Buffett Partnership Letters – 1960

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The 1960 letter has two main parts. The first is operational and the other is about a major investment. The operational bit isn’t to be missed though. Over the four years starting in 1957, the investment partnerships returned a compounded
140.6%.

By comparison, the Dow Jones Industrial Average returned 42.6%. As is the case to date, Buffett does not gloat. He points out that four years is too short a time to come to any conclusions.

His only takeaway is that, as expected, performance seems to be relatively better in moderately declining or static marketsduring a strongly rising market…we might have real difficulty in
matching their performance.

The other thing to note is that he makes special efforts to explain his investment mindset. He attributes this to the addition of new investors to the roster. But this is a key point. Any investment strategy is bound to have its down periods.

If the asset owner does not understand the investment philosophy, it can be hard to stick with the program in these times. By taking pains to explain it up front, Buffett is trying to preempt this.

Even today, Buffett makes a great effort to talk down Berkshire’s stock and manage expectations. This is wise.

And finally, Buffett might have been one of the early managers to report performance properly. I might be wrong though. In Capital Ideas, Peter Bernstein tells how bad performance reporting was around that time.

Clients had only the vaguest idea of how their fortunes were faring, and certainly no idea of whether their portfolios were receiving good management or bad. The only performance report was a number representing the percentage change from the inception date of the trust to the latest reporting date. No adjustments were made for money added or withdrawn. Even worse, the percentage was not converted into annual rates of return, which meant that unsophisticated customers whose portfolios had doubled over ten years might assume they were doing just as well as customers whose portfolios had doubled in five years.

Capital Ideas, Peter L. Bernstein


Given
this state of the affairs, perhaps Buffett was ahead of his times. Again, however, I’m not sure if there were other money managers who did the same.

Sanborn Map Co.

The second part of the letter is about his investment in a company called Sanborn Map Co. You could think of the company like the Google Maps of its time.

It used to make extremely detailed maps of various American cities. It had a stable customer base for insurance companies.

These insurance companies used the maps
to assess the risk of their fire insurance business and used them to underwrite business. That is not material to our story, though. What matters is that the business used to generate very steady cash flows and had limited costs.

This cash was routinely reinvested into a portfolio of securities that had grown substantially over the years. Meanwhile, the mapping business declined in value
as it failed to reinvest in improvements to its product. There were changes in the insurance industry as well which cut into its business.

The governance structure was somewhat broken. Its customers had bought shares in the company and had installed its nominees on the Board.

These nominees barely owned any shares on their own.

All they cared about was that they continue to obtain the maps at reasonable prices.

The investment portfolio generated enough income to pay dividends, although they were cut five times in eight years. The business got so bad that by 1958 the market cap of the company implied a negative $20 per share of the value of the core business.

Buffett, and a couple of other non-controlling shareholders wanted to separate out the investment portfolio and the core business. Together, they owned about 45% of the company. The Buffett Partnerships had put in 35% of their capital in the investment!

What happened next is interesting.

It was obvious that the Board did not want to change anything in the core business of the company. They were the customers and they were happy with what they were getting.

So, instead of getting into a proxy fight (i.e., attempting to install a new Board and taking over the business), Buffett and co. suggested an alternative.

They proposed that any shareholder could exchange his shares for the portfolio of securities in the company at fair value.

How they arrived at a fair value for the whole company
is unclear. However, the SEC approved and 72% of the company’s stock was exchanged for securities. Apparently Buffett took this option as well, and possibly liquidated the securities immediately (he mentions that he didn’t like
the securities at their current price).

Such opportunities probably don’t occur at all today. They are too easy to dig out because of substantially better disclosures and because of computerized databases.

However, there is another crucial element to making this strategy work. You have to be in a position to build a substantial shareholding, have a cohort of shareholders who agree with your plan, and even possibly management that would go along with you.

Without that, you’re likely to be waiting a long time.

Read the original here.

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Parijat
On a quest to understand what makes a business great and what makes a great investment.
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