16/05/2017 Chairman'sLetter1977

BERKSHIREHATHAWAYINC.

TotheStockholdersofBerkshireHathawayInc.:

Operatingearningsin1977of$21,904,000,or$22.54per
share,weremoderatelybetterthananticipatedayearago.Of
theseearnings,$1.43pershareresultedfromsubstantial
realizedcapitalgainsbyBlueChipStampswhich,totheextent
ofourproportionalinterestinthatcompany,areincludedinour
operatingearningsfigure.Capitalgainsorlossesrealized
directlybyBerkshireHathawayInc.oritsinsurancesubsidiaries
arenotincludedinourcalculationofoperatingearnings.While
toomuchattentionshouldnotbepaidtothefigureforany
singleyear,overthelongertermtherecordregardingaggregate
capitalgainsorlossesobviouslyisofsignificance.

Textileoperationscameinwellbelowforecast,whilethe
resultsoftheIllinoisNationalBankaswellastheoperating
earningsattributabletoourequityinterestinBlueChipStamps
wereaboutasanticipated.However,insuranceoperations,led
againbythetrulyoutstandingresultsofPhilLiesches
managerialgroupatNationalIndemnityCompany,wereevenbetter
thanouroptimisticexpectations.

Mostcompaniesdefinerecordearningsasanewhighin
earningspershare.Sincebusinessescustomarilyaddfromyear
toyeartotheirequitybase,wefindnothingparticularly
noteworthyinamanagementperformancecombining,say,a10%
increaseinequitycapitalanda5%increaseinearningsper
share.Afterall,evenatotallydormantsavingsaccountwill
producesteadilyrisinginterestearningseachyearbecauseof
compounding.

Exceptforspecialcases(forexample,companieswith
unusualdebtequityratiosorthosewithimportantassetscarried
atunrealisticbalancesheetvalues),webelieveamore
appropriatemeasureofmanagerialeconomicperformancetobe
returnonequitycapital.In1977ouroperatingearningson
beginningequitycapitalamountedto19%,slightlybetterthan
lastyearandabovebothourownlongtermaverageandthatof
Americanindustryinaggregate.But,whileouroperating
earningspersharewereup37%fromtheyearbefore,our
beginningcapitalwasup24%,makingthegaininearningsper
shareconsiderablylessimpressivethanitmightappearatfirst
glance.

Weexpectdifficultyinmatchingour1977rateofreturn
duringtheforthcomingyear.Beginningequitycapitalisup23%
fromayearago,andweexpectthetrendofinsurance
underwritingprofitmarginstoturndownwellbeforetheendof
theyear.Nevertheless,weexpectareasonablygoodyearandour
presentestimate,subjecttotheusualcaveatsregardingthe
frailtiesofforecasts,isthatoperatingearningswillimprove
somewhatonapersharebasisduring1978.

TextileOperations

Thetextilebusinessagainhadaverypooryearin1977.We
havemistakenlypredictedbetterresultsineachofthelasttwo
years.Thismaysaysomethingaboutourforecastingabilities,
thenatureofthetextileindustry,orboth.Despitestrenuous
efforts,problemsinmarketingandmanufacturinghavepersisted.
Manydifficultiesexperiencedinthemarketingareaaredue
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primarilytoindustryconditions,butsomeoftheproblemshave
beenofourownmaking.

Afewshareholdershavequestionedthewisdomofremaining
inthetextilebusinesswhich,overthelongerterm,isunlikely
toproducereturnsoncapitalcomparabletothoseavailablein
manyotherbusinesses.Ourreasonsareseveral:(1)Ourmillsin
bothNewBedfordandManchesterareamongthelargestemployers
ineachtown,utilizingalaborforceofhighaverageage
possessingrelativelynontransferableskills.Ourworkersand
unionshaveexhibitedunusualunderstandingandeffortin
cooperatingwithmanagementtoachieveacoststructureand
productmixwhichmightallowustomaintainaviableoperation.
(2)Managementalsohasbeenenergeticandstraightforwardinits
approachtoourtextileproblems.Inparticular,KenChaces
effortsafterthechangeincorporatecontroltookplacein1965
generatedcapitalfromthetextiledivisionneededtofinancethe
acquisitionandexpansionofourprofitableinsuranceoperation.
(3)Withhardworkandsomeimaginationregardingmanufacturing
andmarketingconfigurations,itseemsreasonablethatatleast
modestprofitsinthetextiledivisioncanbeachievedinthe
future.

InsuranceUnderwriting

Ourinsuranceoperationcontinuedtogrowsignificantlyin
1977.Itwasearlyin1967thatwemadeourentryintothis
industrythroughthepurchaseofNationalIndemnityCompanyand
NationalFireandMarineInsuranceCompany(sistercompanies)for
approximately$8.6million.Inthatyeartheirpremiumvolume
amountedto$22million.In1977ouraggregateinsurancepremium
volumewas$151million.NoadditionalsharesofBerkshire
Hathawaystockhavebeenissuedtoachieveanyofthisgrowth.

Rather,thisalmost600%increasehasbeenachievedthrough
largegainsinNationalIndemnitystraditionalliabilityareas
plusthestartingofnewcompanies(CornhuskerCasualtyCompany
in1970,LakelandFireandCasualtyCompanyin1971,TexasUnited
InsuranceCompanyin1972,TheInsuranceCompanyofIowain1973,
andKansasFireandCasualtyCompanyinlate1977),thepurchase
forcashofotherinsurancecompanies(HomeandAutomobile
InsuranceCompanyin1971,KerklingReinsuranceCorporation,now
namedCentralFireandCasualtyCompany,in1976,andCypress
InsuranceCompanyatyearend1977),andfinallythroughthe
marketingofadditionalproducts,mostsignificantlyreinsurance,
withintheNationalIndemnityCompanycorporatestructure.

Inaggregate,theinsurancebusinesshasworkedoutvery
well.Butithasntbeenaonewaystreet.Somemajormistakes
havebeenmadeduringthedecade,bothinproductsandpersonnel.
Weexperiencedsignificantproblemsfrom(1)asuretyoperation
initiatedin1969,(2)the1973expansionofHomeand
AutomobilesurbanautomarketingintotheMiami,Floridaarea,
(3)astillunresolvedaviationfrontingarrangement,and(4)
ourWorkersCompensationoperationinCalifornia,whichwe
believeretainsaninterestingpotentialuponcompletionofa
reorganizationnowinprogress.Itiscomfortingtobeina
businesswheresomemistakescanbemadeandyetaquite
satisfactoryoverallperformancecanbeachieved.Inasense,
thisistheoppositecasefromourtextilebusinesswhereeven
verygoodmanagementprobablycanaverageonlymodestresults.
Oneofthelessonsyourmanagementhaslearnedand,
unfortunately,sometimesrelearnedistheimportanceofbeing
inbusinesseswheretailwindsprevailratherthanheadwinds.

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In1977thewindsininsuranceunderwritingweresquarely
behindus.Verylargerateincreaseswereeffectedthroughout
theindustryin1976tooffsetthedisastrousunderwriting
resultsof1974and1975.But,becauseinsurancepolicies
typicallyarewrittenforoneyearperiods,withpricingmistakes
capableofcorrectiononlyuponrenewal,itwas1977beforethe
fullimpactwasfeltuponearningsofthoseearlierrate
increases.

Thependulumnowisbeginningtoswingtheotherway.We
estimatethatcostsinvolvedintheinsuranceareasinwhichwe
operateriseatcloseto1%permonth.Thisisduetocontinuous
monetaryinflationaffectingthecostofrepairinghumansand
property,aswellassocialinflation,abroadeningdefinition
bysocietyandjuriesofwhatiscoveredbyinsurancepolicies.
Unlessratesriseatacomparable1%permonth,underwriting
profitsmustshrink.Recentlythepaceofrateincreaseshas
sloweddramatically,anditisourexpectationthatunderwriting
marginsgenerallywillbedecliningbythesecondhalfofthe
year.

WemustagaingivecredittoPhilLiesche,greatlyassisted
byRolandMillerinUnderwritingandBillLyonsinClaims,foran
extraordinaryunderwritingachievementinNationalIndemnitys
traditionalautoandgeneralliabilitybusinessduring1977.
Largevolumegainshavebeenaccompaniedbyexcellent
underwritingmarginsfollowingcontractionorwithdrawalbymany
competitorsinthewakeofthe197475crisisperiod.These
conditionswillreversebeforelong.Inthemeantime,National
Indemnitysunderwritingprofitabilityhasincreaseddramatically
and,inaddition,largesumshavebeenmadeavailablefor
investment.Asmarketsloosenandratesbecomeinadequate,we
againwillfacethechallengeofphilosophicallyaccepting
reducedvolume.Unusualmanagerialdisciplinewillberequired,
asitrunscountertonormalinstitutionalbehaviortoletthe
otherfellowtakeawaybusinessevenatfoolishprices.

Ourreinsurancedepartment,managedbyGeorgeYoung,
improveditsunderwritingperformanceduring1977.Althoughthe
combinedratio(seedefinitiononpage12)of107.1was
unsatisfactory,itstrendwasdownwardthroughouttheyear.In
addition,reinsurancegeneratesunusuallyhighfundsfor
investmentasapercentageofpremiumvolume.

AtHomeandAuto,JohnSewardcontinuedtomakeprogresson
allfronts.Johnwasabattlefieldpromotionseveralyearsago
whenHomeandAutosunderwritingwasawashinredinkandthe
companyfacedpossibleextinction.Underhismanagementit
currentlyissound,profitable,andgrowing.

JohnRingwaltshomestateoperationnowconsistsoffive
companies,withKansasFireandCasualtyCompanybecoming
operationallatein1977underthedirectionofFloydTaylor.
Thehomestatecompanieshadnetpremiumvolumeof$23million,up
from$5.5millionjustthreeyearsago.Allfourcompaniesthat
operatedthroughouttheyearachievedcombinedratiosbelow100,
withCornhuskerCasualtyCompany,at93.8,theleader.In
additiontoactivelysupervisingtheotherfourhomestate
operations,JohnRingwaltmanagestheoperationsofCornhusker
whichhasrecordedcombinedratiosbelow100insixofitsseven
fullyearsofexistenceand,fromastandingstartin1970,has
growntobeoneoftheleadinginsurancecompaniesoperatingin
Nebraskautilizingtheconventionalindependentagencysystem.
LakelandFireandCasualtyCompany,managedbyJimStodolka,was
thewinneroftheChairmansCupin1977forachievingthelowest
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lossratioamongthehomestatecompanies.Allinall,the
homestateoperationcontinuestomakeexcellentprogress.

ThenewestadditiontoourinsurancegroupisCypress
InsuranceCompanyofSouthPasadena,California.ThisWorkers
Compensationinsurerwaspurchasedforcashinthefinaldaysof
1977and,therefore,itsapproximate$12.5millionofvolumefor
thatyearwasnotincludedinourresults.CypressandNational
IndemnityspresentCaliforniaWorkersCompensationoperation
willnotbecombined,butwilloperateindependentlyutilizing
somewhatdifferentmarketingstrategies.MiltThornton,
PresidentofCypresssince1968,runsafirstclassoperationfor
policyholders,agents,employeesandownersalike.Welook
forwardtoworkingwithhim.

Insurancecompaniesofferstandardizedpolicieswhichcanbe
copiedbyanyone.Theironlyproductsarepromises.Itisnot
difficulttobelicensed,andratesareanopenbook.Thereare
noimportantadvantagesfromtrademarks,patents,location,
corporatelongevity,rawmaterialsources,etc.,andverylittle
consumerdifferentiationtoproduceinsulationfromcompetition.
Itiscommonplace,incorporateannualreports,tostressthe
differencethatpeoplemake.Sometimesthisistrueand
sometimesitisnt.Butthereisnoquestionthatthenatureof
theinsurancebusinessmagnifiestheeffectwhichindividual
managershaveoncompanyperformance.Weareveryfortunateto
havethegroupofmanagersthatareassociatedwithus.

InsuranceInvestments

Duringthepasttwoyearsinsuranceinvestmentsatcost
(excludingtheinvestmentinouraffiliate,BlueChipStamps)
havegrownfrom$134.6millionto$252.8million.Growthin
insurancereserves,producedbyourlargegaininpremiumvolume,
plusretainedearnings,haveaccountedforthisincreasein
marketablesecurities.Inturn,netinvestmentincomeofthe
InsuranceGrouphasimprovedfrom$8.4millionpretaxin1975to
$12.3millionpretaxin1977.

Inadditiontothisincomefromdividendsandinterest,we
realizedcapitalgainsof$6.9millionbeforetax,aboutone
quarterfrombondsandthebalancefromstocks.Ourunrealized
gaininstocksatyearend1977wasapproximately$74millionbut
thisfigure,likeanyotherfigureofasingledate(wehadan
unrealizedlossof$17millionattheendof1974),shouldnotbe
takentooseriously.Mostofourlargestockpositionsaregoing
tobeheldformanyyearsandthescorecardonourinvestment
decisionswillbeprovidedbybusinessresultsoverthatperiod,
andnotbypricesonanygivenday.Justasitwouldbefoolish
tofocusundulyonshorttermprospectswhenacquiringanentire
company,wethinkitequallyunsoundtobecomemesmerizedby
prospectiveneartermearningsorrecenttrendsinearningswhen
purchasingsmallpiecesofacompany;i.e.,marketablecommon
stocks.

Alittledigressionillustratingthispointmaybe
interesting.BerkshireFineSpinningAssociatesandHathaway
Manufacturingweremergedin1955toformBerkshireHathawayInc.
In1948,onaproformacombinedbasis,theyhadearningsafter
taxofalmost$18millionandemployed10,000peopleatadozen
largemillsthroughoutNewEngland.Inthebusinessworldof
thatperiodtheywereaneconomicpowerhouse.Forexample,in
thatsameyearearningsofIBMwere$28million(now$2.7
billion),SafewayStores,$10million,MinnesotaMining,$13
million,andTime,Inc.,$9million.But,inthedecade
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followingthe1955mergeraggregatesalesof$595million
producedanaggregatelossforBerkshireHathawayof$10million.
By1964theoperationhadbeenreducedtotwomillsandnetworth
hadshrunkto$22million,from$53millionatthetimeofthe
merger.Somuchforsingleyearsnapshotsasadequateportrayals
ofabusiness.

Equityholdingsofourinsurancecompanieswithamarket
valueofover$5milliononDecember31,1977wereasfollows:

No.ofSharesCompanyCostMarket

(000somitted)
220,000CapitalCitiesCommunications,Inc......$10,909$13,228
1,986,953GovernmentEmployeesInsurance
CompanyConvertiblePreferred........19,41733,033
1,294,308GovernmentEmployeesInsurance
CompanyCommonStock.................4,11610,516
592,650TheInterpublicGroupofCompanies,Inc.4,53117,187
324,580KaiserAluminum&ChemicalCorporation...11,2189,981
1,305,800KaiserIndustries,Inc..................7786,039
226,900KnightRidderNewspapers,Inc...........7,5348,736
170,800Ogilvy&MatherInternational,Inc......2,7626,960
934,300TheWashingtonPostCompanyClassB.....10,62833,401

Total...................................$71,893$139,081
AllOtherHoldings......................34,99641,992

TotalEquities..........................$106,889$181,073
================

Weselectourmarketableequitysecuritiesinmuchthesame
waywewouldevaluateabusinessforacquisitioninitsentirety.
Wewantthebusinesstobe(1)onethatwecanunderstand,(2)
withfavorablelongtermprospects,(3)operatedbyhonestand
competentpeople,and(4)availableataveryattractiveprice.
Weordinarilymakenoattempttobuyequitiesforanticipated
favorablestockpricebehaviorintheshortterm.Infact,if
theirbusinessexperiencecontinuestosatisfyus,wewelcome
lowermarketpricesofstocksweownasanopportunitytoacquire
evenmoreofagoodthingatabetterprice.

Ourexperiencehasbeenthatprorataportionsoftruly
outstandingbusinessessometimessellinthesecuritiesmarkets
atverylargediscountsfromthepricestheywouldcommandin
negotiatedtransactionsinvolvingentirecompanies.
Consequently,bargainsinbusinessownership,whichsimplyare
notavailabledirectlythroughcorporateacquisition,canbe
obtainedindirectlythroughstockownership.Whenpricesare
appropriate,wearewillingtotakeverylargepositionsin
selectedcompanies,notwithanyintentionoftakingcontroland
notforeseeingselloutormerger,butwiththeexpectationthat
excellentbusinessresultsbycorporationswilltranslateover
thelongtermintocorrespondinglyexcellentmarketvalueand
dividendresultsforowners,minorityaswellasmajority.

Suchinvestmentsinitiallymayhavenegligibleimpactonour
operatingearnings.Forexample,weinvested$10.9millionin
CapitalCitiesCommunicationsduring1977.Earningsattributable
totheshareswepurchasedtotaledabout$1.3millionlastyear.
Butonlythecashdividend,whichcurrentlyprovides$40,000
annually,isreflectedinouroperatingearningsfigure.

CapitalCitiespossessesbothextraordinarypropertiesand
extraordinarymanagement.Andthesemanagementskillsextend
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equallytooperationsandemploymentofcorporatecapital.To
purchase,directly,propertiessuchasCapitalCitiesownswould
costintheareaoftwiceourcostofpurchaseviathestock
market,anddirectownershipwouldoffernoimportantadvantages
tous.Whilecontrolwouldgiveustheopportunityandthe
responsibilitytomanageoperationsandcorporateresources,we
wouldnotbeabletoprovidemanagementineitherofthose
respectsequaltothatnowinplace.Ineffect,wecanobtaina
bettermanagementresultthroughnoncontrolthancontrol.This
isanunorthodoxview,butonewebelievetobesound.

Banking

In1977theIllinoisNationalBankcontinuedtoachievea
rateofearningsonassetsaboutthreetimesthatofmostlarge
banks.Asusual,thisrecordwasachievedwhilethebankpaid
maximumratestosaversandmaintainedanassetposition
combininglowriskandexceptionalliquidity.GeneAbeggformed
thebankin1931with$250,000.Initsfirstfullyearof
operation,earningsamountedto$8,782.Sincethattime,nonew
capitalhasbeencontributedtothebank;onthecontrary,since
ourpurchasein1969,dividendsof$20millionhavebeenpaid.
Earningsin1977amountedto$3.6million,morethanachievedby
manybankstwoorthreetimesitssize.

LatelastyearGene,now80andstillrunningabanking
operationwithoutpeer,askedthatasuccessorbebroughtin.
Accordingly,PeterJeffrey,formerlyPresidentandChief
ExecutiveOfficerofAmericanNationalBankofOmaha,hasjoined
theIllinoisNationalBankeffectiveMarch1stasPresidentand
ChiefExecutiveOfficer.

GenecontinuesingoodhealthasChairman.Weexpecta
continuedsuccessfuloperationatRockfordsleadingbank.

BlueChipStamps

WeagainincreasedourequityinterestinBlueChipStamps,
andownedapproximately361/2%attheendof1977.BlueChip
hadafineyear,earningapproximately$12.9millionfrom
operationsand,inaddition,hadrealizedsecuritiesgainsof
$4.1million.

BothWescoFinancialCorp.,an80%ownedsubsidiaryofBlue
ChipStamps,managedbyLouisVincenti,andSeesCandies,a99%
ownedsubsidiary,managedbyChuckHuggins,madegoodprogressin
1977.SinceSeeswaspurchasedbyBlueChipStampsatthe
beginningof1972,pretaxoperatingearningshavegrownfrom
$4.2millionto$12.6millionwithlittleadditionalcapital
investment.Seesachievedthisrecordwhileoperatinginan
industryexperiencingpracticallynounitgrowth.Shareholders
ofBerkshireHathawayInc.mayobtaintheannualreportofBlue
ChipStampsbyrequestingitfromMr.RobertH.Bird,BlueChip
Stamps,5801SouthEasternAvenue,LosAngeles,California90040.

WarrenE.Buffett,Chairman

March14,1978

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