimize in the eyes of most directors the
need for rejuvenation of the map business.
Sanborn had a sales volume of about $2 million per year and owned
about $7 million worth of marketable securities. The income from the investment portfolio was substantial, the
business had no possible financial worries, the insurance companies were satisfied with the price paid for maps,
and the stockholders still received dividends. However, these dividends were cut five times in eight years
although I could never find any record of suggestions pertaining to cutting salaries or director's and committee
fees.
Prior to my entry on the Board, of the fourteen directors, nine were prominent men from the insurance industry
who combined held 46 shares of stock out of 105,000 shares outstanding. Despite their top positions with very
large companies which would suggest the financial wherewithal to make at least a modest commitment, the
largest holding in this group was ten shares.
In several cases, the insurance companies these men ran owned
small blocks of stock but these were token investments in relation to the portfolios in which they were held. For
the past decade the insurance companies had been only sellers in any transactions involving Sanborn stock.
The tenth director was the company attorney, who held ten shares. The eleventh was a banker with ten shares
who recognized the problems of the company, actively pointed them out, and later added to his holdings. The
next two directors were the top officers of Sanborn who owned about 300 shares combined. The officers were
capable, aware of the problems of the business,
but kept in a subservient role by the Board of Directors. The
final member of our cast was a son of a deceased president of Sanborn. The widow owned about 15,000 shares
of stock.
In late 1958, the son, unhappy with the trend of the business, demanded the top position in the company, was
turned down, and submitted his resignation, which was accepted.
Shortly thereafter we made a bid to his mother
for her block of stock, which was accepted. At the time there were two other large holdings, one of about 10,000
shares (dispersed among customers of a brokerage firm) and one of about 8,000. These people were quite
unhappy with the situation and desired a separation of the investment portfolio from the map business, as did
we.
Subsequently our holdings (including associates) were increased through open market purchases to about 24,000
shares and the total represented by the three groups increased to 46,000 shares. We hoped to separate the two
businesses, realize the fair value of the investment portfolio and work to re-establish the earning power of the
map business.
There appeared to be a real opportunity to multiply map profits through utilization of Sanborn's
wealth of raw material in conjunction with electronic means of converting this data to the most usable form for
the customer.
There was considerable opposition on the Board to change of any type, particularly when initiated by an
outsider, although management was in complete accord with our plan and a similar plan had been recommended
by Booz, Allen & Hamilton (Management Experts). To avoid a proxy fight (which very probably would not
have been forthcoming and which we would have been certain of winning) and to avoid time delay with a large
portion of Sanborn’s money tied up in blue-chip stocks which I didn’t care for at current prices, a plan was
evolved taking out all stockholders at fair value who wanted out. The SEC ruled favorably on the fairness of the
plan. About 72% of the Sanborn stock, involving 50% of the 1,600 stockholders, was exchanged for portfolio
securities at fair value.
The map business was left with over $l,25 million in government and municipal bonds as
a reserve fund, and a potential corporate capital gains tax of over $1 million was eliminated. The remaining
stockholders were left with a slightly improved asset value, substantially higher earnings per share, and an
increased dividend rate.
12 Necessarily, the above little melodrama is a very abbreviated description of this investment operation. However,
it does point up the necessity for secrecy regarding our portfolio operations as well as the futility of measuring
our results over a short span of time such as a year. Such control situations may occur very infrequently.
Our
bread-and-butter business is buying undervalued securities and selling when the undervaluation is corrected
along with investment in special situations where the profit is dependent on corporate rather than market action.
To the extent that partnership funds continue to grow, it is possible that more opportunities will be available in
“control situations.”
The auditors should be mailing your financial statement and tax information within about a week. If you have
any questions at all regarding either their report or this letter, be sure to let me know.
Warren E. Buffett 1-30-61
13 1960 Letter
BUFFETT PARTNERSHIP, LTD.
810 KIEWIT PLAZA
OMAHA 31, NEBRASKA
July, 1961
TO MY PARTNERS:
In the past, partners have commented that a once-a-year letter was “a long time between drinks,” and
that a semi-annual letter would be a good idea. It really shouldn’t be too difficult to find something to say twice
a year; at least it isn’t this year.
Hence, this letter which will be continued in future years.
During the first half of 1961, the overall gain of the Dow-Jones Industrial Average was about 13%,
including dividends. Although this is the type of period when we should have the most difficulty in exceeding
this standard, all partnerships that operated throughout the six months did moderately better then the Average.
Partnerships formed during 1961 either equaled or exceeded results of the Average from the time of formation,
depending primarily on how long they were in operation.
Let me, however, emphasize two points. First, one year is far too short a period to form any kind of an
opinion as to investment performance, and measurements based upon six months become even more unreliable.
One factor that has caused some reluctance on my part to write semi-annual letters is the fear that partners may
begin to think in terms of short-term performance which can be most misleading.
My own thinking is much
more geared to five year performance, preferably with tests of relative results in both strong and weak markets.
The second point I want everyone to understand is that if we continue in a market which advances at the
pace of the first half of 1961, not only do I doubt that we will continue to exceed the results of the DJIA, but it is
very likely that our performance will fall behind the Average.
Our holdings, which I always believe to be on the conservative side compared to general portfolios, tend
to grow more conservative as the general market level rises. At all times, I attempt to have a portion of our
portfolio in securities as least partially insulated from the behavior of the market, and this portion should
increase as the market rises.
However appetizing results for even the amateur cook (and perhaps particularly the
amateur), we find that more of our portfolio is not on the stove.
We have also begun open market acquisition of a potentially major commitment which I, of course,
hope does nothing marketwise for at least a year. Such a commitment may be a deterrent to short range
performance, but it gives strong promise of superior results over a several year period combined with substantial
defensive characteristics.
Progress has been made toward combining all partners at yearend. I have talked with all partners joining
during this past year or so about this goal, and have also gone over the plans with representative partners of all
earlier partnerships
Some of the provisions will be:
(A) A merger of all partnerships, based on market value at yearend, with provisions for proper
allocation among partners of future tax liability due to unrealized gains at yearend.
The merger itself will be tax-
free, and will result in no acceleration of realization of profits;
14 (B) A division of profits between the limited partners and general partner, with the first 6% per year to
partners based upon beginning capital at market, and any excess divided one-fourth to the general partner and
three-fourths to all partners proportional to their capital. Any deficiencies in earnings below the 6% would be
carried forward against future earnings, but would not be carried back. Presently, there are three profit
arrangements which have been optional to incoming partners:
Interest Provision
Excess to Gen. Partner
Excess to Ltd. Partners
(1)
6%
1/3
2/3
(2)
4%
1/4
3/4
(3)
None
1/6
5/6
In the event of profits, the new division will obviously have to be better for limited partners than the first two
arrangements.
Regarding the third, the new arrangement will be superior up to 18% per year; but above this rate
the limited partners would do better under the present agreement. About 80% of total partnership assets have
selected the first two arrangements, and I am hopeful, should we average better than 18% yearly, partners
presently under the third arrangement will not feel short-changed under the new agreement;
(C) In the event of losses, there will be no carry back against amounts previously credited to me as
general partner. Although there will be a carry-forward against future excess earnings. However, my wife and I
will have the largest single investment in the new partnership, probably about one-sixth of total partnership
assets, and thereby a greater dollar stake in losses than any other partner of family group, I am inserting a
provision in the partnership agreement which will prohibit the purchase by me or my family of any marketable
securities.
In other words, the new partnership will represent my entire investment operation in marketable
securities, so that my results will have to be directly proportional to yours, subject to the advantage I obtain if
we do better than 6%;
(D) A provision for monthly payments at the rate of 6% yearly, based on beginning of the year capital
valued at market. Partners not wishing to withdraw money currently can have this credited back to them
automatically as an advance payment, drawing 6%, to purchase an additional equity interest in the partnership at
yearend. This will solve one stumbling block that has heretofore existed in the path of consolidation, since many
partners desire regular withdrawals and others wish to plow everything back;
(E) The right to borrow during the year, up to 20% of the value of your partnership interest, at 6%, such
loans to be liquidated at yearend or earlier. This will add a degree of liquidity to an investment which can now
only be disposed of at yearend.
It is not intended that anything but relatively permanent funds be invested in the
partnership, and we have no desire to turn it into a bank. Rather, I expect this to be a relatively unused provision,
which is available when something unexpected turns up and a wait until yearend to liquidate part of all of a
partner’s interest would cause hardship;
(F) An arrangement whereby any relatively small tax adjustment, made in later years on the
partnership’s return will be assessed directly to me. This way, we will not be faced with the problem of asking
eighty people, or more, to amend their earlier return over some small matter. As it stands now, a small change,
such as a decision that a dividend received by the partnership has 63% a return of capital instead of 68%, could
cause a multitude of paper work.
To prevent this, any change amounting to less than $1,000 of tax will be
charged directly to me.
We have submitted the proposed agreement to Washington for a ruling that the merger would be tax-
free, and that the partnership would be treated as a partnership under the tax laws. While all of this is a lot of
work, it will make things enormously easier in the future. You might save this letter as a reference to read in
conjunction with the agreement which you will receive later in the year.
15 The minimum investment for new partners is currently $25,000, but, of course, this does not apply to
present partners. Our method of operation will enable the partners to add or withdraw amounts of any size (in
round $100) at yearend.
Estimated total assets of the partnership will be in the neighborhood of $4 million,
which enables us to consider investments such as the one mentioned earlier in this letter, which we would have
had to pass several years ago.
This has turned out to be more of a production than my annual letter. If you have any questions,
particularly regarding anything that isn’t clear in my discussion of the new partnership agreement, be sure to let
me know. If there are a large number of questions, I will write a supplemental letter to all partners giving the
questions that arise and the answers to them.
Warren E. Buffett
Vlb
July 22, 1961