1969
BUFFETT PARTNERSHIP. LTD.
610 KIEWIT PLAZA
OMAHA, NEBRASKA 68131
TELEPHONE 042-4110
January 22nd, 1969
Our Performance in 1968
Everyone makes mistakes.
At the beginning of 1968, I felt prospects for BPL performance looked poorer than at any time in our history.
However, due in considerable measure to one simple but sound idea whose time had come (investment ideas,
like women are often more exciting than punctual), we recorded an overall gain of $40,032,691.
Naturally, you all possess sufficient intellectual purity to dismiss the dollar result and demand an accounting of
performance relative to the Dow-Jones Industrial Average. We established a new mark at plus 58.8% versus an
overall plus 7.7 % for the Dow, including dividends which would have been received through ownership of the
Average throughout the year. This result should be treated as a freak like picking up thirteen spades in a bridge
game.
You bid the slam, make it look modest, pocket the money and then get back to work on the part scores.
We will also have our share of hands when we go set.
The following summarizes the year-by-year performance of the Dow, the Partnership before allocation (one
quarter of the excess over 6%) to the General Partner and the results for limited partners:
Year
Overall Results
From Dow (1)
Partnership Results
(2)
Limited Partners’
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%
1965
14.2%
47.2%
36.9%
1966
-15.6%
20.4%
16.8%
1967
19.0%
35.9%
28.4%
1968
7.7%
58.8%
45.6%
(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.
123 On a cumulative or compounded basis, the results are:
Year
Overall Results From
Dow
Partnership Results
Limited Partners’
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%
140.6%
107.2%
1957 – 61
74.9%
251.0%
181.6%
1957 – 62
61.6%
299.8%
215.1%
1957 – 63
95.1%
454.5%
311.2%
1957 – 64
131.3%
608.7%
402.9%
1957 – 65
164.1%
943.2%
588.5%
1957 – 66
122.9%
1156.0%
704.2%
1957 – 67
165.3%
1606.9%
932.6%
1957 – 68
185.7%
2610.6%
1403.5%
Annual Compounded
Rate
9.1%
31.6%
25.3%
Investment Companies
On the following page is the usual tabulation showing the results of what were the two largest mutual funds
(they stood at the top in size from 1957 through 1966 - they are still number two and three) that follow a policy
of being, typically, 95 -100% invested in common stocks, and the two largest diversified closed-end investment
companies.
Year
Mass.
Inv.
Trust (1)
Investors
Stock (1)
Lehman (2)
Tri-Cont
(2)
Dow
Limited
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%
1965
10.2%
9.8%
19.0%
10.7%
14.2%
36.9%
1966
-7.7%
-10.0%
-2.6%
-6.9%
-15.6%
16.8%
1967
20.0%
22.8%
28.0%
25.4%
19.0%
28.4%
1968
10.3%
8.1%
6.7%
6.8%
7.7%
45.6%
Cumulative
Results
189.3%
167.7%
225.6%
200.2%
185.7%
1403.5%
Annual
Compounded
Rate
9.3%
8.6%
10.3%
9.6%
9.1%
25.3%
(1)
Computed from changes in asset value plus any distributions to holders of record during year.
(2)
From 1968 Moody's Bank & Finance
Manual for 1957-1967. Estimated for 1968.
124 It is interesting that after twelve years these four funds (which presently aggregate well over $5 billion and
account for over 10% of the investment company industry) have averaged only a fraction of one percentage
point annually better than the Dow.
Some of the so-called “go-go” funds have recently been re-christened “no-go” funds. For example, Gerald Tsai's
Manhattan Fund, perhaps the world's best-known aggressive investment vehicle, came in at minus 6.9% for
- Many smaller investment entities continued to substantially outperform the general market in 1968, but in
nothing like the quantities of 1966 and 1967.
The investment management business, which I used to severely chastise in this section for excessive lethargy,
has now swung in many quarters to acute hypertension.
One investment manager, representing an organization
(with an old established name you would recognize) handling mutual funds aggregating well over $1 billion,
said upon launching a new advisory service in 1968:
“The complexities of national and international economics make money management a full-time job. A
good money manager cannot maintain a study of securities on a week-by-week or even a day-by-day
basis. Securities must be studied in a minute-by-minute program.”
Wow!
This sort of stuff makes me feel guilty when I go out for a Pepsi. When practiced by large and increasing
numbers of highly motivated people with huge amounts of money on a limited quantity of suitable securities,
the result becomes highly unpredictable. In some ways it is fascinating to watch and in other ways it is
appalling.
Analysis of 1968 Results
All four main categories of our investment operation worked out well in 1968.
Our total overall gain of
$40,032,691 was divided as follows:
Category
Average Investment
Overall Gain
Controls
$24,996,998
$5,886,109
Generals – Private Owner
$16,363,100
$21,994,736
Generals – Relatively
Undervalued
$8,766,878
$4,271,825
Workouts
$18,980,602
$7,317,128
Miscellaneous, primarily US
Treasury Bills
$12,744,973
$839,496
Total Income
$40,309,294
Less – General Expense,
including Interest
$276,603
Overall Gain
$40,032,691
A few caveats, as mentioned in my letter two years ago, are again in order (non-doctoral candidates may
proceed to next section):
An explanation of the various categories listed above was made in the January 18, 1965 letter. If your
memory needs refreshing and your favorite newsstand does not have the pocketbook edition. We'll be
glad to give you a copy.
The classifications are not iron clad. Nothing is changed retroactively, but the initial decision as to
125 category is sometimes arbitrary.
Sometimes later classification proves difficult; e.g. a workout that falls
through but that I continue to hold for reasons unrelated or only partially related to the original decision
(like stubbornness).
Percentage returns calculated on the average investment base by category would be significantly
understated relative to Partnership percentage returns which are calculated on a beginning investment
base. In the foregoing figures, a security purchased by us at 100 on January 1 which appreciated at an
even rate to 200 on December 31 would have an average investment of 150 producing a 66-2/3% result
contrasted to a 100% result by the customary approach. In other words, the foregoing figures use a
monthly average of market values in calculating the average investment.
All results are based on a 100% ownership, non-leverage basis. Interest and other general expenses are
deducted from total performance and not segregated by category.
Expenses directly related to specific
investment operations, such as dividends paid on short stock, are deducted by category. When securities
are borrowed directly and sold short, the net investment (longs minus shorts) is shown for the applicable
category's average investment.
The foregoing table has only limited use. The results applicable to each category are dominated by one
or two investments. They do not represent a collection of great quantities of stable data (mortality rates
of all American males or something of the sort) from which conclusions can be drawn and projections
made.
Instead, they represent infrequent, non-homogeneous phenomena leading to very tentative
suggestions regarding various courses of action and are so used by us.
Finally, these calculations are not made with the same loving care we apply to counting the money and
are subject to possible clerical or mathematical error since they are not entirely se1f-checking.
Controls
Overall, the controlled companies turned in a decent performance during 1968. Diversified Retailing Company
Inc. (80% owned) and Berkshire Hathaway Inc. (70% owned) had combined after-tax earnings of over $5
million.
Particularly outstanding performances were turned in by Associated Cotton Shops, a subsidiary of DRC run by
Ben Rosner, and National Indemnity Company, a subsidiary of B-H run by Jack Ringwalt. Both of these
companies earned about 20% on capital employed in their businesses.
Among Fortune's “500” (the largest
manufacturing entities in the country, starting with General Motors), only 37 companies achieved this figure in
1967, and our boys outshone such mildly better-known (but not better appreciated) companies as IBM, General
Electric, General Motors, Procter & Gamble, DuPont, Control Data, Hewlett-Packard, etc...
I still sometimes get comments from partners like: "Say, Berkshire is up four points - that's great!" or "What's
happening to us, Berkshire was down three last week?" Market price is irrelevant to us in the valuation of our
controlling interests. We valued B-H at 25 at yearend 1967 when the market was about 20 and 31 at yearend
1968 when the market was about 37. We would have done the same thing if the markets had been 15 and 50
respectively. ("Price is what you pay. value is what you get").
We will prosper or suffer in controlled
investments in relation to the operating performances of our businesses - we will not attempt to profit by playing
various games in the securities markets.
Generals -Private Owner
Over the years this has been our best category, measured by average return, and has also maintained by far the
best percentage of profitable transactions. This approach was the way I was taught the business, and it formerly
126 accounted for a large proportion of all our investment ideas. Our total individual profits in this category during
the twelve year BPL history are probably fifty times or more our total losses. The cash register really rang on
one simple industry idea (implemented in several ways) in this area in 1968.
We even received a substantial fee
(included in Other Income in the audit) for some work in this field.
Our total investment in this category (which is where I feel by far the greatest certainty regarding consistently
decent results) is presently under $2 million and I have nothing at all in the hopper to bolster this. What came
through like the Johnstown flood in 1968 looks more like a leaky faucet in Altoona for 1969.
Generals - Relatively Undervalued
This category produced about two-thirds of the overall gain in 1966 and 1967 combined. I mentioned last year
that the great two-year performance here had largely come from one idea. I also said, "We have nothing in this
group remotely approaching the size or potential which formerly existed in this investment.” It gives me great
pleasure to announce that this statement was absolutely correct.
It gives me somewhat less pleasure to announce
that it must be repeated this year.
Workouts
This category, which was a disaster in 1967, did well during 1968. Our relatively heavy concentration in just a
few situations per year (some of the large arbitrage houses may become involved in fifty or more workouts per
annum) gives more variation in yearly results than an across-the-board approach.
I feel the average profitability
will be as good with our policy and 1968 makes me feel better about that conclusion than 1967 did.
It should again be stated that our results in the Workout area (as well as in other categories) are somewhat
understated compared to the more common method of determining results computed on an initial base figure
and utilizing borrowed money (which is often a sensible part of the Workout business).
I can't emphasize too strongly that the quality and quantity of ideas is presently at an all time low - the product
of the factors mentioned in my October 9th, 1967 letter, which have largely been intensified since then.
Sometimes I feel we should have a plaque in our office like the one at the headquarters of Texas Instruments in
Dallas which reads: “We don't believe in miracles, we rely on them.” It is possible for an old, overweight ball
player, whose legs and batting eye are gone, to tag a fast ball on the nose for a pinch-hit home run,
but you don't
change your line-up because of it.
We have a number of important negatives operating on our future and, while they shouldn't add up to futility,
they certainly don't add up to more than an average of quite moderate profitability.
Memorabilia
As one of my older friends says, “Nostalgia just isn't what it used to be.” Let's take a stab at it, anyway.
Buffett Associates, Ltd., the initial predecessor partnership, was formed May 5, 1956 with seven limited
partners (four family, three close friends), contributing $105,000, and the General Partner putting his money
where his mouth was by investing $100.
Two additional single-family limited partnerships were formed during
1956, so that on January 1, 1957 combined net assets were $303,726. During 1957, we had a gain of $31,615.97,
leading to the 10.4% figure shown on page one. During 1968 I would guess that the New York Stock Exchange
127 was open around 1,200 hours, giving us a gain of about $33,000 per hour (sort of makes you wish they had
stayed with the 5-1/2 hour, 5 day week, doesn't it), or roughly the same as the full year gain in 1957.
On January 1, 1962 we consolidated the predecessor limited partnerships moved out of the bedroom and hired
our first full-time employees. Net assets at that time were $7,178,500. From that point to our present net assets
of $104,429,431 we have added one person to the payroll. Since 1963 (Assets $9,405,400) rent has gone from
$3,947 to $5,823 (Ben Rosner would never have forgiven me if I had signed a percentage lease) travel from
$3,206 to $3,603, and dues and subscriptions from $900 to $994.
If one of Parkinson's Laws is operating, at
least the situation hasn't gotten completely out of control.
In making our retrospective survey of our financial assets, our conclusion need not parallel that of Gypsy Rose
Lee who opined, when reviewing her physical assets on her fifty-fifth birthday: “I have everything I had twenty
years ago - it's just that it's all lower.”
Miscellaneous
Although the investment environment is difficult, the office environment is superb. With Donna, Gladys, Bill
and John, we have an organization that functions speedily, efficiently and pleasantly. They are the best.
The office group, along with spouses (one apiece - I still haven't figured out how I should handle that plural) and
children have over $27 million invested in BPL on January 1, 1969.
Assorted sizes and shapes of aunts, uncles,
parents, in-laws, brothers, sisters and cousins make the BPL membership list read like “Our Crowd” - which, so
far as I am concerned, is exactly what it is.
Within a few days, you will receive:
A tax letter giving you all BPL information needed for your 1968 federal income tax return. This letter
is the only item that counts for tax purposes.
An audit from Peat Marwick. Mitchell & Co. (they have again done an excellent job) for 1968, setting
forth the operations and financial position of BPL, as well as your own capital account.
A letter signed by me setting forth the status of your BPL interest on January 1, 1969. This is identical
with the figures developed in the audit.
Let me know if anything in this letter or that occurs during the year needs clarifying. My next letter will be
about July 10 th , summarizing the first half of this year.
Cordially,
Warren E. Buffett
WEB/glk
128 BUFFETT PARTNERSHIP.
LTD.
610 KIEWIT PLAZA
OMAHA, NEBRASKA 68131
TELEPHONE 042-4110
May 29th, 1969
To My Partners:
About eighteen months ago I wrote to you regarding changed environmental and personal factors causing me to
modify our future performance objectives.
The investing environment I discussed at that time (and on which I have commented in various other letters has
generally become more negative
and frustrating as time has passed. Maybe I am merely suffering from a lack of
mental flexibility.
(One observer commenting on security analysts over forty stated: “They know too many
things that are no longer true.”)
However, it seems to me that: (1) opportunities for investment that are open to the analyst who stresses
quantitative factors have virtually disappeared, after rather steadily drying up over the past twenty years; (2) our
$100 million of assets further eliminates a large portion of this seemingly barren investment world, since
commitments of less than about $3 million cannot have a real impact on our overall performance, and this
virtually rules out companies with less than about $100 million of common stock at market value; and (3) a
swelling interest in investment performance has created an increasingly short-term oriented and (in my opinion)
more speculative market.
The October 9 th , 1967 letter stated that personal considerations were the most important factor among those
causing me to modify our objectives.
I expressed a desire to be relieved of the (self-imposed) necessity of
focusing 100% on BPL. I have flunked this test completely during the last eighteen months. The letter said: I
hope limited objectives will make for more limited effort. It hasn't worked out that way. As long as I am “on
stage”, publishing a regular record and assuming responsibility for management of what amounts to virtually
100% of the net worth of many partners, I will never be able to put sustained effort into any non-BPL activity. If
I am going to participate publicly. I can't help being competitive. I know I don't want to be totally occupied with
out-pacing an investment rabbit all my life. The only way to slow down is to stop.
Therefore, before yearend. I intend to give all limited partners the required formal notice of my intention to
retire.
There are, of course, a number of tax and legal problems in connection with liquidating the Partnership,
but overall, I am concerned with working out a plan that attains the following objectives:
The most important item is that I have an alternative regarding money management to suggest to the
many partners who do not want to handle this themselves. Some partners of course, have alternatives of
their own in which they have confidence and find quite acceptable. To the others, however, I will not
hand over their money with a "good luck". I intend to suggest an alternative money manager to whom I
will entrust funds of my relatives and others for whom I have lifetime financial responsibility. This
manager has integrity and ability and will probably perform as well or better than I would in the future
(although nowhere close to what he or I have achieved in the past). He will be available to any partner,
so that no minimum size for accounts will cause any of you a problem.
I intend, in the future, to keep in
general touch with what he is doing, but only on an infrequent basis with any advice on my part largely
limited to a negative type.
I want all partners to have the option of receiving cash and possibly readily marketable securities (there
will probably be only one where this will apply) where I like both the prospects and price but which
129 partners will be able to freely convert to cash if they wish.
However, I also want all partners to have the option of maintaining their proportional interests in our
two controlled companies (Diversified Retailing Company Inc. and Berkshire Hathaway Inc.) and one
other small "restricted" holding.
Because these securities will be valued unilaterally by me at fair value,
I feel it is essential that, if you wish, you can maintain your proportionate interest at such valuation.
However, these securities are not freely marketable (various SEC restrictions apply to “control”
stock and non-registered stock) and they will probably be both non-transferable and non-income
-producing for a considerable period of time. Therefore, I want you to be able to go either way in our
liquidation - either stick with the restricted securities or take cash equivalent. I strongly like all of the
people running our controlled businesses (joined now by the Illinois National Bank and Trust Company
of Rockford, Illinois, a $100 million plus, extremely well-run bank, purchased by Berkshire Hathaway
earlier this year), and want the relationship to be life long. I certainly have no desire to sell a good
controlled business run by people I like and admire, merely to obtain a fancy price.
However, specific
conditions may cause the sale of one operating unit at some point.
I believe we will have a liquidation program which will accomplish the above objectives. Our activities in this
regard should cause no change in your tax planning for 1969.
One final objective, I would like very much to achieve (but which just isn't going to happen) is to go out with a
bang. I hate to end with a poor year, but we are going to have one in 1969. My best guess is that at yearend,
allowing for a substantial increase in value of controlled companies (against which all partners except me will
have the option of taking cash), we will show a breakeven result for 1969 before any monthly payments to
partners.
This will be true even if the market should advance substantially between now and yearend, since we
will not be in any important position which will expose us to much upside potential.
Our experience in workouts this year has been atrocious - during this period I have felt like the bird that
inadvertently flew into the middle of a badminton game. We are not alone in such experience, but it came at a
time when we were toward the upper limit of what has been our historical range of percentage commitment in
this category.
Documenting one's boners is unpleasant business. I find "selective reporting" even more distasteful. Our poor
experience this year is 100% my fault. It did not reflect bad luck, but rather an improper assessment of a very
fast-developing governmental trend.
Paradoxically, I have long believed the government should have been doing
(in terms of the problem attacked – not necessarily the means utilized) what it finally did - in other words, on an
overall basis, I believe the general goal of the activity which has cost us substantial money is socially desirable
and have so preached for some time. Nevertheless, I didn't think it would happen. I never believe in mixing what
I think should happen (socially) with what I think will happen in making decisions - in this case, we would be
some millions better off if I had.
Quite frankly, in spite of any factors set forth on the earlier pages. I would continue to operate the Partnership in
1970, or even 1971, if I had some really first class ideas. Not because I want to, but simply because I would so
much rather end with a good year than a poor one. However.
I just don't see anything available that gives any
reasonable hope of delivering such a good year and I have no desire to grope around, hoping to "get lucky" with
other people's money. I am not attuned to this market environment and I don't want to spoil a decent record by
trying to play a game I don't understand just so I can go out a hero.
Therefore, we will be liquidating holdings throughout the year, working toward a residual of the controlled
companies, the one "investment letter" security, the one marketable security with favorable long-term prospects,
130 and the miscellaneous "stubs", etc. of small total value which will take several years to clean up in the Workout
category.
I have written this letter a little early in lieu of the mid-year letter. Once I made a decision, I wanted you to
know. I also wanted to be available in Omaha for a period after you received this letter to clear up anything that
may be confusing in it.
In July, I expect to be in California.
Some of you are going to ask, "What do you plan to do?" I don't have an answer to that question. I do know that
when I am 60, I should be attempting to achieve different personal goals than those which had priority at age 20.
Therefore, unless I now divorce myself from the activity that has consumed virtually all of my time and energies
during the first eighteen years of my adult life, I am unlikely to develop activities that will be appropriate to new
circumstances in subsequent years.
We will have a letter out in the Fall, probably October, elaborating on the liquidation procedure, the investment
advisor suggestion, etc…
Cordially,
Warren E. Buffett
WEB/glk
131 BUFFETT PARTNERSHIP.
LTD.
610 KIEWIT PLAZA
OMAHA, NEBRASKA 68131
TELEPHONE 042-4110
October 9th, 1969
To My Partners:
Here is my present estimate of the BPL calendar for the months to come:
(1)
This letter - to tell you something of Bill Ruane, the money manager within my knowledge who ranks
the highest when combining the factors of integrity, ability and continued availability to all partners. I
also want to comment upon the present range of expectations involved in deciding on a bond-stock mix.
(2)
Late November - the required thirty days formal notice of my intent to retire from the Partnership at the
end of the year.
(3)
Early December - a package of publicly available material, as well as some general comments by me
relating to our controlled companies. Berkshire Hathaway Inc.
(owning the textile business, Illinois
National Bank and Trust Company of Rockford, Illinois, National Indemnity Company and National
Fire and Marine Insurance Company and Sun Newspapers) and Diversified Retailing Company (owning
Hochschild, Kohn & Co. and Associated Cotton Shops). I want you to have ample time to study the
material relating to such companies before you make any decision to hold, sell or buy such securities
after distribution to you in early January. I will solicit written questions from partners (I don't want to
talk to you individually about such companies, as I want all partners to obtain exactly the same
information) and then have a further mailing late in December, giving all questions received relating to
these companies along with my answers, if possible.
I still anticipate having a plan enabling partners to
promptly convert such controlled company holdings to cash, if they wish.
(4)
About January 5th - (a) a cash distribution amounting to at least 56% (probably more - depending upon
what percentage of our remaining holdings are sold before yearend) of your January 1, 1969 capital, less
any distributions (the regular monthly payments many of you receive) or borrowings by you during
1969, (b) your proportional share of our holdings in Diversified Retailing Company Inc. and Berkshire
Hathaway Inc. I which, if you dispose of them, will bring 30% - 35% (my estimate of value will be
made at yearend) of your January 1, 1969 capital.
We may make substantial additional sales before yearend - if so, the early January cash distribution will
be somewhat larger than the 56% mentioned above. If we don't, such sales will be made during the first
half of 1970 and an interim distribution made.
Residual assets will be sold at appropriate times and I
believe not more than 10% of our present asset value will remain after June 30 th , 1970 pending a final
distribution when all assets and liabilities have been cleaned up.
Unless there is a further substantial decline in the market. I still expect about a breakeven performance
before any monthly payments for 1969. We were lucky - if we had not been in liquidation this year, our
results would have been significantly worse. Ideas that looked potentially interesting on a "continuing"
basis have on balance performed poorly to date. We have only two items of real size left - one we are
selling as I write this and the other is a holding of limited marketability representing about 7-1/2% of the
outstanding stock of Blue Chip Stamps which we may sell via a registered public offering around
yearend, depending upon market conditions and other factors.
132 (5)
March 1st. 1970 - John Harding expects to leave Buffett Partnership. Ltd.
and open a branch office in
Omaha for Ruane, Cunniff & Stires. Bill Scott and I will be available at BPL offices to help any
partners who are desirous of purchasing bonds, tax-free or taxable. We will set aside the month of
March to make our services available without cost to those who want to acquire bonds. Because of some
experience we have in analysis and purchasing, as well as the access we have to wholesale markets. I
think it is likely we can save material elements of cost as well as help select better relative values for
those of you who wish to invest in bonds. After April 1 st , however, we want to be out of any form of
personal advisory activity.
(6)
After March, 1970 - Bill and I will continue to office in Kiewit Plaza, spending a very minor portion of
our time completing the wind-up of BPL.
This will mean filing tax returns for 1970 and probably 1971
resolving minor assets and liabilities etc.
Now, to Bill Ruane - we met in Ben Graham's class at Columbia University in 1951 and I have had considerable
opportunity to observe his qualities of character, temperament and intellect since that time. If Susie and I were
to die while our children are minors, he is one of three trustees who have carte blanche on investment matters -
the other two are not available for continuous investment management for all partners, large or small.
There is no way to eliminate the possibility of error when judging humans particularly in regard to future
behavior in an unknown environment. However, decisions have to be made - whether actively or passively - and
I consider Bill to be an exceptionally high probability decision on character and a high probability one on
investment performance.
I also consider it likely that Bill will continue as a money manager for many years to
come.
Bill has recently formed a New York Stock Exchange firm, Ruane, Cunniff & Stires, Inc., 85 Broad Street, New
York, N.Y. 10004, telephone number (212) 344-6700. John Harding presently plans to establish an office for the
firm in Omaha about March 1st, 1970. Bill manages accounts individually on a fee basis and also executes
brokerage for the accounts - presently with some portion of the brokerage commissions used to offset a portion
of the investment advisory fee. His method of operation allows monthly withdrawals on a basis similar to BPL -
as a percentage of capital and unrelated to realized or unrealized gain or loss. It is possible he may form some
sort of pooled account but such determinations will be made between him and those of you who elect to go with
him. I, of course, will not be involved with his operation.
I am making my list of partners available to him and
he will be writing you fairly soon regarding a trip he plans to make before yearend to Omaha, Los Angeles and
Chicago, so that those of you who wish to meet him may do so. Any of you who are going to be in New York
during the next few months can contact him directly.
Bill's overall record has been very good-averaging fairly close to BPL's, but with considerably greater variation.
From 1956-1961 and from 1964-1968, a composite of his individual accounts averaged over 40% per annum.
However, in 1962, undoubtedly somewhat as a product of the euphoric experience of the earlier years, he was
down about 50%. As he re-oriented his thinking, 1963 was about breakeven.
While two years may sound like a short time when included in a table of performance, it may feel like a long
time when your net worth is down 50%.
I think you run this sort of short-term risk with virtually any money
manager operating in stocks and it is a factor to consider in deciding the portion of your capital to commit to
equities. To date in 1969, Bill is down about 15%, which I believe to be fairly typical of most money managers.
Bill, of course, has not been in control situations or workouts, which have usually tended to moderate the swings
in BPL year-to-year performance. Even excluding these factors, I believe his performance would have been
somewhat more volatile (but not necessarily poorer by any means) than mine - his style is different, and while
his typical portfolio (under most conditions) would tend to have a mild overlap with mine, there would always
be very significant differences.
133 Bill has achieved his results working with an average of $5 to $10 million.
I consider the three most likely
negative factors in his future to be: (1) the probability of managing significantly larger sums - this is a problem
you are going to have rather quickly with any successful money manager, and it will tend to moderate
performance; I believe Bill's firm is now managing $20 -$30 million and, of course, they will continue to add
accounts; (2) the possibility of Bill's becoming too involved in the detail of his operation rather than spending all
of his time simply thinking about money management. The problems of being the principal factor in a NYSE
firm as well as handling many individual accounts can mean that he, like most investment advisors, will be
subject to pressures to spend much of his time in activities that do nothing to lead to superior investment
performance.
In this connection, I have asked Bill to make his services available to all BPL partners - large or
small and he will, but I have also told him he is completely a free agent if he finds particular clients diverting
him from his main job; (3) the high probability that even excellent investment management during the next
decade will only produce limited advantages over passive management. I will comment on this below.
The final point regarding the negatives listed above is that they are not the sort of drawbacks leading to horrible
performance, but more likely the sort of things that lead to average performance. I think this is the main risk you
run with Bill - and average performance is just not that terrible a risk.
In recommending Bill, I am engaging in the sort of activity I have tried to avoid in BPL portfolio activities - a
decision where there is nothing to gain (personally) and considerable to lose.
Some of my friends who are not in
the Partnership have suggested that I make no recommendation since, if results were excellent it would do me
no good and, if something went wrong, I might well get a portion of the blame. If you and I had just had a
normal commercial relationship, such reasoning might be sound. However, the degree of trust partners have
extended to me and the cooperation manifested in various ways precludes such a "hands off" policy. Many of
you are professional investors or close thereto and need no advice from me on managers - you may well do
better yourself. For those partners who are financially inexperienced. I feel it would be totally unfair for me to
assume a passive position and deliver you to the most persuasive salesman who happened to contact you early in
Finally, a word about expectations. A decade or so ago was quite willing to set a target of ten percentage points
per annum better than the Dow, with the expectation that the Dow would average about 7%.
This meant an
expectancy for us of around 17%, with wide variations and no guarantees, of course - but, nevertheless, an
expectancy. Tax-free bonds at the time yielded about 3%. While stocks had the disadvantage of irregular
performance, overall they seemed much the more desirable option. I also stressed this preference for stocks in
teaching classes, participating in panel discussions, etc…
For the first time in my investment lifetime. I now believe there is little choice for the average investor between
professionally managed money in stocks and passive investment in bonds. If correct. this view has important
implications. Let me briefly (and in somewhat oversimplified form) set out the situation as I see it:
(1)
I am talking about the situation for, say, a taxpayer in a 40% Federal Income Tax bracket who also has
some State Income Tax to pay.
Various changes are being proposed in the tax laws, which may
adversely affect net results from presently tax-exempt income, capital gains, and perhaps other types of
investment income. More proposals will probably come in the future. Overall, I feel such changes over
the years will not negate my relative expectations about after-tax income from presently tax-free bonds
versus common stocks, and may well even mildly reinforce them.
(2)
I am talking about expectations over the next ten years - not the next weeks or months. I find it much
easier to think about what should develop over a relatively long period of time than what is likely in any
short period. As Ben Graham said: “In the long run, the market is a weighing machine - in the short run,
a voting machine.” I have always found it easier to evaluate weights dictated by fundamentals than
votes dictated by psychology.
134 (3)
Purely passive investment in tax-free bonds will now bring about 6-1/2%.
This yield can be achieved
with excellent quality and locked up for just about any period for which the investor wishes to contract.
Such conditions may not exist in March when Bill and I will be available to assist you in bond
purchases, but they exist today.
(4)
The ten year expectation for corporate stocks as a group is probably not better than 9% overall. say 3%
dividends and 6% gain in value. I would doubt that Gross National Product grows more than 6% per
annum - I don't believe corporate profits are likely to grow significantly as a percentage of GNP - and if
earnings multipliers don't change (and with these assumptions and present interest rates they shouldn't)
the aggregate valuation of American corporate enterprise should not grow at a long-term compounded
rate above 6% per annum. This typical experience in stocks might produce (for the taxpayer described
earlier) 1-3/4% after tax from dividends and 4-3/4% after tax from capital gain, for a total after-tax
return of about 6-1/2%.
The pre-tax mix between dividends and capital gains might be more like 4% and
5%, giving a slightly lower aftertax result. This is not far from historical experience and overall, I
believe future tax rules on capital gains are likely to be stiffer than in the past.
(5)
Finally, probably half the money invested in stocks over the next decade will be professionally
managed. Thus, by definition virtually, the total investor experience with professionally managed
money will be average results (or 6-1/2% after tax if my assumptions above are correct).
My judgment would be that less than 10% of professionally managed money (which might imply an
average of $40 billion just for this superior segment) handled consistently for the decade would average
2 points per annum over group expectancy. So-called "aggressively run" money is unlikely to do
significantly better than the general run of professionally managed money.
There is probably $50 billion
in various gradations of this "aggressive" category now - maybe 100 times that of a decade ago - and
$50 billion just can't "perform".
If you are extremely fortunate and select advisors who achieve results in the top 1% to 2% of the
country (but who will be working with material sums of money because they are that good), I think it is
unlikely you will do much more than 4 points per annum better than the group expectancy. I think the
odds are good that Bill Ruane is in this select category. My estimate . therefore, is that over the next
decade the results of really excellent management for our "typical taxpayer" after tax might be 1-3/4%
from dividends and 7-3/4% from capital gain.
or 9 –1.2% overall.
(6)
The rather startling conclusion is that under today's historically unusual conditions, passive investment
in tax-free bonds is likely to be fully the equivalent of expectations from professionally managed money
in stocks, and only modestly inferior to extremely well-managed equity money.
(7)
A word about inflation - it has very little to do with the above calculation except that it enters into the
6% assumed growth rate in GNP and contributes to the causes producing 6-1/2% on tax-free bonds. If
stocks should produce 8% after tax and bonds 4%, stocks are better to own than bonds, regardless of
whether prices go up, down or sidewise. The converse is true if bonds produce 6-1/2% after tax. and
stocks 6%. The simple truth, of course, is that the best expectable after-tax rate of return makes the most
sense - given a rising, declining or stable dollar.
All of the above should be viewed with all the suspicion properly accorded to assessments of the future.
It does
seem to me to be the most realistic evaluation of what is always an uncertain future - I present it with no great
feeling regarding its approximate accuracy, but only so you will know what I think at this time.
You will have to make your own decision as between bonds and stocks and, if the latter, who advises you on
135 such stocks. In many cases, I think the decision should largely reflect your tangible and intangible
(temperamental) needs for regularity of income and absence of large principal fluctuation, perhaps balanced
against psychic needs for some excitement and the fun associated with contemplating and perhaps enjoying
really juicy results. If you would like to talk over the problem with me, I will be very happy to help.
Sincerely,
Warren E. Buffett
WEB/glk
136 BUFFETT PARTNERSHIP.
LTD.
610 KIEWIT PLAZA
OMAHA, NEBRASKA 68131
TELEPHONE 042-4110
December 5 th
, 1969
To My Partners:
This letter is to supply you with some published information relating to our two controlled companies (and their
four principal operating components), as well as to give you my general views regarding their operations. My
comments are not designed to give you loads of detailed information prospectus-style, but only my general
"slant" as I see the businesses at this time.
At yearend, BPL will own 800,000 of 1,000,000 shares outstanding of Diversified Retailing Company. First
Manhattan Company and Wheeler, Munger & Company will each own 100,000 shares. DRC previously owned
100% of Hochschild, Kohn & Company of Baltimore, and currently owns 100% of Associated Retail Stores
(formerly named Associated Cotton Shops). On December 1st, DRC sold its entire interest in H-K to
Supermarkets General Corp.
for $5,045,205 of cash plus non-interest bearing SGC notes for $2 million due 2-1-
70, and $4,540,000 due 2-1-71. The present value of these notes approximates $6.0 million so, effectively, DRC
received about $11 million on the sale. Various warranties were made by DRC in connection with the sale, and,
while we expect no claims pursuant to the contract, a remote contingent liability always exists while warranties
are in force.
Associated Retail Stores has a net worth of about $7.5 million. It is an excellent business with a strong financial
position, good operating margins and a record of increasing sales and earnings in recent years. Last year, sales
were about $37.5 million and net income about $1 million.
This
year should see new records in sales and earnings, with my guess on the latter to be in the area of $1.1 million
after full taxes.
DRC has $6.6 million in debentures outstanding (prospectus with full description of the business as of
December 18th, 1967 and the debenture terms will be sent you upon request) which have one unusual feature in
that if I, or an entity controlled by me, is not the largest shareholder of DRC, the debentureholders have the right
to present their debentures for payment by the company at par.
Thus, DRC has tangible net assets of about $11.50 - $12.00 per share, an excellent operating business and
substantial funds available for reinvestment in other operating businesses. On an interim basis, such funds will
be employed in marketable securities.
Berkshire Hathaway Inc. has 983,582 shares outstanding, of which BPL owns 691,441.
B-H has three main
operating businesses, the textile operation, the insurance operation (conducted by National Indemnity Company
and National Fire & Marine Insurance Company, which will be collectively called the insurance company) and
the Illinois National Bank and Trust Company of Rockford, Illinois. It also owns Sun Newspapers Inc, Blacker
Printing Company and 70% of Gateway Underwriters, but these operations are not financially significant
relative to the total.
The textile operation presently employs about $16 per share in capital and, while I think it has made some
progress relative to the textile industry generally, cannot be judged a satisfactory business. Its return on capital
has not been sufficient to support the assets employed in the business and, realistically, an adequate return has
less than an even chance of being averaged in the future. It represents the best segments of the business that
existed when we purchased control four and one-half years ago.
Capital from the other segments has been
137 successfully redeployed - first, on an interim basis into marketable securities and, now on a permanent basis into
insurance and banking. I like the textile operating people - they have worked hard to improve the business under
difficult conditions - and, despite the poor return, we expect to continue the textile operation as long as it
produces near current levels.
The insurance operation (of which B-H owns virtually 100%) and the bank (where B-H owns 97.7%) present a
much happier picture. Both are first-class businesses, earning good returns on capital and stacking up well on
any absolute or comparative analysis of operating statistics. The bank has about $17 per share of net tangible
assets applicable to B-H, and the insurance company approximately $15.
I would estimate their normal current
earning power to be about $4 per share (compared to about $3.40 from operations pro-forma in 1968), with good
prospects for future growth on the combined $32 of tangible net assets in the bank and insurance company.
Adding in the textile business and miscellaneous assets, and subtracting parent company bank debt of about $7
million, gives a tangible net asset value of about $43 per share for B-H, or about $45 stated book value, allowing
for the premium over tangible assets paid for the bank.
One caveat - when I talk above of tangible net assets. I am valuing the $75 million of bonds held by the
insurance company and bank at amortized cost. This is in accord with standard accounting procedures used in
those industries and also in accord with the realities of their business operations where it is quite unlikely that
bonds will have to be sold before maturity.
At today's historically low bond prices, however, our bonds have a
market value substantially below carrying value, probably on the order of $10 per share of B-H stock.
Between DRC and B-H, we have four main operating businesses with three of them in my opinion, definitely
first class by any of the usual standards of evaluation. The three excellent businesses are all run by men over
sixty who are largely responsible for building each operation from scratch. These men are hard working,
wealthy, and good – extraordinarily good. Their age is a negative, but it is the only negative applicable to them.
One of the reasons I am happy to have a large segment of my capital in B-H and DRC is because we have such
excellent men in charge of the operating businesses.
We have various annual reports, audits, interim reports, proxy materials prospectuses, etc… applicable to our
control holdings and we will be glad to supply you with any item you request.
I also solicit your written
questions and will send to all partners the questions and answers shortly before yearend. Don't hesitate to ask
any question at all that comes to mind - if it isn't clear to you, it probably isn't clear to others - and there is no
reason for any of you to be wondering about something that I might clear up.
DRC and B-H presently pay no dividends and will probably pay either no dividends or very modest dividends
for some years to come. There are a number of reasons for this. Both parent companies have borrowed money -
we want to maintain a good level of protection for depositors at the bank and policyholders at the insurance
company - some of the operating companies have very satisfactory ways to utilize additional capital - and we are
hopeful of finding new businesses to both diversify and augment our earning power.
My personal opinion is that the intrinsic value of DRC and B-H will grow substantially over the years.
While no
one knows the future, I would be disappointed if such growth wasn't at a rate of approximately 10% per annum.
Market prices for stocks fluctuate at great amplitudes around intrinsic value but, over the long term, intrinsic
value is virtually always reflected at some point in market price. Thus, I think both securities should be very
decent long-term holdings and I am happy to have a substantial portion of my net worth invested in them. You
should be unconcerned about short-term price action when you own the securities directly, just as you were
unconcerned when you owned them indirectly through BPL. I think about them as businesses, not “stocks”, and
if the business does all right over the long term, so will the stock.
I want to stress that I will not be in a managerial or partnership status with you regarding your future holdings of
such securities. You will be free to do what you wish with your stock in the future and so, of course, will I.
I
138 think that there is a very high probability that I will maintain my investment in DRC and B-H for a very long
period, but I want no implied moral commitment to do so nor do so nor do I wish to advise others over an
indefinite future period regarding their holdings. The companies, of course, will keep all shareholders advised of
their activities and you will receive reports as issued by them, probably on a semi-annual basis. Should I
continue to hold the securities, as I fully expect to do, my degree of involvement in their activities may vary
depending upon my other interests. The odds are that I will take an important position on matters of policy, but I
want no moral obligation to be other than a passive shareholder, should my interests develop elsewhere.
We presently plan to make the initial BPL cash distribution on January 5th, which will now come to at least
64% of January 1, 1969 capital less any distributions (including monthly payments) you have received from us
since January 1, 1969.
There is now pending a public offering, headed by Merrill, Lynch, Pierce, Fenner &
Smith, of our Blue Chip Stamps holdings which, if completed this month as expected, should bring the figure to
at least 70%.
If you wish Bill and me to give you our ideas regarding bonds in March, you should purchase U.S. Treasury
Bills maturing in late March with the applicable portion of the January 5th distribution. Then advise us in the
last week of February of the amount you wish to invest in bonds and we will let you know our thoughts.
About the middle of January (as soon as the exact amounts are figured and shares are received from the Transfer
Agent after having been registered in your name) we will distribute the DRC and B-H stock applicable to your
partnership interest and subsequently advise you of your tax basis and acquisition date attributable to the stock.
Such shares will be "legended" as described in the enclosed letter from Monen, Seidler & Ryan.
These stock
certificates are valuable and should be kept in a safe place.
In past letters I had expressed the hope that BPL could supply a mechanism whereby you could, if you wished,
automatically convert your DRC and B-H to cash. I have had two law firms consider extensively the status of
these shares in your hands following the liquidation and the accompanying letters (which should be saved and
kept with the shares) give their conclusions. As you can see, it is not an area that produces simple, clear-cut
guidelines. I see no prudent way to implement the alternatives I had previously been considering. Therefore, you
must follow the guidelines they set forth if you wish to dispose of your shares. As you probably realize, the
restrictions on subsequent sale apply more severely to Susie and me (because of my continued "insider"
position) than they probably do to you. Substantial quantities of securities often are sold via the "private sale"
option described in paragraph (3) of the opinion.
If the rules become clearer or more simplified in the future, I
will be sure to let you know.
At the time of distribution of DRC and B-H, I will advise you of the values applied to such shares at 1969
yearend. You will receive our audit and tax letter about the end of January. It presently appears that sale of our
Blue Chip shares and a substantial increase in value of DRC and B- H will bring our overall gain for the year to
slightly over 6%.
My next letter will be in late December, summarizing the questions and answers regarding DRC and B-H. and
also supplying a final estimate on the January 5th cash distribution.
Warren E. Buffett
WEBI glk
Enclosures:
Legal opinion. Monen, Seidler & Ryan
Concurring opinion, Munger, Tolles. Hills & Rickershauser 1968 Annual Report. Berkshire Hathaway. Inc.
1969 Semi-Annual Report. Berkshire Hathaway. Inc.
April 3. 1969 letter to Shareholders. Berkshire Hathaway. Inc. 1968 Annual Report. Diversified Retailing
139 Company.
Inc.
Financial information regarding Associated Retail Stores. Inc. Financial information regarding Illinois National
Bank & Trust Co. 1969 Best's Report. National Indemnity Company
1969 Best's Report. National Fire & Marine Insurance Company
140 BUFFETT PARTNERSHIP. LTD.
610 KIEWIT PLAZA
OMAHA, NEBRASKA 68131
TELEPHONE 042-4110
December 26, 1969
To My Partners:
Our plans regarding the initial cash distribution have been finalized and we expect to mail to you on January 3rd
a check dated January 5 th , 1970 for approximately 64% of your January 1st. 1969 capital, less any distributions
made to you (including monthly payments) since January 1st. 1969. If you have taken no monthly payments
during 1969, there will be a small interest adjustment in your favor; if you have had loans from BPL, there will
be an interest charge. I couldn't be more delighted about the action of the bond and stock markets from the
standpoint of the timing of our liquidation.
I believe practically all partners - whether they would have invested
in bonds or stocks - will be far better off receiving the cash now than if we had liquidated at the end of last year.
Those seeking income will receive about 40% more after tax on the same principal investment than they would
have achieved only a year ago at what then seemed like generous yields.
Our tax picture is virtually complete and it appears that you will have ordinary income (dividends plus interest
income less ordinary loss) for Federal tax purposes of about 3 –3/4% of your January 1st. 1969 capital (item 1 in
enclosed letter), no significant long-term capital gain or loss, and a short-term capital loss of about 8-1/2% of
your January 1 st , 1969 unrealized appreciation (item 3). These estimates are just rough approximations -
definitive figures will reach you in early February.
The sale of our 371,400 shares of Blue Chip Stamps was not completed in 1969.
When the stock went into
registration, it was selling at about $24 per share. The underwriters indicated a range where they expected to
offer our shares (along with others) with heavy weight placed on a comparison with Sperry & Hutchinson.
Shortly before the stock was to be offered, with the Dow-Jones Industrials much lower but S & H virtually
unchanged, they indicated a price below their former range. We reluctantly agreed and felt we had a deal but, on
the next business day, they stated that our agreed price was not feasible. We then withdrew and a much smaller
offering was done.
I intend to hold our block of Blue Chip Stamps in BPL for a more advantageous disposal or eventual distribution
to our partners. The odds are decent that we will do better in this manner -even if it takes a year or two - than if
we had participated in a very large sale into a somewhat distressed market.
Unless there is a material change in
the market in the next few days, I plan to value our Blue Chip holdings at yearend at the price received by
selling shareholders on the public offering after underwriting discount and expenses.
Various questions have been asked pursuant to the last letter:
If we are not getting a good return on the textile business of Berkshire Hathaway Inc., why do we
continue to operate it?
Pretty much for the reasons outlined in my letter. I don't want to liquidate a business employing 1100 people
when the Management has worked hard to improve their relative industry position, with reasonable results,
and as long as the business does not require substantial additional capital investment. I have no desire to
trade severe human dislocations for a few percentage points additional return per annum.
Obviously, if we
faced material compulsory additional investment or sustained operating losses, the decision might have to
be different, but I don't anticipate such alternatives.
141 2.
How large is our investment in Sun Newspapers, etc., and do we intend to expand in the newspaper,
radio and TV business?
The combined investment in Sun, Blacker Printing and Gateway Underwriters is a little over $1 per share of
Berkshire Hathaway, and earns something less than 10 cent per share. We have no particular plans to
expand in the communication field.
What does Gateway Underwriters do?
Gateway Underwriters serves primarily as a General Agent for National Indemnity Company in the State of
Missouri.
Are there good "second men" to take over from the men running the three excellent operating
businesses?
In any company where the founder and chief driving force behind the enterprise is still active, it is very
difficult to evaluate "second men".
The only real way to see how someone is going to do when running a
company is to let him run it. Some of our businesses have certainly been more "one-man shows" than the
typical corporation. Subject to the foregoing caveat, I think that we do have some good “second men”
coming along.
In what area do you plan to invest the cash in Diversified Retailing Company and do you intend to stick
primarily to the retailing field?
While we prefer the retailing field, we do not preclude anything that will make sense. We have been looking
without success for two years for an intelligent acquisition for DRC, so we are not about to rule out any
industry, if the business looks good.
Pending such time as we find one or more operating businesses to buy,
the money will be invested in marketable securities.
Why didn't DRC payout the money it received on the sale of Hochschild, Kohn & Company?
In addition to the fact that such a payment would constitute a dividend, taxable in significant part as
ordinary income, there are restrictions in the bond indenture which prevent such a pay-out without turning
over control of the company to the bondholders.
Will distribution of the DRC stock cause the DRC debentures to be called?
After distribution of the stock, I will be the largest stockholder in DRC and, hence, the call provision will
not apply.
How would we know if the DRC debentures were called?
All stockholders and debenture holders would find out directly from the company through regular or special
reports that the company issues to its security holders.
There is no intention at all of calling the debentures.
Why did you not register our Berkshire Hathaway and Diversified Retailing shares so that the stock,
when received by the partners, would be freely marketable?
We considered this possibility but rejected it for both practical and legal considerations. I will just discuss
the practicalities, since they would independently dictate the decision we made.
142 There is presently no existing market for Diversified Retailing, and our holdings of Berkshire Hathaway are
probably four or five times the present floating supply of this stock. An attempt to quickly buy or sell a few
thousand shares can easily move BH stock several points or more. We own 691,441 shares.
Were we to
distribute these stocks to you via a registration without an underwriting, and with the possibility that a
substantial portion would be offered for sale by many sellers operating individually but virtually
simultaneously, there is a real likelihood, particularly in a stock market environment such as we have seen
recently, that the market for these two stocks would be little short of chaotic. It has not seemed to me that
this was the kind of situation with which I should leave you, both from the standpoint of the price level
which might prevail, as well as for the reason that different partners might well have to liquidate at widely
varying price levels. The more sophisticated partners might have an important edge on the less sophisticated
ones, and I believe many partner’s might have no chance to realize the prices I anticipate using for yearend
valuation.
This would rightly seem most unfair to you, since I would have received some allocation of 1969
BPL profits based upon these yearend valuations. If the markets were to become distressed, I would
probably come in for criticism, whether I personally bought at lower prices or, perhaps more so, if I
refrained from buying.
Were we to attempt to sponsor an underwriting in connection with a registration for those partners who
might wish to sell, there would be, in my opinion, the likelihood that the result would still be far less than
satisfactory. We have just been around this track with our holdings of Blue Chip Stamps, where we watched
the price of our stock go from 24 to 16-1/2 after announcement of the underwriting, of which we originally
were to be a part.
I did not want this sort of result for the partners with respect to their holdings of Berkshire
and Diversified.
It is my belief that, by confining sales to private placements, those partners who wish to sell will realize
more for their stock (with the sophisticated partners having no marketing edge on the less knowledgeable)
than would be achieved, through an underwriting at this time. Also, the stock should be more likely to find
its way into the hands of long-term investment-minded holders, which should mean less volatile markets in
the future. We have had several phone calls from persons indicating that they wish to make private sales -
we anticipate there will be no difficulty in effectuating such sales at prices related to our yearend valuations.
Those partners who would prefer an underwritten distribution always have the option of having a
registration of their own.
I will be glad to facilitate this by placing all partners in touch with each other who
indicate to me their desire to sell via a registered underwriting, at their expense and through an underwriter
of their choice. In this way the expense of an underwriting, which can be considerable, would be borne by
the selling partners and not by the partners as a whole.
I have also had partners ask if they could participate in a registered offering in the future if I should sell
shares in this manner. I think it is almost certain I will never sell stock via public offering but, should it ever
happen, I will be glad to let any of you participate in any underwritten offering in which I might be
involved. In all probability, if it ever did happen, your stock would already be “free”, although mine would
still be restricted.
I cannot make the same commitment to you regarding any private sale I might make in the
future, just as I can't expect you to restrict any sale options you might have in order to include me.
Will you let us know if you sell your holdings of BH or DRC?
You would undoubtedly know from corporate communications, reports in the press and reports to
Government agencies if I disposed of my holdings. I have no intention at all of doing so in the foreseeable
future - I merely make no commitment not to. However, former BPL partners will have no priority over
other BH or DRC security holders in obtaining information relating to their corporate activities.
Should I hold my BH or DRC stock?
143 I can’t give you the answer on this one. All I can say is that I’m going to do so and I plan to buy more. I am
very happy to have a material portion of my net worth invested in these companies on a long term basis.
Obviously, I think they will be worth significantly more money five or ten years hence.
Compared to most
stocks, I think there is a low risk of loss. I hope their price patterns follow a rather moderate range related to
business results rather than behaving in a volatile manner related to speculative enthusiasm or depression.
Obviously, I cannot control the latter phenomena, but there is no intent to "promote" the stocks a la much of
the distasteful general financial market activity of recent years.
Can I give either BH or DRC shares to my wife or children?
We are advised by counsel that this is permissible but, of course the same restrictions on transfer that
applied to you would apply to the donee of the gift.
Why are you waiting until March to give us your suggestions regarding bonds?
January and February promise to be very busy months. Many partners may want to talk to me about their
questions and objectives regarding bonds. I want to have all important BPL matters out of the way before I
talk with any of them on an individual basis.
I make no forecasts regarding the bond market (or stock
market) - it may be higher or lower in March than now. After my October letter, several partners became
very eager to buy bonds immediately - to date they are much better off by waiting. The excellent quality tax-
free bonds I talked about at that time with yields of 6 -1/2% can now be bought to yield about 7%.
Cordially,
Warren E. Buffett
WEB/glk
144 BUFFETT PARTNERSHIP. LTD.
610 KIEWIT PLAZA
OMAHA, NEBRASKA 68131
TELEPHONE 042-4110
February 25 th , 1970
To My Partners:
This letter will attempt to provide a very elementary education regarding tax-exempt bonds with emphasis on
the types and maturities of bonds which we expect to help partners in purchasing next month. If you expect to
use our help in the purchase of bonds, it is important that you carefully read (and, if necessary , reread) this
letter as it will serve as background for the specific purchases I suggest.
If you disagree with me as to
conclusions regarding types of bonds or maturities (and you would have been right and I would have been
wrong if you had disagreed with me on the latter point either one or two years ago), you may well be correct, but
we cannot be of assistance to you in the purchase of bonds outside our area. We will simply have our hands full
concentrating in our recommended area, so will be unavailable to assist or advise in the purchase of convertible
bonds, corporate bonds or short term issues.
I have tried to boil this letter down as much as possible. Some of it will be a little weighty - some a little over-
simplified. I apologize for the shortcomings in advance. I have a feeling I am trying to put all the meat of a 100
page book in 10 pages - and have it read like the funny papers.
I am sure you understand that our aid in the purchase of bonds will involve no future assistance regarding either
these specific bonds or general investment decisions.
I want to be available at this time to be of help because of
the unusual amount of cash you have received in one distribution from us. I have no desire to be in the
investment counseling business, directly or indirectly, and will not be available for discussion of financial
matters after March 31st.
The mechanics of Tax-Free Bonds.
For those who wish our help, we will arrange the purchase of bonds directly from municipal bond dealers
throughout the country and have them confirm sale of the bonds directly to you. The confirmation should be
saved as a basic document for tax purposes. You should not send a check to the bond dealer since he will deliver
the bonds to your bank, along with a draft which the bank will pay by charging your account with them. In the
case of bonds purchased in the secondary market (issues already outstanding), this settlement date will usually
be about a week after confirmation date whereas, on new issues, the settlement date may be as much as a month
later.
The settlement date is shown plainly on the confirmation ticket (in the case of new issues this will be the
second and final ticket rather than the preliminary "when issued" ticket), and you should have the funds at your
bank ready to pay for the bonds on the settlement date. If you presently own Treasury Bills, they can be sold on
a couple of days notice by your bank upon your instructions, so you should experience no problems in having
the money available on time. Interest begins to accrue to you on the settlement date, even if the bond dealer is
late in getting them delivered to your bank.
Bonds will be delivered in negotiable form (so-called "bearer" form which makes them like currency) with
145 coupons attached. Usually the bonds are in $5,000 denominations and frequently they can be exchanged for
registered bonds (sometimes at considerable expense and sometimes free-it depends upon the terms).
Bonds in
registered form are nonnegotiable without assignment by you, since you are the registered owner on the Transfer
Agent's books. Bonds trade almost exclusively on a bearer basis and it is virtually impossible to sell registered
bonds without converting them back into bearer form. Thus, unless you are going to own great physical
quantities of bonds. I recommend keeping bonds in bearer form. This means keeping them in a very safe place
and clipping the coupons every six months. Such coupons, when clipped, can be deposited in your bank account
just like checks. If you have $250,000 in bonds, this probably means about fifty separate pieces of paper ($5,000
denominations) and perhaps six or eight trips a year to the safe deposit section to cut and deposit coupons.
It is also possible to open a custody account with a bank where, for a fairly nominal cost, they will keep the
bonds, collect the interest and preserve your records for you.
For example, a bank will probably perform the
custodial service for you for about $200 a year on a
$250,000 portfolio. If you are interested in a custodial
account, you should talk to a Trust Officer at your commercial bank as to the nature of their services and cost.
Otherwise, you should have a safe deposit box.
Taxation
The interest received upon the deposit of coupons from tax-free bonds is, of course, free from Federal Income
Taxes. This means if you are at a 30% top Federal Income Tax bracket, a 6% return from tax-free bonds is
equivalent to about 8-1/2% from taxable bonds. Thus, for most of our partners, excluding minors or some retired
people, tax-free bonds will be more attractive than taxable bonds. For people with little or no income from
wages or dividends, but with substantial capital, it is possible that a combination of taxable bonds (to bring
taxable income up to about the 25% or 30% bracket) plus tax-free bonds will bring the highest total after-tax
income.
Where appropriate, we will work with you to achieve such a balance.
The situation in respect to State Income Taxes is more complicated. In Nebraska. where the State Income Tax is
computed as a percentage of the Federal Income Tax, the effect is that there is no state tax on interest from tax-
free bonds. My understanding of both the New York and California law is that tax-free bonds of entities within
the home state are not subject to State Income Tax, but tax-free bonds from other states are subject to the local
State Income Tax. I also believe that the New York City Income Tax exempts tax-free bonds of entities based
within the State of New York, but taxes those from other states. I am no expert on state income taxes and make
no attempt to post myself on changes taking place within the various states or cities. Therefore, I defer to your
local tax advisor, but simply mention these few general impressions so that you will be alert to the existence of a
potential problem.
In Nebraska there is no need to have any local considerations enter into the after-tax
calculation. Where out-of-state issues are subject to local taxation, the effective cost of your State or Municipal
Income Tax is reduced by the benefit received from deducting it on your Federal Income Tax return. This, of
course, varies with the individual. Additionally, in some states there are various taxes on intangible property
which may apply to all tax-free bonds or just those of out-of-state entities. There are none of these in Nebraska,
but I cannot advise on the other states.
When bonds are bought at a discount from par and later are sold or mature (come due and get paid), the
difference between the proceeds and cost is subject to capital gain or loss treatment. (There are minor exceptions
to this statement as, unfortunately, there are to most general statements on investments and taxes but they will
be pointed out to you should they affect any securities we recommend).
This reduces the net after-tax yield by a
factor involving the general rate of future capital gains taxes and the specific future tax position of the
individual. Later on, we will discuss the impact of such capital gains taxes in calculating the relative
attractiveness of discount bonds versus "full coupon" bonds.
Finally, one most important point. Although the law is not completely clear, you should probably not
contemplate owning tax-free bonds if you have, or expect to have, general purpose bank or other indebtedness.
146 The law excludes the deductibility of interest on loans incurred or continued to purchase or carry tax-free bonds,
and the interpretation of this statute will probably tend to be broadened as the years pass.
For example, my
impression is that you have no problem if you have a mortgage against real property (unless the debt was
incurred in order to acquire municipal bonds) in deducting the mortgage interest on your Federal Tax return,
even though you own tax-free bonds at the same time. However, I believe that if you have a general bank loan,
even though the proceeds were directly used to purchase stocks, a handball court, etc. and the tax-free bonds are
not used for security for the loan, you are asking for trouble if you deduct the interest and, at the same time, are
the owner of tax-free bonds. Therefore, I would pay off bank loans before owning tax-free bonds, but I leave
detailed examination of this question to you and your tax advisor. I merely mention it to make you aware of the
potential problem.
Marketability
Tax-free bonds are materially different from common stocks or corporate bonds in that there are literally
hundreds of thousands of issues, with the great majority having very few holders.
This substantially inhibits the
development of close, active markets. Whenever the City of New York or Philadelphia wants to raise money it
sells perhaps twenty, thirty or forty non-identical securities, since it will offer an issue with that many different
maturities. A 6% bond of New York coming due in 1980 is a different animal from a 6% bond of New York
coming due in 1981. One cannot be exchanged for the other, and a seller has to find a buyer for the specific item
he holds. When you consider that New York may offer bonds several times a year, it is easy to see why just this
one city may have somewhere in the neighborhood of 1,000 issues outstanding. Grand Island, Nebraska may
have 75 issues outstanding. The average amount of each issue might be $100,000 and the average number of
holders may be six or eight per issue. Thus, it is absolutely impossible to have quoted markets at all times for all
issues and spreads between bids and offers may be very wide.
You can't set forth in the morning to buy a
specific Grand Island issue of your choosing. It may not be offered at any price, anywhere, and if you do find
one seller, there is no reason why he has to be realistic compared to other offerings of similar quality. On the
other hand, there are single issues such as those of the Ohio Turnpike, Illinois Turnpike, etc. that amount to
$200 million or more and have thousands of bondholders owning a single entirely homogeneous and
interchangeable issue. Obviously, here you get a high degree of marketability.
My impression is that marketability is generally a function of the following three items, in descending order of
importance: (1) the size of the particular issue; (2) the size of the issuer (a $100,000 issue of the State of Ohio
will be more marketable than a $100,000 issue of Podunk, Ohio); and (3) the quality of the issuer. By far the
most sales effort goes into the selling of new issues of bonds.
An average of over $200 million per week of new
issues comes up for sale, and the machinery of bond distribution is geared to get them sold, large or small. In my
opinion, there is frequently insufficient differential in yield at time of issue for the marketability differences that
will exist once the initial sales push is terminated. We have frequently run into markets in bonds where the
spread between bid and asked prices may get to 15%. There is no need to buy bonds with the potential for such
grotesque markets (although the profit spread to the dealer who originally offers them is frequently wider than
on more marketable bonds) and we will not be buying them for you. The bonds we expect to buy will usually
tend to have spreads (reflecting the difference between what you would pay net for such bonds on purchase and
receive net on sale at the same point in time) of from 2% to 5%.
Such a spread would be devastating if you
attempted to trade in such bonds, but I don't believe it should be a deterrent for a long-term investor. The real
necessity is to stay away from bonds of very limited marketability - which frequently are the type local bond
dealers have the greatest monetary incentive to push.
Specific Areas of Purchase
We will probably concentrate our purchases in the following general areas:
(1)
Large revenue-producing public entities such as toll roads, electric power districts, water districts, etc.
147 Many of these issues possess high marketability, are subject to quantitative analysis, and sometimes
have favorable sinking fund or other factors which tend not to receive full valuation in the market place.
(2)
Industrial Development Authority bonds which arise when a public entity holds title to property leased
to a private corporation. For example, Lorain, Ohio holds title to an $80 million project for U.S. Steel
Corp.
The Development Authority Board issued bonds to pay for the project and has executed a net and
absolute lease with U.S. Steel to cover the bond payments. The credit of the city or state is not behind
the bonds and they are only as good as the company that is on the lease. Many top-grade corporations
stand behind an aggregate of several billion dollars of these obligations, although new ones are being
issued only in small amounts ($5 million per project or less) because of changes in the tax laws. For a
period of time there was a very substantial prejudice against such issues, causing them to sell at yields
considerably higher than those commensurate with their inherent credit standing. This prejudice has
tended to diminish, reducing the premium yields available, but I still consider it a most attractive field.
Our insurance company owns a majority of its bonds in this category.
(3)
Public Housing Authority Issues for those of you who wish the very highest grade of tax-free bonds.
In
effect, these bonds bear the guarantee of the U.S. Government, so they are all rated AAA. In states
where local taxes put a premium on buying in-state issues, and I can’t fill your needs from (1) and (2) ,
my tendency would be to put you into Housing Authority issues rather than try to select from among
credits that I don't understand. If you direct me to buy obligations of your home state, you should expect
substantial quantities of Housing Authority issues. There is no need to diversify among such issues, as
they all represent the top credit available.
(4)
State obligations of a direct or indirect nature.
You will notice I am not buying issues of large cities. I don't have the faintest idea how to analyze a New York
City, Chicago, Philadelphia, etc. (a friend mentioned the other day when Newark was trying to sell bonds at a
very fancy rate that the Mafia was getting very upset because Newark was giving them a bad name).
Your
analysis of a New York City - and I admit it is hard to imagine them not paying their bills for any extended
period of time - would be as good as mine. My approach to bonds is pretty much like my approach to stocks. If I
can't understand something, I tend to forget it. Passing an opportunity which I don't understand - even if
someone else is perceptive enough to analyze it and get paid well for doing it - doesn't bother me. All I want to
be sure of is that I get paid well for the things I do feel capable of handling - and that I am right when I make
affirmative decisions.
We will probably tend to purchase somewhere between five and ten issues for most of you. However, if you
wish to limit me to your home state, it may be fewer issues - and perhaps those will only be Housing
Authorities. We will try not to buy in smaller than $25,000 pieces and will prefer larger amounts where
appropriate. Smaller lots of bonds are usually penalized upon resale, sometimes substantially.
The bond
salesman doesn't usually explain this to you when you buy the $10,000 of bonds from him, but it gets explained
when you later try to sell the $10,000 to him. We may make exceptions where we are buying secondary market
issues in smaller pieces - but only if we are getting an especially good price on the buy side because of the small
size of the offering.
Callable Bonds
We will not buy bonds where the issuer of the bonds has a right to call (retire) the bonds on a basis which
substantially loads the contract in his favor. It is amazing to me to see people buy bonds which are due in forty
years, but where the issuer has the right to call the bonds at a tiny premium in five or ten years. Such a contract
essentially means that you have made a forty year deal if it is advantageous to the issuer (and disadvantageous to
you) and a five year deal if the initial contract turns out to be advantageous to you (and disadvantageous to the
148 issuer).
Such contracts are really outrageous and exist because bond investors can't think through the
implications of such a contract form and bond dealers don't insist on better terms for their customers. One
extremely interesting fact is that bonds with very unattractive call features sell at virtually the same yield as
otherwise identical bonds which are noncallable.
It should be pointed out that most Nebraska bonds carry highly unfair call provisions. Despite this severe
contractual disadvantage, they do not offer higher yields than bonds with more equitable terms.
One way to avoid this problem is to buy bonds which are totally noncallable. Another way is to buy discount
bonds where the right of the issuer to call the bond is at a price so far above your cost as to render the possible
call inconsequential. If you buy a bond at 60 which is callable at 103, the effective cost to you of granting the
issuer the right to prematurely terminate the contract (which is a right you never have) is insignificant.
But to
buy a bond of the Los Angeles Department of Water and Power at 100 to come due at 100 in 1999 or to come
due at
104 in 1974, depending on which is to the advantage of the issuer and to your disadvantage, is the height of
foolishness when comparable yields are available on similar credits without such an unfair contract.
Nevertheless, just such a bond was issued in October, 1969 and similar bonds continue to be issued every day. I
only write at such length about an obvious point, since it is apparent from the continual sale of such bonds that
many investors haven't the faintest notion how this loads the dice against them and many bond salesmen aren't
about to tell them.
Maturity and the Mathematics of Bonds
Many people, in buying bonds, select maturities based on how long they think they are going to want to hold
bonds, how long they are going to live, etc. While this is not a silly approach, it is not necessarily the most
logical.
The primary determinants in selection of maturity should probably be (1) the shape of the yield curve;
(2) your expectations regarding future levels of interest rates and (3) the degree of quotational fluctuation you
are willing to endure or hope to possibly profit from. Of course, (2) is the most important but by far the most
difficult upon which to comment intelligently.
Let's tackle the yield curve first. When other aspects of quality are identical, there will be a difference in interest
rates paid based upon the length of the bond being offered. For example, a top grade bond being offered now
might have a yield of 4.75% if it came due in six or nine months, 5.00% in two years, 5.25% in five years,
5.50% in ten years and 6.25% in twenty years. When long rates are substantially higher than short rates, the
curve is said to be strongly positive. In the U. S.
Government bond market, rates recently have tended to
produce a negative yield curve; that is, a long term Government bond over the last year or so has consistently
yielded less than a short term one. Sometimes the yield curve has been very flat, and sometimes it is positive out
to a given point, such as ten years, and then flattens out. What you should understand is that it varies, often very
substantially, and that on an historical basis the present slope tends to be in the high positive range. This doesn't
mean that long bonds are going to be worth more but it does mean that you are being paid more to extend
maturity than in many periods. If yields remained constant for several years, you would do better with longer
bonds than shorter bonds, regardless of how long you intended to hold them.
The second factor in determining maturity selection is expectations regarding future rate levels. Anyone who has
done much predicting in this field has tended to look very foolish very fast.
I did not regard rates as unattractive
one year ago, and I was proved very wrong almost immediately. I believe present rates are not unattractive and I
may look foolish again. Nevertheless, a decision has to be made and you can make just as great a mistake if you
buy short term securities now and rates available on reinvestment in a few years are much lower.
The final factor involves your tolerance for quotational fluctuation. This involves the mathematics of bond
investment and may be a little difficult for you to understand. Nevertheless, it is important that you get a general
149 grasp of the principles. Let's assume for the moment a perfectly flat yield curve and a non-callable bond. Further
assume present rates are 5% and that you buy two bonds, one due in two years and one due in twenty years.
Now assume one year later that yields on new issues have gone to 3% and that you wish to sell your bonds.
Forgetting about market spreads, commissions, etc.
, you will receive $1,019.60 for the original two year $1,000
bond (now with one year to run) and $1,288.10 for the nineteen year bond (originally twenty years). At these
prices, a purchaser will get exactly 3% on his money after amortizing the premium he has paid and cashing the
stream of 5% coupons attached to each bond. It is a matter of indifference to him whether to buy your nineteen
year 5% bond at $1,288.10 or a new 3% bond (which we have assumed is the rate current - one year later) at
$1,000.00. On the other hand, let's assume rates went to 7%. Again we will ignore commissions, capital gains
taxes on the discount, etc. Now the buyer will only pay $981.00 for the bond with one year remaining until
maturity and $791.60 for the bond with nineteen years left.
Since he can get 7% on new issues, he is only
willing to buy your bond at a discount sufficient so that accrual of this discount will give him the same
economic benefits from your 5% coupon that a 7% coupon at $1,000.00 would give him.
The principle is simple. The wider the swings in interest rates and the longer the bond, the more the value of a
bond can go up or down on an interim basis before maturity. It should be pointed out in the first example where
rates went to 3%, our long term bond would only have appreciated to about $1,070.00 if it had been callable in
five years at par, although it would have gone down just as much if 7% rates had occurred. This just illustrates
the inherent unfairness of call provisions.
For over two decades, interest rates on tax-free bonds have almost continuously gone higher and buyers of long
term bonds have continuously suffered.
This does not mean it is bad now to buy long term bonds - it simply
means that the illustration in the above paragraph has worked in only one direction for a long period of time and
people are much more conscious of the downside risks from higher rates than the upside potential from lower
ones.
If it is a 50-50 chance as to the future general level of interest rates and the yield curve is substantially positive,
then the odds are better in buying long term non-callable bonds than shorter term ones. This reflects my current
conclusion and, therefore, I intend to buy bonds within the ten to twenty-five year range. If you have any
preferences within that range, we will try to select bonds reflecting such preferences, but if you are interested in
shorter term bonds, we will not be able to help you as we are not searching out bonds in this area.
Before you decide to buy a twenty year bond, go back and read the paragraph showing how prices change based
upon changes in interest rates.
Of course, if you hold the bond straight through, you are going to get the
contracted rate of interest, but if you sell earlier, you are going to be subject to the mathematical forces
described in that paragraph, for better or for worse. Bond prices also change because of changes in quality over
the years but, in the tax-free area, this has tended to be - and probably will continue to be - a relatively minor
factor compared to the impact of changes in the general structure of interest rates.
Discount Versus Full Coupon Bonds
You will have noticed in the above discussion that if you now wanted to buy a 7% return on a nineteen year
bond, you had a choice between buying a new nineteen year bond with a 7% coupon rate or buying a bond with
a 5% coupon at $791.60, which would pay you $1,000.00 in nineteen years. Either purchase would have yielded
exactly 7% compounded semi-annually to you. Mathematically, they are the same.
In the case of tax-free bonds
the equation is complicated, however, by the fact that the $70.00 coupon is entirely tax-free to you, whereas the
bond purchased at a discount gives you tax-free income of $50.00 per year but a capital gain at the end of the
nineteenth year of $208.40. Under the present tax law, you would owe anything from a nominal tax, if the gain
from realization of the discount was your only taxable income in the nineteenth year, up to a tax of over $70.00
if it came on top of very large amounts of capital gain at that time (the new tax law provides for capital gain
rates of 35%, and even slightly higher on an indirect basis in 1972 and thereafter for those realizing very large
150 gains.) In addition to this, you might have some state taxes to pay on the capital gain.
Obviously, under these circumstances you are not going to pay the $791.60 for the 5% coupon and feel you are
equally as well off as with the 7% coupon at $1,000.00. Neither is anyone else.
Therefore, identical quality
securities with identical maturities sell at considerably higher gross yields when they have low coupons and are
priced at discounts than if they bear current high coupons.
Interestingly enough, for most taxpayers, such higher gross yields over-compensate for the probable tax to be
paid. This is due to several factors. First, no one knows what the tax law will be when the bonds mature and it is
both natural and probably correct to assume the tax rate will be stiffer at that time than now. Second, even
though a 5% coupon on a $1,000.00 bond purchased at $791.60 due in nineteen years is the equivalent of a 7%
coupon on a $1,000.00 bond purchased at par with the same maturity, people prefer to get the higher current
return in their pocket.
The owner of the 5% coupon bond is only getting around 6.3% current yield on his
$791.60 with the balance necessary to get him up to 7% coming from the extra $208.40 he picks up at the end.
Finally, the most important factor affecting prices currently on discount bonds (and which will keep affecting
them) is that banks have been taken out of the market as buyers of discount tax-free bonds by changes brought
about in bank tax treatment through the 1969 Tax Reform Act. Banks have historically been the largest
purchasers and owners of tax-free bonds and anything that precludes them from one segment of the market has
dramatic effects on the supply-demand situation in that segment.
This may tend to give some edge to individuals
in the discount tax-free market, particularly those who are not likely to be in a high tax bracket when the bonds
mature or are sold.
If I can get a significantly higher effective after-tax yield (allowing for sensible estimates of your particular
future tax rate possibilities), I intend to purchase discount bonds for you. I know some partners prefer full
coupon bonds, even though their effective yield is less, since they prefer to maximize the current cash yield and
if they will so advise me, we will stick to full coupon issues (or very close thereto) in their cases.
Procedure
I intend to be in the office solidly through March (including every Saturday except March 7th) and will be glad
to see any partner or talk with him by phone. To aid in scheduling, please make an appointment with Gladys (or
me). The only request I make is that you absorb as much as possible of this letter before we talk.
As you can see,
it would be an enormous problem if I had to explain each item to all of you.
If you decide you want us to help you in buying bonds, you should let us know:
(1)
Whether you want to restrict purchases to your home state for local tax reasons;
(2)
Whether you want to restrict us to full coupon issues or let us use our judgment as to where you get the
best value;
(3)
Your preference as to maturity in the ten to twenty-five year range or if you prefer to let us use our
judgment in that area;
(4)
How much you want to invest - we may end up several per cent short of the figure you name, but we
will never go over;
(5)
On what bank the bonds should be drafted.
We will advise you by phone or letter as we buy bonds. Bill and John will be doing much of the mechanical
work. Needless to say, none of us will have any financial interest in any transaction.
Should you have any
151 questions regarding the mechanics, please direct them to John or Bill as I will probably be swamped and they
will be more familiar with specific transactions. After March 31st, I don't expect to be around the office for
several months. Therefore, if you want to talk things over, come in by then. The completion of all purchases
may go into April, but Bill will be taking care of this and the mechanics will all be set up.
You should realize that because of the enormous diversity of issues mentioned earlier, it is impossible to say just
what will be bought. Sometimes the tax-free bond market has more similarities to real estate than to stocks.
There are hundreds of thousands of items of varying comparability, some with no sellers, some with reluctant
sellers and some with eager sellers. Which may be the best buy depends on the quality of what is being offered,
how well it fits your needs and the eagerness of the seller.
The standard of comparison is always new issues
where an average of several hundred million dollars worth have to be sold each week - however, specific
secondary market opportunities (issues already outstanding) may be more attractive than new issues and we can
only find out how attractive they are when we are ready to make bids.
Although markets can change, it looks as if we will have no difficulty in getting in the area of 6-1/2% after tax
(except from Housing Authority issues) on bonds in the twenty-year maturity range.
Cordially,
Warren E. Buffett
WEBI glk