Becoming Berkshire: 1963 - Breakfast at Berkshire

Issue 4 | 1963

1963 was a year filled with several historical events, such as Civil Rights protests, Dr. Martin Luther King's "I Have a Dream" speech, the Assassination of President John F. Kennady, and the release of the Beatles’s first banger, “I want to Hold Your Hand.” And yet, the Dow Jones finished the year up 17%. I indeed would have thought the market would end negatively in a year when the President of the United States was assassinated; however, as Buffett has always taught us, the market perseveres.

BPL Annual Report

Given the lack of Buffett's commentary in the Berkshire Annual Report, I thought sharing his wisdom from the BPL letter was appropriate as Buffett touches on the joys of compounding and his investment strategy for the partnership.

Compounding

Francis I of France paid 4,000 euros in 1540 for Leonardo da Vinci’s Mona Lisa, on the off chance that a few of you have not kept track of the fluctuations of the euros 4,000 converted out to about $20,000. If Francis had kept his feet on the ground and he (and his trustees) had been able to find a 6% after-tax investment, the estate now would be worth something over $1,000,000,000,000,000.00. That's $1 quadrillion or over 3,000 times the present national debt, all from 6%. I trust this will end all discussions in our household about any purchase or paintings qualifying as an investment.

Investment Strategy

Buffett broke down his investment strategy into three categories.

Generals

A category of generally undervalued stocks, determined primarily by quantitative standards, but with considerable attention also paid to the qualitative factor. There is often little or nothing to indicate immediate market improvement. The issues lack glamour or market sponsorship. Their main qualification is a bargain price; that is, an overall valuation on the enterprise substantially below what careful analysis indicates its value to a private owner to be. Again let me emphasize that while the quantitative comes first and is essential, the qualitative is important. We like good management - we like a decent industry - we like a certain amount of “ferment” in a previously dormant management or stockholder group. But we demand value. The general group behaves very much in sympathy with the Dow and will turn in a big minus result during a year of substantial decline by the Dow. Contrarywise, it should be the star performer in a strongly advancing market. Over the years we expect it, of course, to achieve a satisfactory margin over the Dow.

Workouts

“Workouts” - These are the securities with a timetable. They arise from corporate activity - sell-outs, mergers, reorganizations, spin-offs, etc. In this category we are not talking about rumors or "inside information" pertaining to such developments, but to publicly announced activities of this sort. We wait until we can read it in the paper. The risk pertains not primarily to general market behavior (although that is sometimes tied in to a degree), but instead to something upsetting the applecart so that the expected development does not materialize. Such killjoys could include anti-trust or other negative government action, stockholder disapproval, withholding of tax rulings, etc. The gross profits in many workouts appear quite small. A friend refers to this as getting the last nickel after the other fellow has made the first ninety-five cents. However, the predictability coupled with a short holding period produces quite decent annual rates of return. This category produces more steady absolute profits from year to year than generals do. In years of market decline, it piles up a big edge for us; during bull markets, it is a drag on performance. On a long term basis, I expect it to achieve the same sort of margin over the Dow attained by generals.

Controls

These are rarities, but when they occur they are likely to be of significant size. Unless we start off with the purchase of a sizable block or stock, controls develop from the general category. They result from situations where a cheap security does nothing price-wise for such an extended period of time that we are able to buy a significant percentage of the company's stock. At that point we are probably in a position to assume some degree of, or perhaps complete, control of the company's activities; whether we become active or remain relatively passive at this point depends upon our assessment of the company’s future and the management's capabilities. The general we have been buying the most aggressively in recent months possesses excellent management following policies that appear to make very good sense to us. If our continued buying puts us in a controlling position at some point in the future, we will probably remain very passive regarding the operation or this business.

Buffett began purchasing Berkshire stock in 1962, at what could be described as a “general;” this is the type of Security that Graham would have purchased based on a quantitive value. Buffett kept purchasing the stock in 1963 at $14.86, far below its net working capital of $19 per share, until his partnership became the largest shareholder, placing the investment in the “Control” category.

Berkshire 1963 Annual Report

The Company surprisingly squeezed out a profit of $27,406 in the quarter ending September 28th but ended the year at a loss of ($648,811). The Company continued to reduce the number of looms running on cotton staple grey goods. On November 6th, the Board approved discontinuing production at the Berkshire Phillip A Division and disposed of the physical assets not needed at other plants.

Berkshire suspended the dividend and looked at ways to cut costs in 1963. Although Buffett may have been the largest shareholder and had a seat on the Board, he had little say in the capital allocation strategy. However, the Company was doing a decent job of strengthening its balance sheet. It reduced long-term liabilities and inventories and suspended the dividend.