25 มีนาคม 2560

Berkshire Hathaway Letters to Shareholders (1985)

To the Shareholders of Berkshire Hathaway Inc.:

     You may remember the wildly upbeat message of last year’s 
report: nothing much was in the works but our experience had been 
that something big popped up occasionally.  This carefully-
crafted corporate strategy paid off in 1985.  Later sections of 
this report discuss (a) our purchase of a major position in 
Capital Cities/ABC, (b) our acquisition of Scott & Fetzer, (c) 
our entry into a large, extended term participation in the 
insurance business of Fireman’s Fund, and (d) our sale of our 
stock in General Foods.

     Our gain in net worth during the year was $613.6 million, or 
48.2%. It is fitting that the visit of Halley’s Comet coincided 
with this percentage gain: neither will be seen again in my 
lifetime.  Our gain in per-share book value over the last twenty-
one years (that is, since present management took over) has been 
from $19.46 to $1643.71, or 23.2% compounded annually, another 
percentage that will not be repeated.

    Two factors make anything approaching this rate of gain 
unachievable in the future.  One factor probably transitory - is 
a stock market that offers very little opportunity compared to 
the markets that prevailed throughout much of the 1964-1984 
period.  Today we cannot find significantly-undervalued equities 
to purchase for our insurance company portfolios.  The current 
situation is 180 degrees removed from that existing about a 
decade ago, when the only question was which bargain to choose.

     This change in the market also has negative implications for 
our present portfolio.  In our 1974 annual report I could say:  
“We consider several of our major holdings to have great 
potential for significantly increased values in future years.” I 
can’t say that now.  It’s true that our insurance companies 
currently hold major positions in companies with exceptional 
underlying economics and outstanding managements, just as they 
did in 1974.  But current market prices generously appraise these 
attributes, whereas they were ignored in 1974.  Today’s 
valuations mean that our insurance companies have no chance for 
future portfolio gains on the scale of those achieved in the 

     The second negative factor, far more telling, is our size.  
Our equity capital is more than twenty times what it was only ten 
years ago.  And an iron law of business is that growth eventually 
dampens exceptional economics. just look at the records of high-
return companies once they have amassed even $1 billion of equity 
capital.  None that I know of has managed subsequently, over a 
ten-year period, to keep on earning 20% or more on equity while 
reinvesting all or substantially all of its earnings.  Instead, 
to sustain their high returns, such companies have needed to shed 
a lot of capital by way of either dividends or repurchases of 
stock.  Their shareholders would have been far better off if all 
earnings could have been reinvested at the fat returns earned by 
these exceptional businesses.  But the companies simply couldn’t 
turn up enough high-return opportunities to make that possible.

     Their problem is our problem.  Last year I told you that we 
needed profits of $3.9 billion over the ten years then coming up 
to earn 15% annually.  The comparable figure for the ten years 
now ahead is $5.7 billion, a 48% increase that corresponds - as 
it must mathematically - to the growth in our capital base during 
1985. (Here’s a little perspective: leaving aside oil companies, 
only about 15 U.S. businesses have managed to earn over $5.7 
billion during the past ten years.)

     Charlie Munger, my partner in managing Berkshire, and I are 
reasonably optimistic about Berkshire’s ability to earn returns 
superior to those earned by corporate America generally, and you 
will benefit from the company’s retention of all earnings as long 
as those returns are forthcoming.  We have several things going 
for us: (1) we don’t have to worry about quarterly or annual 
figures but, instead, can focus on whatever actions will maximize 
long-term value; (2) we can expand the business into any areas 
that make sense - our scope is not circumscribed by history, 
structure, or concept; and (3) we love our work.  All of these 
help.  Even so, we will also need a full measure of good fortune 
to average our hoped-for 15% - far more good fortune than was 
required for our past 23.2%.

     We need to mention one further item in the investment 
equation that could affect recent purchasers of our stock.  
Historically, Berkshire shares have sold modestly below intrinsic 
business value.  With the price there, purchasers could be 
certain (as long as they did not experience a widening of this 
discount) that their personal investment experience would at 
least equal the financial experience of the business.  But 
recently the discount has disappeared, and occasionally a modest 
premium has prevailed.

     The elimination of the discount means that Berkshire’s 
market value increased even faster than business value (which, 
itself, grew at a pleasing pace).  That was good news for any 
owner holding while that move took place, but it is bad news for 
the new or prospective owner.  If the financial experience of new 
owners of Berkshire is merely to match the future financial 
experience of the company, any premium of market value over 
intrinsic business value that they pay must be maintained.

     Management cannot determine market prices, although it can, 
by its disclosures and policies, encourage rational behavior by 
market participants.  My own preference, as perhaps you’d guess, 
is for a market price that consistently approximates business 
value.  Given that relationship, all owners prosper precisely as 
the business prospers during their period of ownership.  Wild 
swings in market prices far above and below business value do not 
change the final gains for owners in aggregate; in the end, 
investor gains must equal business gains.  But long periods of 
substantial undervaluation and/or overvaluation will cause the 
gains of the business to be inequitably distributed among various 
owners, with the investment result of any given owner largely 
depending upon how lucky, shrewd, or foolish he happens to be.

     Over the long term there has been a more consistent 
relationship between Berkshire’s market value and business value 
than has existed for any other publicly-traded equity with which 
I am familiar.  This is a tribute to you.  Because you have been 
rational, interested, and investment-oriented, the market price 
for Berkshire stock has almost always been sensible.  This 
unusual result has been achieved by a shareholder group with 
unusual demographics: virtually all of our shareholders are 
individuals, not institutions.  No other public company our size 
can claim the same.

     You might think that institutions, with their large staffs 
of highly-paid and experienced investment professionals, would be 
a force for stability and reason in financial markets.  They are 
not: stocks heavily owned and constantly monitored by 
institutions have often been among the most inappropriately 

     Ben Graham told a story 40 years ago that illustrates why 
investment professionals behave as they do: An oil prospector, 
moving to his heavenly reward, was met by St. Peter with bad 
news.  “You’re qualified for residence”, said St. Peter, “but, as 
you can see, the compound reserved for oil men is packed.  
There’s no way to squeeze you in.” After thinking a moment, the 
prospector asked if he might say just four words to the present 
occupants.  That seemed harmless to St. Peter, so the prospector 
cupped his hands and yelled, “Oil discovered in hell.” 
Immediately the gate to the compound opened and all of the oil 
men marched out to head for the nether regions.  Impressed, St. 
Peter invited the prospector to move in and make himself 
comfortable.  The prospector paused.  “No,” he said, “I think 
I’ll go along with the rest of the boys.  There might be some 
truth to that rumor after all.”

Sources of Reported Earnings

     The table on the next page shows the major sources of 
Berkshire’s reported earnings.  These numbers, along with far 
more detailed sub-segment numbers, are the ones that Charlie and 
I focus upon.  We do not find consolidated figures an aid in 
either managing or evaluating Berkshire and, in fact, never 
prepare them for internal use.

     Segment information is equally essential for investors 
wanting to know what is going on in a multi-line business.  
Corporate managers always have insisted upon such information 
before making acquisition decisions but, until a few years ago, 
seldom made it available to investors faced with acquisition and 
disposition decisions of their own.  Instead, when owners wishing 
to understand the economic realities of their business asked for 
data, managers usually gave them a we-can’t-tell-you-what-is-
going-on-because-it-would-hurt-the-company answer.  Ultimately 
the SEC ordered disclosure of segment data and management began 
supplying real answers.  The change in their behavior recalls an 
insight of Al Capone: “You can get much further with a kind word 
and a gun than you can with a kind word alone.”

In the table, amortization of Goodwill is not charged against the 
specific businesses but, for reasons outlined in the Appendix to 
my letter in the 1983 annual report, is aggregated as a separate 
item. (A compendium of the 1977-1984 letters is available upon 
request.) In the Business Segment Data and Management’s 
Discussion sections on pages 39-41 and 49-55, much additional 
information regarding our businesses is provided, including 
Goodwill and Goodwill Amortization figures for each of the 
segments.  I urge you to read those sections as well as Charlie 
Munger’s letter to Wesco shareholders, which starts on page 56.

                                                (000s omitted) 
                                                         Berkshire's Share 
                                                          of Net Earnings 
                                                         (after taxes and 
                                    Pre-Tax Earnings    minority interests)
                                  -------------------   -------------------
                                    1985       1984       1985       1984 
                                  --------   --------   --------   --------
Operating Earnings:
  Insurance Group:
    Underwriting ................ $(44,230)  $(48,060)  $(23,569)  $(25,955)
    Net Investment Income .......   95,217     68,903     79,716     62,059
  Associated Retail Stores ......      270     (1,072)       134       (579)
  Blue Chip Stamps ..............    5,763     (1,843)     2,813       (899)
  Buffalo News ..................   29,921     27,328     14,580     13,317
  Mutual Savings and Loan .......    2,622      1,456      4,016      3,151
  Nebraska Furniture Mart .......   12,686     14,511      5,181      5,917
  Precision Steel ...............    3,896      4,092      1,477      1,696
  See’s Candies .................   28,989     26,644     14,558     13,380
  Textiles ......................   (2,395)       418     (1,324)       226
  Wesco Financial ...............    9,500      9,777      4,191      4,828
  Amortization of Goodwill ......   (1,475)    (1,434)    (1,475)    (1,434)
  Interest on Debt ..............  (14,415)   (14,734)    (7,288)    (7,452)
     Contributions ..............   (4,006)    (3,179)    (2,164)    (1,716)
  Other .........................    3,106      4,932      2,102      3,475
                                  --------   --------   --------   --------
Operating Earnings ..............  125,449     87,739     92,948     70,014
Special General Foods Distribution   4,127      8,111      3,779      7,294
Special Washington Post 
   Distribution .................   14,877      ---       13,851      ---
Sales of Securities .............  468,903    104,699    325,237     71,587
                                  --------   --------   --------   --------
Total Earnings - all entities ... $613,356   $200,549   $435,815   $148,895
                                  ========   ========   ========   ======== 

     Our 1985 results include unusually large earnings from the 
sale of securities.  This fact, in itself, does not mean that we 
had a particularly good year (though, of course, we did).  
Security profits in a given year bear similarities to a college 
graduation ceremony in which the knowledge gained over four years 
is recognized on a day when nothing further is learned.  We may 
hold a stock for a decade or more, and during that period it may 
grow quite consistently in both business and market value.  In 
the year in which we finally sell it there may be no increase in 
value, or there may even be a decrease.  But all growth in value 
since purchase will be reflected in the accounting earnings of 
the year of sale. (If the stock owned is in our insurance 
subsidiaries, however, any gain or loss in market value will be 
reflected in net worth annually.) Thus, reported capital gains or 
losses in any given year are meaningless as a measure of how well 
we have done in the current year.

     A large portion of the realized gain in 1985 ($338 million 
pre-tax out of a total of $488 million) came about through the 
sale of our General Foods shares.  We held most of these shares 
since 1980, when we had purchased them at a price far below what 
we felt was their per/share business value.  Year by year, the 
managerial efforts of Jim Ferguson and Phil Smith substantially 
increased General Foods’ business value and, last fall, Philip 
Morris made an offer for the company that reflected the increase.  
We thus benefited from four factors: a bargain purchase price, a 
business with fine underlying economics, an able management 
concentrating on the interests of shareholders, and a buyer 
willing to pay full business value.  While that last factor is 
the only one that produces reported earnings, we consider 
identification of the first three to be the key to building value 
for Berkshire shareholders.  In selecting common stocks, we 
devote our attention to attractive purchases, not to the 
possibility of attractive sales.

     We have again reported substantial income from special 
distributions, this year from Washington Post and General Foods. 
(The General Foods transactions obviously took place well before 
the Philip Morris offer.) Distributions of this kind occur when 
we sell a portion of our shares in a company back to it 
simultaneously with its purchase of shares from other 
shareholders.  The number of shares we sell is contractually set 
so as to leave our percentage ownership in the company precisely 
the same after the sale as before.  Such a transaction is quite 
properly regarded by the IRS as substantially equivalent to a 
dividend since we, as a shareholder, receive cash while 
maintaining an unchanged ownership interest.  This tax treatment 
benefits us because corporate taxpayers, unlike individual 
taxpayers, incur much lower taxes on dividend income than on 
income from long-term capital gains. (This difference will be 
widened further if the House-passed tax bill becomes law: under 
its provisions, capital gains realized by corporations will be 
taxed at the same rate as ordinary income.) However, accounting 
rules are unclear as to proper treatment for shareholder 
reporting.  To conform with last year’s treatment, we have shown 
these transactions as capital gains.

     Though we have not sought out such transactions, we have 
agreed to them on several occasions when managements initiated 
the idea.  In each case we have felt that non-selling 
shareholders (all of whom had an opportunity to sell at the same 
price we received) benefited because the companies made their 
repurchases at prices below intrinsic business value.  The tax 
advantages we receive and our wish to cooperate with managements 
that are increasing values for all shareholders have sometimes 
led us to sell - but only to the extent that our proportional 
share of the business was undiminished.

     At this point we usually turn to a discussion of some of our 
major business units.  Before doing so, however, we should first 
look at a failure at one of our smaller businesses.  Our Vice 
Chairman, Charlie Munger, has always emphasized the study of 
mistakes rather than successes, both in business and other 
aspects of life.  He does so in the spirit of the man who said: 
“All I want to know is where I’m going to die so I’ll never go 
there.” You’ll immediately see why we make a good team: Charlie 
likes to study errors and I have generated ample material for 
him, particularly in our textile and insurance businesses.

Shutdown of Textile Business

     In July we decided to close our textile operation, and by 
yearend this unpleasant job was largely completed.  The history 
of this business is instructive.

     When Buffett Partnership, Ltd., an investment partnership of 
which I was general partner, bought control of Berkshire Hathaway 
21 years ago, it had an accounting net worth of $22 million, all 
devoted to the textile business.  The company’s intrinsic 
business value, however, was considerably less because the 
textile assets were unable to earn returns commensurate with 
their accounting value.  Indeed, during the previous nine years 
(the period in which Berkshire and Hathaway operated as a merged 
company) aggregate sales of $530 million had produced an 
aggregate loss of $10 million.  Profits had been reported from 
time to time but the net effect was always one step forward, two 
steps back.

     At the time we made our purchase, southern textile plants - 
largely non-union - were believed to have an important 
competitive advantage.  Most northern textile operations had 
closed and many people thought we would liquidate our business as 

     We felt, however, that the business would be run much better 
by a long-time employee whom. we immediately selected to be 
president, Ken Chace.  In this respect we were 100% correct: Ken 
and his recent successor, Garry Morrison, have been excellent 
managers, every bit the equal of managers at our more profitable 

     In early 1967 cash generated by the textile operation was 
used to fund our entry into insurance via the purchase of 
National Indemnity Company.  Some of the money came from earnings 
and some from reduced investment in textile inventories, 
receivables, and fixed assets.  This pullback proved wise: 
although much improved by Ken’s management, the textile business 
never became a good earner, not even in cyclical upturns.

     Further diversification for Berkshire followed, and 
gradually the textile operation’s depressing effect on our 
overall return diminished as the business became a progressively 
smaller portion of the corporation.  We remained in the business 
for reasons that I stated in the 1978 annual report (and 
summarized at other times also): “(1) our textile businesses are 
very important employers in their communities, (2) management has 
been straightforward in reporting on problems and energetic in 
attacking them, (3) labor has been cooperative and understanding 
in facing our common problems, and (4) the business should 
average modest cash returns relative to investment.” I further 
said, “As long as these conditions prevail - and we expect that 
they will - we intend to continue to support our textile business 
despite more attractive alternative uses for capital.”

     It turned out that I was very wrong about (4).  Though 1979 
was moderately profitable, the business thereafter consumed major 
amounts of cash. By mid-1985 it became clear, even to me, that 
this condition was almost sure to continue.  Could we have found 
a buyer who would continue operations, I would have certainly 
preferred to sell the business rather than liquidate it, even if 
that meant somewhat lower proceeds for us.  But the economics 
that were finally obvious to me were also obvious to others, and 
interest was nil.

     I won’t close down businesses of sub-normal profitability 
merely to add a fraction of a point to our corporate rate of 
return.  However, I also feel it inappropriate for even an 
exceptionally profitable company to fund an operation once it 
appears to have unending losses in prospect.  Adam Smith would 
disagree with my first proposition, and Karl Marx would disagree 
with my second; the middle ground is the only position that 
leaves me comfortable.

     I should reemphasize that Ken and Garry have been 
resourceful, energetic and imaginative in attempting to make our 
textile operation a success.  Trying to achieve sustainable 
profitability, they reworked product lines, machinery 
configurations and distribution arrangements.  We also made a 
major acquisition, Waumbec Mills, with the expectation of 
important synergy (a term widely used in business to explain an 
acquisition that otherwise makes no sense).  But in the end 
nothing worked and I should be faulted for not quitting sooner.  
A recent Business Week article stated that 250 textile mills have 
closed since 1980.  Their owners were not privy to any 
information that was unknown to me; they simply processed it more 
objectively.  I ignored Comte’s advice - “the intellect should be 
the servant of the heart, but not its slave” - and believed what 
I preferred to believe.

     The domestic textile industry operates in a commodity 
business, competing in a world market in which substantial excess 
capacity exists.  Much of the trouble we experienced was 
attributable, both directly and indirectly, to competition from 
foreign countries whose workers are paid a small fraction of the 
U.S. minimum wage.  But that in no way means that our labor force 
deserves any blame for our closing.  In fact, in comparison with 
employees of American industry generally, our workers were poorly 
paid, as has been the case throughout the textile business.  In 
contract negotiations, union leaders and members were sensitive 
to our disadvantageous cost position and did not push for 
unrealistic wage increases or unproductive work practices.  To 
the contrary, they tried just as hard as we did to keep us 
competitive.  Even during our liquidation period they performed 
superbly. (Ironically, we would have been better off financially 
if our union had behaved unreasonably some years ago; we then 
would have recognized the impossible future that we faced, 
promptly closed down, and avoided significant future losses.)

     Over the years, we had the option of making large capital 
expenditures in the textile operation that would have allowed us 
to somewhat reduce variable costs.  Each proposal to do so looked 
like an immediate winner.  Measured by standard return-on-
investment tests, in fact, these proposals usually promised 
greater economic benefits than would have resulted from 
comparable expenditures in our highly-profitable candy and 
newspaper businesses.

     But the promised benefits from these textile investments 
were illusory.  Many of our competitors, both domestic and 
foreign, were stepping up to the same kind of expenditures and, 
once enough companies did so, their reduced costs became the 
baseline for reduced prices industrywide.  Viewed individually, 
each company’s capital investment decision appeared cost-
effective and rational; viewed collectively, the decisions 
neutralized each other and were irrational (just as happens when 
each person watching a parade decides he can see a little better 
if he stands on tiptoes).  After each round of investment, all 
the players had more money in the game and returns remained 

     Thus, we faced a miserable choice: huge capital investment 
would have helped to keep our textile business alive, but would 
have left us with terrible returns on ever-growing amounts of 
capital.  After the investment, moreover, the foreign competition 
would still have retained a major, continuing advantage in labor 
costs.  A refusal to invest, however, would make us increasingly 
non-competitive, even measured against domestic textile 
manufacturers.  I always thought myself in the position described 
by Woody Allen in one of his movies: “More than any other time in 
history, mankind faces a crossroads.  One path leads to despair 
and utter hopelessness, the other to total extinction.  Let us 
pray we have the wisdom to choose correctly.”

     For an understanding of how the to-invest-or-not-to-invest 
dilemma plays out in a commodity business, it is instructive to 
look at Burlington Industries, by far the largest U.S. textile 
company both 21 years ago and now.  In 1964 Burlington had sales 
of $1.2 billion against our $50 million.  It had strengths in 
both distribution and production that we could never hope to 
match and also, of course, had an earnings record far superior to 
ours.  Its stock sold at 60 at the end of 1964; ours was 13.

     Burlington made a decision to stick to the textile business, 
and in 1985 had sales of about $2.8 billion.  During the 1964-85 
period, the company made capital expenditures of about $3 
billion, far more than any other U.S. textile company and more 
than $200-per-share on that $60 stock.  A very large part of the 
expenditures, I am sure, was devoted to cost improvement and 
expansion.  Given Burlington’s basic commitment to stay in 
textiles, I would also surmise that the company’s capital 
decisions were quite rational.

     Nevertheless, Burlington has lost sales volume in real 
dollars and has far lower returns on sales and equity now than 20 
years ago.  Split 2-for-1 in 1965, the stock now sells at 34 -- 
on an adjusted basis, just a little over its $60 price in 1964.  
Meanwhile, the CPI has more than tripled.  Therefore, each share 
commands about one-third the purchasing power it did at the end 
of 1964.  Regular dividends have been paid but they, too, have 
shrunk significantly in purchasing power.

     This devastating outcome for the shareholders indicates what 
can happen when much brain power and energy are applied to a 
faulty premise.  The situation is suggestive of Samuel Johnson’s 
horse: “A horse that can count to ten is a remarkable horse - not 
a remarkable mathematician.” Likewise, a textile company that 
allocates capital brilliantly within its industry is a remarkable 
textile company - but not a remarkable business.

     My conclusion from my own experiences and from much 
observation of other businesses is that a good managerial record 
(measured by economic returns) is far more a function of what 
business boat you get into than it is of how effectively you row 
(though intelligence and effort help considerably, of course, in 
any business, good or bad).  Some years ago I wrote: “When a 
management with a reputation for brilliance tackles a business 
with a reputation for poor fundamental economics, it is the 
reputation of the business that remains intact.” Nothing has 
since changed my point of view on that matter.  Should you find 
yourself in a chronically-leaking boat, energy devoted to 
changing vessels is likely to be more productive than energy 
devoted to patching leaks.

                            *  *  *

     There is an investment postscript in our textile saga.  Some 
investors weight book value heavily in their stock-buying 
decisions (as I, in my early years, did myself).  And some 
economists and academicians believe replacement values are of 
considerable importance in calculating an appropriate price level 
for the stock market as a whole.  Those of both persuasions would 
have received an education at the auction we held in early 1986 
to dispose of our textile machinery.

     The equipment sold (including some disposed of in the few 
months prior to the auction) took up about 750,000 square feet of 
factory space in New Bedford and was eminently usable.  It 
originally cost us about $13 million, including $2 million spent 
in 1980-84, and had a current book value of $866,000 (after 
accelerated depreciation).  Though no sane management would have 
made the investment, the equipment could have been replaced new 
for perhaps $30-$50 million.

     Gross proceeds from our sale of this equipment came to 
$163,122.  Allowing for necessary pre- and post-sale costs, our 
net was less than zero.  Relatively modern looms that we bought 
for $5,000 apiece in 1981 found no takers at $50.  We finally 
sold them for scrap at $26 each, a sum less than removal costs.

     Ponder this: the economic goodwill attributable to two paper 
routes in Buffalo - or a single See’s candy store - considerably 
exceeds the proceeds we received from this massive collection of 
tangible assets that not too many years ago, under different 
competitive conditions, was able to employ over 1,000 people.

Three Very Good Businesses (and a Few Thoughts About Incentive 

     When I was 12, I lived with my grandfather for about four 
months.  A grocer by trade, he was also working on a book and 
each night he dictated a few pages to me.  The title - brace 
yourself - was “How to Run a Grocery Store and a Few Things I 
Have Learned About Fishing”.  My grandfather was sure that 
interest in these two subjects was universal and that the world 
awaited his views.  You may conclude from this section’s title 
and contents that I was overexposed to Grandpa’s literary style 
(and personality).

     I am merging the discussion of Nebraska Furniture Mart, 
See’s Candy Shops, and Buffalo Evening News here because the 
economic strengths, weaknesses, and prospects of these businesses 
have changed little since I reported to you a year ago.  The 
shortness of this discussion, however, is in no way meant to 
minimize the importance of these businesses to us: in 1985 they 
earned an aggregate of $72 million pre-tax.  Fifteen years ago, 
before we had acquired any of them, their aggregate earnings were 
about $8 million pre-tax.

     While an increase in earnings from $8 million to $72 million 
sounds terrific - and usually is - you should not automatically 
assume that to be the case.  You must first make sure that 
earnings were not severely depressed in the base year.  If they 
were instead substantial in relation to capital employed, an even 
more important point must be examined: how much additional 
capital was required to produce the additional earnings?

     In both respects, our group of three scores well.  First, 
earnings 15 years ago were excellent compared to capital then 
employed in the businesses.  Second, although annual earnings are 
now $64 million greater, the businesses require only about $40 
million more in invested capital to operate than was the case 

     The dramatic growth in earning power of these three 
businesses, accompanied by their need for only minor amounts of 
capital, illustrates very well the power of economic goodwill 
during an inflationary period (a phenomenon explained in detail 
in the 1983 annual report).  The financial characteristics of 
these businesses have allowed us to use a very large portion of 
the earnings they generate elsewhere.  Corporate America, 
however, has had a different experience: in order to increase 
earnings significantly, most companies have needed to increase 
capital significantly also.  The average American business has 
required about $5 of additional capital to generate an additional 
$1 of annual pre-tax earnings.  That business, therefore, would 
have required over $300 million in additional capital from its 
owners in order to achieve an earnings performance equal to our 
group of three.

     When returns on capital are ordinary, an earn-more-by-
putting-up-more record is no great managerial achievement.  You 
can get the same result personally while operating from your 
rocking chair. just quadruple the capital you commit to a savings 
account and you will quadruple your earnings.  You would hardly 
expect hosannas for that particular accomplishment.  Yet, 
retirement announcements regularly sing the praises of CEOs who 
have, say, quadrupled earnings of their widget company during 
their reign - with no one examining whether this gain was 
attributable simply to many years of retained earnings and the 
workings of compound interest.

     If the widget company consistently earned a superior return 
on capital throughout the period, or if capital employed only 
doubled during the CEO’s reign, the praise for him may be well 
deserved.  But if return on capital was lackluster and capital 
employed increased in pace with earnings, applause should be 
withheld.  A savings account in which interest was reinvested 
would achieve the same year-by-year increase in earnings - and, 
at only 8% interest, would quadruple its annual earnings in 18 

     The power of this simple math is often ignored by companies 
to the detriment of their shareholders.  Many corporate 
compensation plans reward managers handsomely for earnings 
increases produced solely, or in large part, by retained earnings 
- i.e., earnings withheld from owners.  For example, ten-year, 
fixed-price stock options are granted routinely, often by 
companies whose dividends are only a small percentage of 

     An example will illustrate the inequities possible under 
such circumstances.  Let’s suppose that you had a $100,000 
savings account earning 8% interest and “managed” by a trustee 
who could decide each year what portion of the interest you were 
to be paid in cash.  Interest not paid out would be “retained 
earnings” added to the savings account to compound.  And let’s 
suppose that your trustee, in his superior wisdom, set the “pay-
out ratio” at one-quarter of the annual earnings.

     Under these assumptions, your account would be worth 
$179,084 at the end of ten years.  Additionally, your annual 
earnings would have increased about 70% from $8,000 to $13,515 
under this inspired management.  And, finally, your “dividends” 
would have increased commensurately, rising regularly from $2,000 
in the first year to $3,378 in the tenth year.  Each year, when 
your manager’s public relations firm prepared his annual report 
to you, all of the charts would have had lines marching skyward.

     Now, just for fun, let’s push our scenario one notch further 
and give your trustee-manager a ten-year fixed-price option on 
part of your “business” (i.e., your savings account) based on its 
fair value in the first year.  With such an option, your manager 
would reap a substantial profit at your expense - just from 
having held on to most of your earnings.  If he were both 
Machiavellian and a bit of a mathematician, your manager might 
also have cut the pay-out ratio once he was firmly entrenched.

     This scenario is not as farfetched as you might think.  Many 
stock options in the corporate world have worked in exactly that 
fashion: they have gained in value simply because management 
retained earnings, not because it did well with the capital in 
its hands.

     Managers actually apply a double standard to options.  
Leaving aside warrants (which deliver the issuing corporation 
immediate and substantial compensation), I believe it is fair to 
say that nowhere in the business world are ten-year fixed-price 
options on all or a portion of a business granted to outsiders.  
Ten months, in fact, would be regarded as extreme.  It would be 
particularly unthinkable for managers to grant a long-term option 
on a business that was regularly adding to its capital.  Any 
outsider wanting to secure such an option would be required to 
pay fully for capital added during the option period.

     The unwillingness of managers to do-unto-outsiders, however, 
is not matched by an unwillingness to do-unto-themselves. 
(Negotiating with one’s self seldom produces a barroom brawl.) 
Managers regularly engineer ten-year, fixed-price options for 
themselves and associates that, first, totally ignore the fact 
that retained earnings automatically build value and, second, 
ignore the carrying cost of capital.  As a result, these managers 
end up profiting much as they would have had they had an option 
on that savings account that was automatically building up in 

     Of course, stock options often go to talented, value-adding 
managers and sometimes deliver them rewards that are perfectly 
appropriate. (Indeed, managers who are really exceptional almost 
always get far less than they should.) But when the result is 
equitable, it is accidental.  Once granted, the option is blind 
to individual performance.  Because it is irrevocable and 
unconditional (so long as a manager stays in the company), the 
sluggard receives rewards from his options precisely as does the 
star.  A managerial Rip Van Winkle, ready to doze for ten years, 
could not wish for a better “incentive” system.

     (I can’t resist commenting on one long-term option given an 
“outsider”: that granted the U.S. Government on Chrysler shares 
as partial consideration for the government’s guarantee of some 
lifesaving loans.  When these options worked out well for the 
government, Chrysler sought to modify the payoff, arguing that 
the rewards to the government were both far greater than intended 
and outsize in relation to its contribution to Chrysler’s 
recovery.  The company’s anguish over what it saw as an imbalance 
between payoff and performance made national news.  That anguish 
may well be unique: to my knowledge, no managers - anywhere - 
have been similarly offended by unwarranted payoffs arising from 
options granted to themselves or their colleagues.)

     Ironically, the rhetoric about options frequently describes 
them as desirable because they put managers and owners in the 
same financial boat.  In reality, the boats are far different.  
No owner has ever escaped the burden of capital costs, whereas a 
holder of a fixed-price option bears no capital costs at all.  An 
owner must weigh upside potential against downside risk; an 
option holder has no downside.  In fact, the business project in 
which you would wish to have an option frequently is a project in 
which you would reject ownership. (I’ll be happy to accept a 
lottery ticket as a gift - but I’ll never buy one.)

     In dividend policy also, the option holders’ interests are 
best served by a policy that may ill serve the owner.  Think back 
to the savings account example.  The trustee, holding his option, 
would benefit from a no-dividend policy.  Conversely, the owner 
of the account should lean to a total payout so that he can 
prevent the option-holding manager from sharing in the account’s 
retained earnings.

     Despite their shortcomings, options can be appropriate under 
some circumstances.  My criticism relates to their indiscriminate 
use and, in that connection, I would like to emphasize three 

     First, stock options are inevitably tied to the overall 
performance of a corporation.  Logically, therefore, they should 
be awarded only to those managers with overall responsibility.  
Managers with limited areas of responsibility should have 
incentives that pay off in relation to results under their 
control.  The .350 hitter expects, and also deserves, a big 
payoff for his performance - even if he plays for a cellar-
dwelling team.  And the .150 hitter should get no reward - even 
if he plays for a pennant winner.  Only those with overall 
responsibility for the team should have their rewards tied to its 

     Second, options should be structured carefully.  Absent 
special factors, they should have built into them a retained-
earnings or carrying-cost factor.  Equally important, they should 
be priced realistically.  When managers are faced with offers for 
their companies, they unfailingly point out how unrealistic 
market prices can be as an index of real value.  But why, then, 
should these same depressed prices be the valuations at which 
managers sell portions of their businesses to themselves? (They 
may go further: officers and directors sometimes consult the Tax 
Code to determine the lowest prices at which they can, in effect, 
sell part of the business to insiders.  While they’re at it, they 
often elect plans that produce the worst tax result for the 
company.) Except in highly unusual cases, owners are not well 
served by the sale of part of their business at a bargain price - 
whether the sale is to outsiders or to insiders.  The obvious 
conclusion: options should be priced at true business value.

     Third, I want to emphasize that some managers whom I admire 
enormously - and whose operating records are far better than mine 
- disagree with me regarding fixed-price options.  They have 
built corporate cultures that work, and fixed-price options have 
been a tool that helped them.  By their leadership and example, 
and by the use of options as incentives, these managers have 
taught their colleagues to think like owners.  Such a Culture is 
rare and when it exists should perhaps be left intact - despite 
inefficiencies and inequities that may infest the option program.  
“If it ain’t broke, don’t fix it” is preferable to “purity at any 

     At Berkshire, however, we use an incentive@compensation 
system that rewards key managers for meeting targets in their own 
bailiwicks.  If See’s does well, that does not produce incentive 
compensation at the News - nor vice versa.  Neither do we look at 
the price of Berkshire stock when we write bonus checks.  We 
believe good unit performance should be rewarded whether 
Berkshire stock rises, falls, or stays even.  Similarly, we think 
average performance should earn no special rewards even if our 
stock should soar.  “Performance”, furthermore, is defined in 
different ways depending upon the underlying economics of the 
business: in some our managers enjoy tailwinds not of their own 
making, in others they fight unavoidable headwinds.

     The rewards that go with this system can be large.  At our 
various business units, top managers sometimes receive incentive 
bonuses of five times their base salary, or more, and it would 
appear possible that one manager’s bonus could top $2 million in 
1986. (I hope so.) We do not put a cap on bonuses, and the 
potential for rewards is not hierarchical.  The manager of a 
relatively small unit can earn far more than the manager of a 
larger unit if results indicate he should.  We believe, further, 
that such factors as seniority and age should not affect 
incentive compensation (though they sometimes influence basic 
compensation).  A 20-year-old who can hit .300 is as valuable to 
us as a 40-year-old performing as well.

     Obviously, all Berkshire managers can use their bonus money 
(or other funds, including borrowed money) to buy our stock in 
the market.  Many have done just that - and some now have large 
holdings.  By accepting both the risks and the carrying costs 
that go with outright purchases, these managers truly walk in the 
shoes of owners.

     Now let’s get back - at long last - to our three businesses:

     At Nebraska Furniture Mart our basic strength is an 
exceptionally low-cost operation that allows the business to 
regularly offer customers the best values available in home 
furnishings.  NFM is the largest store of its kind in the 
country.  Although the already-depressed farm economy worsened 
considerably in 1985, the store easily set a new sales record.  I 
also am happy to report that NFM’s Chairman, Rose Blumkin (the 
legendary “Mrs.  B”), continues at age 92 to set a pace at the 
store that none of us can keep up with.  She’s there wheeling and 
dealing seven days a week, and I hope that any of you who visit 
Omaha will go out to the Mart and see her in action.  It will 
inspire you, as it does me.

     At See’s we continue to get store volumes that are far 
beyond those achieved by any competitor we know of.  Despite the 
unmatched consumer acceptance we enjoy, industry trends are not 
good, and we continue to experience slippage in poundage sales on 
a same-store basis.  This puts pressure on per-pound costs.  We 
now are willing to increase prices only modestly and, unless we 
can stabilize per-shop poundage, profit margins will narrow.

     At the News volume gains are also difficult to achieve.  
Though linage increased during 1985, the gain was more than 
accounted for by preprints.  ROP linage (advertising printed on 
our own pages) declined.  Preprints are far less profitable than 
ROP ads, and also more vulnerable to competition.  In 1985, the 
News again controlled costs well and our household penetration 
continues to be exceptional.

     One problem these three operations do not have is 
management.  At See’s we have Chuck Huggins, the man we put in 
charge the day we bought the business.  Selecting him remains one 
of our best business decisions.  At the News we have Stan Lipsey, 
a manager of equal caliber.  Stan has been with us 17 years, and 
his unusual business talents have become more evident with every 
additional level of responsibility he has tackled.  And, at the 
Mart, we have the amazing Blumkins - Mrs. B, Louie, Ron, Irv, and 
Steve - a three-generation miracle of management.

     I consider myself extraordinarily lucky to be able to work 
with managers such as these.  I like them personally as much as I 
admire them professionally.

Insurance Operations

     Shown below is an updated version of our usual table, 
listing two key figures for the insurance industry:

                         Yearly Change       Combined Ratio
                          in Premiums      after Policyholder
                          Written (%)          Dividends
                         -------------     ------------------
     1972 ...............    10.2                  96.2
     1973 ...............     8.0                  99.2
     1974 ...............     6.2                 105.4
     1975 ...............    11.0                 107.9
     1976 ...............    21.9                 102.4
     1977 ...............    19.8                  97.2
     1978 ...............    12.8                  97.5
     1979 ...............    10.3                 100.6
     1980 ...............     6.0                 103.1
     1981 ...............     3.9                 106.0
     1982 ...............     4.4                 109.7
     1983 ...............     4.5                 111.9
     1984 (Revised) .....     9.2                 117.9
     1985 (Estimated) ...    20.9                 118.0

Source: Best’s Aggregates and Averages

     The combined ratio represents total insurance costs (losses 
incurred plus expenses) compared to revenue from premiums: a 
ratio below 100 indicates an underwriting profit, and one above 
100 indicates a loss.

     The industry’s 1985 results were highly unusual.  The 
revenue gain was exceptional, and had insured losses grown at 
their normal rate of most recent years - that is, a few points 
above the inflation rate - a significant drop in the combined 
ratio would have occurred.  But losses in 1985 didn’t cooperate, 
as they did not in 1984.  Though inflation slowed considerably in 
these years, insured losses perversely accelerated, growing by 
16% in 1984 and by an even more startling 17% in 1985.  The 
year’s growth in losses therefore exceeds the inflation rate by 
over 13 percentage points, a modern record.

     Catastrophes were not the culprit in this explosion of loss 
cost.  True, there were an unusual number of hurricanes in 1985, 
but the aggregate damage caused by all catastrophes in 1984 and 
1985 was about 2% of premium volume, a not unusual proportion.  
Nor was there any burst in the number of insured autos, houses, 
employers, or other kinds of “exposure units”.

     A partial explanation for the surge in the loss figures is 
all the additions to reserves that the industry made in 1985.  As 
results for the year were reported, the scene resembled a revival 
meeting: shouting “I’ve sinned, I’ve sinned”, insurance managers 
rushed forward to confess they had under reserved in earlier 
years.  Their corrections significantly affected 1985 loss 

     A more disturbing ingredient in the loss surge is the 
acceleration in “social” or “judicial” inflation.  The insurer’s 
ability to pay has assumed overwhelming importance with juries 
and judges in the assessment of both liability and damages.  More 
and more, “the deep pocket” is being sought and found, no matter 
what the policy wording, the facts, or the precedents.

     This judicial inflation represents a wild card in the 
industry’s future, and makes forecasting difficult.  
Nevertheless, the short-term outlook is good.  Premium growth 
improved as 1985 went along (quarterly gains were an estimated 
15%, 19%, 24%, and 22%) and, barring a supercatastrophe, the 
industry’s combined ratio should fall sharply in 1986.

     The profit improvement, however, is likely to be of short 
duration.  Two economic principles will see to that.  First, 
commodity businesses achieve good levels of profitability only 
when prices are fixed in some manner or when capacity is short.  
Second, managers quickly add to capacity when prospects start to 
improve and capital is available.

     In my 1982 report to you, I discussed the commodity nature 
of the insurance industry extensively.  The typical policyholder 
does not differentiate between products but concentrates instead 
on price.  For many decades a cartel-like procedure kept prices 
up, but this arrangement has disappeared for good.  The insurance 
product now is priced as any other commodity for which a free 
market exists: when capacity is tight, prices will be set 
remuneratively; otherwise, they will not be.

     Capacity currently is tight in many lines of insurance - 
though in this industry, unlike most, capacity is an attitudinal 
concept, not a physical fact.  Insurance managers can write 
whatever amount of business they feel comfortable writing, 
subject only to pressures applied by regulators and Best’s, the 
industry’s authoritative rating service.  The comfort level of 
both managers and regulators is tied to capital.  More capital 
means more comfort, which in turn means more capacity.  In the 
typical commodity business, furthermore, such as aluminum or 
steel, a long gestation precedes the birth of additional 
capacity.  In the insurance industry, capital can be secured 
instantly.  Thus, any capacity shortage can be eliminated in 
short order.

     That’s exactly what’s going on right now.  In 1985, about 15 
insurers raised well over $3 billion, piling up capital so that 
they can write all the business possible at the better prices now 
available.  The capital-raising trend has accelerated 
dramatically so far in 1986.

     If capacity additions continue at this rate, it won’t be 
long before serious price-cutting appears and next a fall in 
profitability.  When the fall comes, it will be the fault of the 
capital-raisers of 1985 and 1986, not the price-cutters of 198X. 
(Critics should be understanding, however: as was the case in our 
textile example, the dynamics of capitalism cause each insurer to 
make decisions that for itself appear sensible, but that 
collectively slash profitability.)

     In past reports, I have told you that Berkshire’s strong 
capital position - the best in the industry - should one day 
allow us to claim a distinct competitive advantage in the 
insurance market.  With the tightening of the market, that day 
arrived.  Our premium volume more than tripled last year, 
following a long period of stagnation.  Berkshire’s financial 
strength (and our record of maintaining unusual strength through 
thick and thin) is now a major asset for us in securing good 

     We correctly foresaw a flight to quality by many large 
buyers of insurance and reinsurance who belatedly recognized that 
a policy is only an IOU - and who, in 1985, could not collect on 
many of their IOUs.  These buyers today are attracted to 
Berkshire because of its strong capital position.  But, in a 
development we did not foresee, we also are finding buyers drawn 
to us because our ability to insure substantial risks sets us 
apart from the crowd.

     To understand this point, you need a few background facts 
about large risks.  Traditionally, many insurers have wanted to 
write this kind of business.  However, their willingness to do so 
has been almost always based upon reinsurance arrangements that 
allow the insurer to keep just a small portion of the risk itself 
while passing on (“laying off”) most of the risk to its 
reinsurers.  Imagine, for example, a directors and officers 
(“D & O”) liability policy providing $25 million of coverage.  
By various “excess-of-loss” reinsurance contracts, the company 
issuing that policy might keep the liability for only the first 
$1 million of any loss that occurs.  The liability for any loss 
above that amount up to $24 million would be borne by the 
reinsurers of the issuing insurer.  In trade parlance, a company 
that issues large policies but retains relatively little of the 
risk for its own account writes a large gross line but a small 
net line.

     In any reinsurance arrangement, a key question is how the 
premiums paid for the policy should be divided among the various 
“layers” of risk.  In our D & O policy, for example. what part of 
the premium received should be kept by the issuing company to 
compensate it fairly for taking the first $1 million of risk and 
how much should be passed on to the reinsurers to compensate them 
fairly for taking the risk between $1 million and $25 million?

     One way to solve this problem might be deemed the Patrick 
Henry approach: “I have but one lamp by which my feet are guided, 
and that is the lamp of experience.” In other words, how much of 
the total premium would reinsurers have needed in the past to 
compensate them fairly for the losses they actually had to bear?

     Unfortunately, the lamp of experience has always provided 
imperfect illumination for reinsurers because so much of their 
business is “long-tail”, meaning it takes many years before they 
know what their losses are.  Lately, however, the light has not 
only been dim but also grossly misleading in the images it has 
revealed.  That is, the courts’ tendency to grant awards that are 
both huge and lacking in precedent makes reinsurers’ usual 
extrapolations or inferences from past data a formula for 
disaster.  Out with Patrick Henry and in with Pogo: “The future 
ain’t what it used to be.”

     The burgeoning uncertainties of the business, coupled with 
the entry into reinsurance of many unsophisticated participants, 
worked in recent years in favor of issuing companies writing a 
small net line: they were able to keep a far greater percentage 
of the premiums than the risk.  By doing so, the issuing 
companies sometimes made money on business that was distinctly 
unprofitable for the issuing and reinsuring companies combined. 
(This result was not necessarily by intent: issuing companies 
generally knew no more than reinsurers did about the ultimate 
costs that would be experienced at higher layers of risk.) 
Inequities of this sort have been particularly pronounced in 
lines of insurance in which much change was occurring and losses 
were soaring; e.g., professional malpractice, D & 0, products 
liability, etc.  Given these circumstances, it is not surprising 
that issuing companies remained enthusiastic about writing 
business long after premiums became woefully inadequate on a 
gross basis.

     An example of just how disparate results have been for 
issuing companies versus their reinsurers is provided by the 1984 
financials of one of the leaders in large and unusual risks.  In 
that year the company wrote about $6 billion of business and kept 
around $2 1/2 billion of the premiums, or about 40%.  It gave the 
remaining $3 1/2 billion to reinsurers.  On the part of the 
business kept, the company’s underwriting loss was less than $200 
million - an excellent result in that year.  Meanwhile, the part 
laid off produced a loss of over $1.5 billion for the reinsurers.  
Thus, the issuing company wrote at a combined ratio of well under 
110 while its reinsurers, participating in precisely the same 
policies, came in considerably over 140.  This result was not 
attributable to natural catastrophes; it came from run-of-the-
mill insurance losses (occurring, however, in surprising 
frequency and size).  The issuing company’s 1985 report is not 
yet available, but I would predict it will show that dramatically 
unbalanced results continued.

     A few years such as this, and even slow-witted reinsurers 
can lose interest, particularly in explosive lines where the 
proper split in premium between issuer and reinsurer remains 
impossible to even roughly estimate.  The behavior of reinsurers 
finally becomes like that of Mark Twain’s cat: having once sat on 
a hot stove, it never did so again - but it never again sat on a 
cold stove, either.  Reinsurers have had so many unpleasant 
surprises in long-tail casualty lines that many have decided 
(probably correctly) to give up the game entirely, regardless of 
price inducements.  Consequently, there has been a dramatic pull-
back of reinsurance capacity in certain important lines.

     This development has left many issuing companies under 
pressure.  They can no longer commit their reinsurers, time after 
time, for tens of millions per policy as they so easily could do 
only a year or two ago, and they do not have the capital and/or 
appetite to take on large risks for their own account.  For many 
issuing companies, gross capacity has shrunk much closer to net 
capacity - and that is often small, indeed.

     At Berkshire we have never played the lay-it-off-at-a-profit 
game and, until recently, that put us at a severe disadvantage in 
certain lines.  Now the tables are turned: we have the 
underwriting capability whereas others do not.  If we believe the 
price to be right, we are willing to write a net line larger than 
that of any but the largest insurers.  For instance, we are 
perfectly willing to risk losing $10 million of our own money on 
a single event, as long as we believe that the price is right and 
that the risk of loss is not significantly correlated with other 
risks we are insuring.  Very few insurers are willing to risk 
half that much on single events - although, just a short while 
ago, many were willing to lose five or ten times that amount as 
long as virtually all of the loss was for the account of their 

     In mid-1985 our largest insurance company, National 
Indemnity Company, broadcast its willingness to underwrite large 
risks by running an ad in three issues of an insurance weekly.  
The ad solicited policies of only large size: those with a 
minimum premium of $1 million.  This ad drew a remarkable 600 
replies and ultimately produced premiums totaling about $50 
million. (Hold the applause: it’s all long-tail business and it 
will be at least five years before we know whether this marketing 
success was also an underwriting success.) Today, our insurance 
subsidiaries continue to be sought out by brokers searching for 
large net capacity.

     As I have said, this period of tightness will pass; insurers 
and reinsurers will return to underpricing.  But for a year or 
two we should do well in several segments of our insurance 
business.  Mike Goldberg has made many important improvements in 
the operation (prior mismanagement by your Chairman having 
provided him ample opportunity to do so).  He has been 
particularly successful recently in hiring young managers with 
excellent potential.  They will have a chance to show their stuff 
in 1986.

     Our combined ratio has improved - from 134 in 1984 to 111 in 
1985 - but continues to reflect past misdeeds.  Last year I told 
you of the major mistakes I had made in loss-reserving, and 
promised I would update you annually on loss-development figures.  
Naturally, I made this promise thinking my future record would be 
much improved.  So far this has not been the case.  Details on 
last year’s loss development are on pages 50-52.  They reveal 
significant underreserving at the end of 1984, as they did in the 
several years preceding.

     The only bright spot in this picture is that virtually all 
of the underreserving revealed in 1984 occurred in the 
reinsurance area - and there, in very large part, in a few 
contracts that were discontinued several years ago.  This 
explanation, however, recalls all too well a story told me many 
years ago by the then Chairman of General Reinsurance Company.  
He said that every year his managers told him that “except for 
the Florida hurricane” or “except for Midwestern tornadoes”, they 
would have had a terrific year.  Finally he called the group 
together and suggested that they form a new operation - the 
Except-For Insurance Company - in which they would henceforth 
place all of the business that they later wouldn’t want to count.

     In any business, insurance or otherwise, “except for” should 
be excised from the lexicon.  If you are going to play the game, 
you must count the runs scored against you in all nine innings.  
Any manager who consistently says “except for” and then reports 
on the lessons he has learned from his mistakes may be missing 
the only important lesson - namely, that the real mistake is not 
the act, but the actor.

     Inevitably, of course, business errors will occur and the 
wise manager will try to find the proper lessons in them.  But 
the trick is to learn most lessons from the experiences of 
others.  Managers who have learned much from personal experience 
in the past usually are destined to learn much from personal 
experience in the future.

     GEICO, 38%-owned by Berkshire, reported an excellent year in 
1985 in premium growth and investment results, but a poor year - 
by its lofty standards - in underwriting.  Private passenger auto 
and homeowners insurance were the only important lines in the 
industry whose results deteriorated significantly during the 
year.  GEICO did not escape the trend, although its record was 
far better than that of virtually all its major competitors.

     Jack Byrne left GEICO at mid-year to head Fireman’s Fund, 
leaving behind Bill Snyder as Chairman and Lou Simpson as Vice 
Chairman.  Jack’s performance in reviving GEICO from near-
bankruptcy was truly extraordinary, and his work resulted in 
enormous gains for Berkshire.  We owe him a great deal for that.

     We are equally indebted to Jack for an achievement that 
eludes most outstanding leaders: he found managers to succeed him 
who have talents as valuable as his own.  By his skill in 
identifying, attracting and developing Bill and Lou, Jack 
extended the benefits of his managerial stewardship well beyond 
his tenure.

Fireman’s Fund Quota-Share Contract

     Never one to let go of a meal ticket, we have followed Jack 
Byrne to Fireman’s Fund (“FFIC”) where he is Chairman and CEO of 
the holding company.

     On September 1, 1985 we became a 7% participant in all of 
the business in force of the FFIC group, with the exception of 
reinsurance they write for unaffiliated companies.  Our contract 
runs for four years, and provides that our losses and costs will 
be proportionate to theirs throughout the contract period.  If 
there is no extension, we will thereafter have no participation 
in any ongoing business.  However, for a great many years in the 
future, we will be reimbursing FFIC for our 7% of the losses that 
occurred in the September 1, 1985 - August 31, 1989 period.

     Under the contract FFIC remits premiums to us promptly and 
we reimburse FFIC promptly for expenses and losses it has paid.  
Thus, funds generated by our share of the business are held by us 
for investment.  As part of the deal, I’m available to FFIC for 
consultation about general investment strategy.  I’m not 
involved, however, in specific investment decisions of FFIC, nor 
is Berkshire involved in any aspect of the company’s underwriting 

     Currently FFIC is doing about $3 billion of business, and it 
will probably do more as rates rise.  The company’s September 1, 
1985 unearned premium reserve was $1.324 billion, and it 
therefore transferred 7% of this, or $92.7 million, to us at 
initiation of the contract.  We concurrently paid them $29.4 
million representing the underwriting expenses that they had 
incurred on the transferred premium.  All of the FFIC business is 
written by National Indemnity Company, but two-sevenths of it is 
passed along to Wesco-Financial Insurance Company (“Wes-FIC”), a 
new company organized by our 80%-owned subsidiary, Wesco 
Financial Corporation.  Charlie Munger has some interesting 
comments about Wes-FIC and the reinsurance business on pages 60-

     To the Insurance Segment tables on page 41, we have added a 
new line, labeled Major Quota Share Contracts.  The 1985 results 
of the FFIC contract are reported there, though the newness of 
the arrangement makes these results only very rough 

After the end of the year, we secured another quota-share 
contract, whose 1986 volume should be over $50 million.  We hope 
to develop more of this business, and industry conditions suggest 
that we could: a significant number of companies are generating 
more business than they themselves can prudently handle.  Our 
financial strength makes us an attractive partner for such 

Marketable Securities

We show below our 1985 yearend net holdings in marketable 
equities.  All positions with a market value over $25 million are 
listed, and the interests attributable to minority shareholders 
of Wesco and Nebraska Furniture Mart are excluded.

No. of Shares                                           Cost       Market
-------------                                        ----------  ----------
                                                         (000s omitted)
  1,036,461    Affiliated Publications, Inc. .......   $ 3,516    $  55,710
    900,800    American Broadcasting Companies, Inc.    54,435      108,997
  2,350,922    Beatrice Companies, Inc. ............   106,811      108,142
  6,850,000    GEICO Corporation ...................    45,713      595,950
  2,379,200    Handy & Harman ......................    27,318       43,718
    847,788    Time, Inc. ..........................    20,385       52,669
  1,727,765    The Washington Post Company .........     9,731      205,172
                                                     ----------  ----------
                                                       267,909    1,170,358
               All Other Common Stockholdings ......     7,201       27,963
                                                     ----------  ----------
               Total Common Stocks                    $275,110   $1,198,321
                                                     ==========  ==========

     We mentioned earlier that in the past decade the investment 
environment has changed from one in which great businesses were 
totally unappreciated to one in which they are appropriately 
recognized.  The Washington Post Company (“WPC”) provides an 
excellent example.

     We bought all of our WPC holdings in mid-1973 at a price of 
not more than one-fourth of the then per-share business value of 
the enterprise.  Calculating the price/value ratio required no 
unusual insights.  Most security analysts, media brokers, and 
media executives would have estimated WPC’s intrinsic business 
value at $400 to $500 million just as we did.  And its $100 
million stock market valuation was published daily for all to 
see.  Our advantage, rather, was attitude: we had learned from 
Ben Graham that the key to successful investing was the purchase 
of shares in good businesses when market prices were at a large 
discount from underlying business values.

     Most institutional investors in the early 1970s, on the 
other hand, regarded business value as of only minor relevance 
when they were deciding the prices at which they would buy or 
sell.  This now seems hard to believe.  However, these 
institutions were then under the spell of academics at 
prestigious business schools who were preaching a newly-fashioned 
theory: the stock market was totally efficient, and therefore 
calculations of business value - and even thought, itself - were 
of no importance in investment activities. (We are enormously 
indebted to those academics: what could be more advantageous in 
an intellectual contest - whether it be bridge, chess, or stock 
selection than to have opponents who have been taught that 
thinking is a waste of energy?)

     Through 1973 and 1974, WPC continued to do fine as a 
business, and intrinsic value grew.  Nevertheless, by yearend 
1974 our WPC holding showed a loss of about 25%, with market 
value at $8 million against our cost of $10.6 million.  What we 
had thought ridiculously cheap a year earlier had become a good 
bit cheaper as the market, in its infinite wisdom, marked WPC 
stock down to well below 20 cents on the dollar of intrinsic 

     You know the happy outcome.  Kay Graham, CEO of WPC, had the 
brains and courage to repurchase large quantities of stock for 
the company at those bargain prices, as well as the managerial 
skills necessary to dramatically increase business values.  
Meanwhile, investors began to recognize the exceptional economics 
of the business and the stock price moved closer to underlying 
value.  Thus, we experienced a triple dip: the company’s business 
value soared upward, per-share business value increased 
considerably faster because of stock repurchases and, with a 
narrowing of the discount, the stock price outpaced the gain in 
per-share business value.

     We hold all of the WPC shares we bought in 1973, except for 
those sold back to the company in 1985’s proportionate 
redemption.  Proceeds from the redemption plus yearend market 
value of our holdings total $221 million.

     If we had invested our $10.6 million in any of a half-dozen 
media companies that were investment favorites in mid-1973, the 
value of our holdings at yearend would have been in the area of 
$40 - $60 million.  Our gain would have far exceeded the gain in 
the general market, an outcome reflecting the exceptional 
economics of the media business.  The extra $160 million or so we 
gained through ownership of WPC came, in very large part, from 
the superior nature of the managerial decisions made by Kay as 
compared to those made by managers of most media companies.  Her 
stunning business success has in large part gone unreported but 
among Berkshire shareholders it should not go unappreciated.

     Our Capital Cities purchase, described in the next section, 
required me to leave the WPC Board early in 1986.  But we intend 
to hold indefinitely whatever WPC stock FCC rules allow us to.  
We expect WPC’s business values to grow at a reasonable rate, and 
we know that management is both able and shareholder-oriented.  
However, the market now values the company at over $1.8 billion, 
and there is no way that the value can progress from that level 
at a rate anywhere close to the rate possible when the company’s 
valuation was only $100 million.  Because market prices have also 
been bid up for our other holdings, we face the same vastly-
reduced potential throughout our portfolio.

     You will notice that we had a significant holding in 
Beatrice Companies at yearend.  This is a short-term arbitrage 
holding - in effect, a parking place for money (though not a 
totally safe one, since deals sometimes fall through and create 
substantial losses).  We sometimes enter the arbitrage field when 
we have more money than ideas, but only to participate in 
announced mergers and sales.  We would be a lot happier if the 
funds currently employed on this short-term basis found a long-
term home.  At the moment, however, prospects are bleak.

     At yearend our insurance subsidiaries had about $400 million 
in tax-exempt bonds, of which $194 million at amortized cost were 
issues of Washington Public Power Supply System (“WPPSS”) 
Projects 1, 2, and 3. 1 discussed this position fully last year, 
and explained why we would not disclose further purchases or 
sales until well after the fact (adhering to the policy we follow 
on stocks).  Our unrealized gain on the WPPSS bonds at yearend 
was $62 million, perhaps one-third arising from the upward 
movement of bonds generally, and the remainder from a more 
positive investor view toward WPPSS 1, 2, and 3s.  Annual tax-
exempt income from our WPPSS issues is about $30 million.

Capital Cities/ABC, Inc.

     Right after yearend, Berkshire purchased 3 million shares of 
Capital Cities/ABC, Inc. (“Cap Cities”) at $172.50 per share, the 
market price of such shares at the time the commitment was made 
early in March, 1985.  I’ve been on record for many years about 
the management of Cap Cities: I think it is the best of any 
publicly-owned company in the country.  And Tom Murphy and Dan 
Burke are not only great managers, they are precisely the sort of 
fellows that you would want your daughter to marry.  It is a 
privilege to be associated with them - and also a lot of fun, as 
any of you who know them will understand.

     Our purchase of stock helped Cap Cities finance the $3.5 
billion acquisition of American Broadcasting Companies.  For Cap 
Cities, ABC is a major undertaking whose economics are likely to 
be unexciting over the next few years.  This bothers us not an 
iota; we can be very patient. (No matter how great the talent or 
effort, some things just take time: you can’t produce a baby in 
one month by getting nine women pregnant.)

     As evidence of our confidence, we have executed an unusual 
agreement: for an extended period Tom, as CEO (or Dan, should he 
be CEO) votes our stock.  This arrangement was initiated by 
Charlie and me, not by Tom.  We also have restricted ourselves in 
various ways regarding sale of our shares.  The object of these 
restrictions is to make sure that our block does not get sold to 
anyone who is a large holder (or intends to become a large 
holder) without the approval of management, an arrangement 
similar to ones we initiated some years ago at GEICO and 
Washington Post.

     Since large blocks frequently command premium prices, some 
might think we have injured Berkshire financially by creating 
such restrictions.  Our view is just the opposite.  We feel the 
long-term economic prospects for these businesses - and, thus, 
for ourselves as owners - are enhanced by the arrangements.  With 
them in place, the first-class managers with whom we have aligned 
ourselves can focus their efforts entirely upon running the 
businesses and maximizing long-term values for owners.  Certainly 
this is much better than having those managers distracted by 
“revolving-door capitalists” hoping to put the company “in play”. 
(Of course, some managers place their own interests above those 
of the company and its owners and deserve to be shaken up - but, 
in making investments, we try to steer clear of this type.)

     Today, corporate instability is an inevitable consequence of 
widely-diffused ownership of voting stock.  At any time a major 
holder can surface, usually mouthing reassuring rhetoric but 
frequently harboring uncivil intentions.  By circumscribing our 
blocks of stock as we often do, we intend to promote stability 
where it otherwise might be lacking.  That kind of certainty, 
combined with a good manager and a good business, provides 
excellent soil for a rich financial harvest.  That’s the economic 
case for our arrangements.

     The human side is just as important.  We don’t want managers 
we like and admire - and who have welcomed a major financial 
commitment by us - to ever lose any sleep wondering whether 
surprises might occur because of our large ownership.  I have 
told them there will be no surprises, and these agreements put 
Berkshire’s signature where my mouth is.  That signature also 
means the managers have a corporate commitment and therefore need 
not worry if my personal participation in Berkshire’s affairs 
ends prematurely (a term I define as any age short of three 

     Our Cap Cities purchase was made at a full price, reflecting 
the very considerable enthusiasm for both media stocks and media 
properties that has developed in recent years (and that, in the 
case of some property purchases, has approached a mania). it’s no 
field for bargains.  However, our Cap Cities investment allies us 
with an exceptional combination of properties and people - and we 
like the opportunity to participate in size.

     Of course, some of you probably wonder why we are now buying 
Cap Cities at $172.50 per share given that your Chairman, in a 
characteristic burst of brilliance, sold Berkshire’s holdings in 
the same company at $43 per share in 1978-80.  Anticipating your 
question, I spent much of 1985 working on a snappy answer that 
would reconcile these acts.

     A little more time, please.

Acquisition of Scott & Fetzer

     Right after yearend we acquired The Scott & Fetzer Company 
(“Scott Fetzer”) of Cleveland for about $320 million. (In 
addition, about $90 million of pre-existing Scott Fetzer debt 
remains in place.) In the next section of this report I describe 
the sort of businesses that we wish to buy for Berkshire.  Scott 
Fetzer is a prototype - understandable, large, well-managed, a 
good earner.

     The company has sales of about $700 million derived from 17 
businesses, many leaders in their fields.  Return on invested 
capital is good to excellent for most of these businesses.  Some 
well-known products are Kirby home-care systems, Campbell 
Hausfeld air compressors, and Wayne burners and water pumps.

     World Book, Inc. - accounting for about 40% of Scott 
Fetzer’s sales and a bit more of its income - is by far the 
company’s largest operation.  It also is by far the leader in its 
industry, selling more than twice as many encyclopedia sets 
annually as its nearest competitor.  In fact, it sells more sets 
in the U.S. than its four biggest competitors combined.

     Charlie and I have a particular interest in the World Book 
operation because we regard its encyclopedia as something 
special.  I’ve been a fan (and user) for 25 years, and now have 
grandchildren consulting the sets just as my children did.  World 
Book is regularly rated the most useful encyclopedia by teachers, 
librarians and consumer buying guides.  Yet it sells for less 
than any of its major competitors. Childcraft, another World 
Book, Inc. product, offers similar value.  This combination of 
exceptional products and modest prices at World Book, Inc. helped 
make us willing to pay the price demanded for Scott Fetzer, 
despite declining results for many companies in the direct-
selling industry.

     An equal attraction at Scott Fetzer is Ralph Schey, its CEO 
for nine years.  When Ralph took charge, the company had 31 
businesses, the result of an acquisition spree in the 1960s.  He 
disposed of many that did not fit or had limited profit 
potential, but his focus on rationalizing the original potpourri 
was not so intense that he passed by World Book when it became 
available for purchase in 1978.  Ralph’s operating and capital-
allocation record is superb, and we are delighted to be 
associated with him.

     The history of the Scott Fetzer acquisition is interesting, 
marked by some zigs and zags before we became involved.  The 
company had been an announced candidate for purchase since early 
1984.  A major investment banking firm spent many months 
canvassing scores of prospects, evoking interest from several.  
Finally, in mid-1985 a plan of sale, featuring heavy 
participation by an ESOP (Employee Stock Ownership Plan), was 
approved by shareholders.  However, as difficulty in closing 
followed, the plan was scuttled.

     I had followed this corporate odyssey through the 
newspapers.  On October 10, well after the ESOP deal had fallen 
through, I wrote a short letter to Ralph, whom I did not know.  I 
said we admired the company’s record and asked if he might like 
to talk.  Charlie and I met Ralph for dinner in Chicago on 
October 22 and signed an acquisition contract the following week.

     The Scott Fetzer acquisition, plus major growth in our 
insurance business, should push revenues above $2 billion in 
1986, more than double those of 1985.


     The Scott Fetzer purchase illustrates our somewhat haphazard 
approach to acquisitions.  We have no master strategy, no 
corporate planners delivering us insights about socioeconomic 
trends, and no staff to investigate a multitude of ideas 
presented by promoters and intermediaries.  Instead, we simply 
hope that something sensible comes along - and, when it does, we 

     To give fate a helping hand, we again repeat our regular 
“business wanted” ad.  The only change from last year’s copy is 
in (1): because we continue to want any acquisition we make to 
have a measurable impact on Berkshire’s financial results, we 
have raised our minimum profit requirement.

     Here’s what we’re looking for:
     (1) large purchases (at least $10 million of after-tax 
     (2) demonstrated consistent earning power (future 
         projections are of little interest to us, nor are 
         “turn-around” situations),
     (3) businesses earning good returns on equity while 
         employing little or no debt,
     (4) management in place (we can’t supply it),
     (5) simple businesses (if there’s lots of technology, we 
         won’t understand it),
     (6) an offering price (we don’t want to waste our time 
         or that of the seller by talking, even preliminarily, 
         about a transaction when price is unknown).
     We will not engage in unfriendly takeovers.  We can promise 
complete confidentiality and a very fast answer - customarily 
within five minutes - as to whether we’re interested.  We prefer 
to buy for cash, but will consider issuance of stock when we 
receive as much in intrinsic business value as we give.  Indeed, 
following recent advances in the price of Berkshire stock, 
transactions involving stock issuance may be quite feasible.  We 
invite potential sellers to check us out by contacting people 
with whom we have done business in the past.  For the right 
business - and the right people - we can provide a good home.

     On the other hand, we frequently get approached about 
acquisitions that don’t come close to meeting our tests: new 
ventures, turnarounds, auction-like sales, and the ever-popular 
(among brokers) “I’m-sure-something-will-work-out-if-you-people-
get-to-know-each-other”.  None of these attracts us in the least.

                           *  *  *
     Besides being interested in the purchases of entire 
businesses as described above, we are also interested in the 
negotiated purchase of large, but not controlling, blocks of 
stock, as in our Cap Cities purchase.  Such purchases appeal to 
us only when we are very comfortable with both the economics of 
the business and the ability and integrity of the people running 
the operation.  We prefer large transactions: in the unusual case 
we might do something as small as $50 million (or even smaller), 
but our preference is for commitments many times that size.

                           *  *  *

     About 96.8% of all eligible shares participated in 
Berkshire’s 1985 shareholder-designated contributions program.  
Total contributions made through the program were $4 million, and 
1,724 charities were recipients.  We conducted a plebiscite last 
year in order to get your views about this program, as well as 
about our dividend policy.  (Recognizing that it’s possible to 
influence the answers to a question by the framing of it, we 
attempted to make the wording of ours as neutral as possible.) We 
present the ballot and the results in the Appendix on page 69. I 
think it’s fair to summarize your response as highly supportive 
of present policies and your group preference - allowing for the 
tendency of people to vote for the status quo - to be for 
increasing the annual charitable commitment as our asset values 

     We urge new shareholders to read the description of our 
shareholder-designated contributions program that appears on 
pages 66 and 67.  If you wish to participate in future programs, 
we strongly urge that you immediately make sure that your shares 
are registered in the name of the actual owner, not in “street” 
name or nominee name.  Shares not so registered on September 30, 
1986 will be ineligible for the 1986 program.
                           *  *  *

     Five years ago we were required by the Bank Holding Company 
Act of 1969 to dispose of our holdings in The Illinois National 
Bank and Trust Company of Rockford, Illinois.  Our method of 
doing so was unusual: we announced an exchange ratio between 
stock of Rockford Bancorp Inc. (the Illinois National’s holding 
company) and stock of Berkshire, and then let each of our 
shareholders - except me - make the decision as to whether to 
exchange all, part, or none of his Berkshire shares for Rockford 
shares.  I took the Rockford stock that was left over and thus my 
own holding in Rockford was determined by your decisions.  At the 
time I said, “This technique embodies the world’s oldest and most 
elementary system of fairly dividing an object.  Just as when you 
were a child and one person cut the cake and the other got first 
choice, I have tried to cut the company fairly, but you get first 
choice as to which piece you want.”

     Last fall Illinois National was sold.  When Rockford’s 
liquidation is completed, its shareholders will have received 
per-share proceeds about equal to Berkshire’s per-share intrinsic 
value at the time of the bank’s sale.  I’m pleased that this 
five-year result indicates that the division of the cake was 
reasonably equitable.
     Last year I put in a plug for our annual meeting, and you 
took me up on the invitation.  Over 250 of our more than 3,000 
registered shareholders showed up.  Those attending behaved just 
as those present in previous years, asking the sort of questions 
you would expect from intelligent and interested owners.  You can 
attend a great many annual meetings without running into a crowd 
like ours. (Lester Maddox, when Governor of Georgia, was 
criticized regarding the state’s abysmal prison system.  “The 
solution”, he said, “is simple.  All we need is a better class of 
prisoners.” Upgrading annual meetings works the same way.)

     I hope you come to this year’s meeting, which will be held 
on May 20 in Omaha.  There will be only one change: after 48 
years of allegiance to another soft drink, your Chairman, in an 
unprecedented display of behavioral flexibility, has converted to 
the new Cherry Coke.  Henceforth, it will be the Official Drink 
of the Berkshire Hathaway Annual Meeting.

     And bring money: Mrs. B promises to have bargains galore if 
you will pay her a visit at The Nebraska Furniture Mart after the 

                                           Warren E. Buffett
                                           Chairman of the Board

March 4, 1986

Berkshire Hathaway Letters to Shareholders (1984)

To the Shareholders of Berkshire Hathaway Inc.:

     Our gain in net worth during 1984 was $152.6 million, or 
$133 per share.  This sounds pretty good but actually it’s 
mediocre.  Economic gains must be evaluated by comparison with 
the capital that produces them.  Our twenty-year compounded 
annual gain in book value has been 22.1% (from $19.46 in 1964 to 
$1108.77 in 1984), but our gain in 1984 was only 13.6%.

     As we discussed last year, the gain in per-share intrinsic 
business value is the economic measurement that really counts.  
But calculations of intrinsic business value are subjective.  In 
our case, book value serves as a useful, although somewhat 
understated, proxy.  In my judgment, intrinsic business value and 
book value increased during 1984 at about the same rate.

     Using my academic voice, I have told you in the past of the 
drag that a mushrooming capital base exerts upon rates of return. 
Unfortunately, my academic voice is now giving way to a 
reportorial voice.  Our historical 22% rate is just that - 
history.  To earn even 15% annually over the next decade 
(assuming we continue to follow our present dividend policy, 
about which more will be said later in this letter) we would need 
profits aggregating about $3.9 billion.  Accomplishing this will 
require a few big ideas - small ones just won’t do.  Charlie 
Munger, my partner in general management, and I do not have any 
such ideas at present, but our experience has been that they pop 
up occasionally. (How’s that for a strategic plan?)

Sources of Reported Earnings

     The table on the following page shows the sources of 
Berkshire’s reported earnings.  Berkshire’s net ownership 
interest in many of the constituent businesses changed at midyear 
1983 when the Blue Chip merger took place.  Because of these 
changes, the first two columns of the table provide the best 
measure of underlying business performance.

     All of the significant gains and losses attributable to 
unusual sales of assets by any of the business entities are 
aggregated with securities transactions on the line near the 
bottom of the table, and are not included in operating earnings. 
(We regard any annual figure for realized capital gains or losses 
as meaningless, but we regard the aggregate realized and 
unrealized capital gains over a period of years as very 

     Furthermore, amortization of Goodwill is not charged against 
the specific businesses but, for reasons outlined in the Appendix 
to my letter in the 1983 annual report, is set forth as a 
separate item.

                                                    (000s omitted)
                                                                         Net Earnings
                                   Earnings Before Income Taxes            After Tax
                              --------------------------------------  ------------------
                                    Total          Berkshire Share     Berkshire Share
                              ------------------  ------------------  ------------------
                                1984      1983      1984      1983      1984      1983
                              --------  --------  --------  --------  --------  --------
Operating Earnings:
  Insurance Group:  
    Underwriting ............ $(48,060) $(33,872) $(48,060) $(33,872) $(25,955) $(18,400)
    Net Investment Income ...   68,903    43,810    68,903    43,810    62,059    39,114
  Buffalo News ..............   27,328    19,352    27,328    16,547    13,317     8,832
  Nebraska Furniture Mart(1)    14,511     3,812    11,609     3,049     5,917     1,521
  See’s Candies .............   26,644    27,411    26,644    24,526    13,380    12,212
  Associated Retail Stores ..   (1,072)      697    (1,072)      697      (579)      355
  Blue Chip Stamps(2)           (1,843)   (1,422)   (1,843)   (1,876)     (899)     (353)
  Mutual Savings and Loan ...    1,456      (798)    1,166      (467)    3,151     1,917
  Precision Steel ...........    4,092     3,241     3,278     2,102     1,696     1,136
  Textiles ..................      418      (100)      418      (100)      226       (63)
  Wesco Financial ...........    9,777     7,493     7,831     4,844     4,828     3,448
  Amortization of Goodwill ..   (1,434)     (532)   (1,434)     (563)   (1,434)     (563)
  Interest on Debt ..........  (14,734)  (15,104)  (14,097)  (13,844)   (7,452)   (7,346)
     Contributions ..........   (3,179)   (3,066)   (3,179)   (3,066)   (1,716)   (1,656)
  Other .....................    4,932    10,121     4,529     9,623     3,476     8,490
                              --------  --------  --------  --------  --------  --------
Operating Earnings ..........   87,739    61,043    82,021    51,410    70,015    48,644
Special GEICO Distribution ..     --      19,575      --      19,575      --      18,224
Special Gen. Foods Distribution  8,111      --       7,896      --       7,294      --
Sales of securities and
   unusual sales of assets ..  104,699    67,260   101,376    65,089    71,587    45,298
                              --------  --------  --------  --------  --------  --------
Total Earnings - all entities $200,549  $147,878  $191,293  $136,074  $148,896  $112,166
                              ========  ========  ========  ========  ========  ========

(1) 1983 figures are those for October through December.
(2) 1984 and 1983 are not comparable; major assets were                       
    transferred in the mid-year 1983 merger of Blue Chip Stamps.

     Sharp-eyed shareholders will notice that the amount of the 
special GEICO distribution and its location in the table have 
been changed from the presentation of last year.  Though they 
reclassify and reduce “accounting” earnings, the changes are 
entirely of form, not of substance.  The story behind the 
changes, however, is interesting.

     As reported last year: (1) in mid-1983 GEICO made a tender 
offer to buy its own shares; (2) at the same time, we agreed by 
written contract to sell GEICO an amount of its shares that would 
be proportionately related to the aggregate number of shares 
GEICO repurchased via the tender from all other shareholders; (3) 
at completion of the tender, we delivered 350,000 shares to 
GEICO, received $21 million cash, and were left owning exactly 
the same percentage of GEICO that we owned before the tender; (4) 
GEICO’s transaction with us amounted to a proportionate 
redemption, an opinion rendered us, without qualification, by a 
leading law firm; (5) the Tax Code logically regards such 
proportionate redemptions as substantially equivalent to 
dividends and, therefore, the $21 million we received was taxed 
at only the 6.9% inter-corporate dividend rate; (6) importantly, 
that $21 million was far less than the previously-undistributed 
earnings that had inured to our ownership in GEICO and, thus, 
from the standpoint of economic substance, was in our view 
equivalent to a dividend.

     Because it was material and unusual, we highlighted the 
GEICO distribution last year to you, both in the applicable 
quarterly report and in this section of the annual report.  
Additionally, we emphasized the transaction to our auditors, 
Peat, Marwick, Mitchell & Co. Both the Omaha office of Peat 
Marwick and the reviewing Chicago partner, without objection, 
concurred with our dividend presentation.

     In 1984, we had a virtually identical transaction with 
General Foods.  The only difference was that General Foods 
repurchased its stock over a period of time in the open market, 
whereas GEICO had made a “one-shot” tender offer.  In the General 
Foods case we sold to the company, on each day that it 
repurchased shares, a quantity of shares that left our ownership 
percentage precisely unchanged.  Again our transaction was 
pursuant to a written contract executed before repurchases began.  
And again the money we received was far less than the retained 
earnings that had inured to our ownership interest since our 
purchase.  Overall we received $21,843,601 in cash from General 
Foods, and our ownership remained at exactly 8.75%.

     At this point the New York office of Peat Marwick came into 
the picture.  Late in 1984 it indicated that it disagreed with 
the conclusions of the firm’s Omaha office and Chicago reviewing 
partner.  The New York view was that the GEICO and General Foods 
transactions should be treated as sales of stock by Berkshire 
rather than as the receipt of dividends.  Under this accounting 
approach, a portion of the cost of our investment in the stock of 
each company would be charged against the redemption payment and 
any gain would be shown as a capital gain, not as dividend 
income.  This is an accounting approach only, having no bearing 
on taxes: Peat Marwick agrees that the transactions were 
dividends for IRS purposes.

     We disagree with the New York position from both the 
viewpoint of economic substance and proper accounting.  But, to 
avoid a qualified auditor’s opinion, we have adopted herein Peat 
Marwick’s 1984 view and restated 1983 accordingly.  None of this, 
however, has any effect on intrinsic business value: our 
ownership interests in GEICO and General Foods, our cash, our 
taxes, and the market value and tax basis of our holdings all 
remain the same.

     This year we have again entered into a contract with General 
Foods whereby we will sell them shares concurrently with open 
market purchases that they make.  The arrangement provides that 
our ownership interest will remain unchanged at all times.  By 
keeping it so, we will insure ourselves dividend treatment for 
tax purposes.  In our view also, the economic substance of this 
transaction again is the creation of dividend income.  However, 
we will account for the redemptions as sales of stock rather than 
dividend income unless accounting rules are adopted that speak 
directly to this point.  We will continue to prominently identify 
any such special transactions in our reports to you.

     While we enjoy a low tax charge on these proportionate 
redemptions, and have participated in several of them, we view 
such repurchases as at least equally favorable for shareholders 
who do not sell.  When companies with outstanding businesses and 
comfortable financial positions find their shares selling far 
below intrinsic value in the marketplace, no alternative action 
can benefit shareholders as surely as repurchases.

     (Our endorsement of repurchases is limited to those dictated 
by price/value relationships and does not extend to the 
“greenmail” repurchase - a practice we find odious and repugnant.  
In these transactions, two parties achieve their personal ends by 
exploitation of an innocent and unconsulted third party.  The 
players are: (1) the “shareholder” extortionist who, even before 
the ink on his stock certificate dries, delivers his “your-
money-or-your-life” message to managers; (2) the corporate 
insiders who quickly seek peace at any price - as long as the 
price is paid by someone else; and (3) the shareholders whose 
money is used by (2) to make (1) go away.  As the dust settles, 
the mugging, transient shareholder gives his speech on “free 
enterprise”, the muggee management gives its speech on “the best 
interests of the company”, and the innocent shareholder standing 
by mutely funds the payoff.)

     The companies in which we have our largest investments have 
all engaged in significant stock repurhases at times when wide 
discrepancies existed between price and value.  As shareholders, 
we find this encouraging and rewarding for two important reasons 
- one that is obvious, and one that is subtle and not always 
understood.  The obvious point involves basic arithmetic: major 
repurchases at prices well below per-share intrinsic business 
value immediately increase, in a highly significant way, that 
value.  When companies purchase their own stock, they often find 
it easy to get $2 of present value for $1.  Corporate acquisition 
programs almost never do as well and, in a discouragingly large 
number of cases, fail to get anything close to $1 of value for 
each $1 expended.

     The other benefit of repurchases is less subject to precise 
measurement but can be fully as important over time.  By making 
repurchases when a company’s market value is well below its 
business value, management clearly demonstrates that it is given 
to actions that enhance the wealth of shareholders, rather than 
to actions that expand management’s domain but that do nothing 
for (or even harm) shareholders.  Seeing this, shareholders and 
potential shareholders increase their estimates of future returns 
from the business.  This upward revision, in turn, produces 
market prices more in line with intrinsic business value.  These 
prices are entirely rational.  Investors should pay more for a 
business that is lodged in the hands of a manager with 
demonstrated pro-shareholder leanings than for one in the hands 
of a self-interested manager marching to a different drummer. (To 
make the point extreme, how much would you pay to be a minority 
shareholder of a company controlled by Robert Wesco?)

     The key word is “demonstrated”.  A manager who consistently 
turns his back on repurchases, when these clearly are in the 
interests of owners, reveals more than he knows of his 
motivations.  No matter how often or how eloquently he mouths 
some public relations-inspired phrase such as “maximizing 
shareholder wealth” (this season’s favorite), the market 
correctly discounts assets lodged with him.  His heart is not 
listening to his mouth - and, after a while, neither will the 

     We have prospered in a very major way - as have other 
shareholders - by the large share repurchases of GEICO, 
Washington Post, and General Foods, our three largest holdings. 
(Exxon, in which we have our fourth largest holding, has also 
wisely and aggressively repurchased shares but, in this case, we 
have only recently established our position.) In each of these 
companies, shareholders have had their interests in outstanding 
businesses materially enhanced by repurchases made at bargain 
prices.  We feel very comfortable owning interests in businesses 
such as these that offer excellent economics combined with 
shareholder-conscious managements.

     The following table shows our 1984 yearend net holdings in 
marketable equities.  All numbers exclude the interests 
attributable to minority shareholders of Wesco and Nebraska 
Furniture Mart.

No. of Shares                                           Cost       Market
-------------                                        ----------  ----------
                                                         (000s omitted)
    690,975    Affiliated Publications, Inc. .......  $  3,516    $  32,908
    740,400    American Broadcasting Companies, Inc.    44,416       46,738
  3,895,710    Exxon Corporation ...................   173,401      175,307
  4,047,191    General Foods Corporation ...........   149,870      226,137
  6,850,000    GEICO Corporation ...................    45,713      397,300
  2,379,200    Handy & Harman ......................    27,318       38,662
    818,872    Interpublic Group of Companies, Inc.      2,570       28,149
    555,949    Northwest Industries                     26,581       27,242
  2,553,488    Time, Inc. ..........................    89,327      109,162
  1,868,600    The Washington Post Company .........    10,628      149,955
                                                     ----------  ----------
                                                      $573,340   $1,231,560
               All Other Common Stockholdings           11,634       37,326
                                                     ----------  ----------
               Total Common Stocks                    $584,974   $1,268,886
                                                     ==========  ==========

     It’s been over ten years since it has been as difficult as 
now to find equity investments that meet both our qualitative 
standards and our quantitative standards of value versus price.  
We try to avoid compromise of these standards, although we find 
doing nothing the most difficult task of all. (One English 
statesman attributed his country’s greatness in the nineteenth 
century to a policy of “masterly inactivity”.  This is a strategy 
that is far easier for historians to commend than for 
participants to follow.)

     In addition to the figures supplied at the beginning of this 
section, information regarding the businesses we own appears in 
Management’s Discussion on pages 42-47.  An amplified discussion 
of Wesco’s businesses appears in Charlie Munger’s report on pages 
50-59.  You will find particularly interesting his comments about 
conditions in the thrift industry.  Our other major controlled 
businesses are Nebraska Furniture Mart, See’s, Buffalo Evening 
News, and the Insurance Group, to which we will give some special 
attention here.

Nebraska Furniture Mart

     Last year I introduced you to Mrs. B (Rose Blumkin) and her 
family.  I told you they were terrific, and I understated the 
case.  After another year of observing their remarkable talents 
and character, I can honestly say that I never have seen a 
managerial group that either functions or behaves better than the 
Blumkin family.

     Mrs. B, Chairman of the Board, is now 91, and recently was 
quoted in the local newspaper as saying, “I come home to eat and 
sleep, and that’s about it.  I can’t wait until it gets daylight 
so I can get back to the business”.  Mrs. B is at the store seven 
days a week, from opening to close, and probably makes more 
decisions in a day than most CEOs do in a year (better ones, 

     In May Mrs. B was granted an Honorary Doctorate in 
Commercial Science by New York University. (She’s a “fast track” 
student: not one day in her life was spent in a school room prior 
to her receipt of the doctorate.) Previous recipients of honorary 
degrees in business from NYU include Clifton Garvin, Jr., CEO of 
Exxon Corp.; Walter Wriston, then CEO of Citicorp; Frank Cary, 
then CEO of IBM; Tom Murphy, then CEO of General Motors; and, 
most recently, Paul Volcker. (They are in good company.)

     The Blumkin blood did not run thin.  Louie, Mrs. B’s son, 
and his three boys, Ron, Irv, and Steve, all contribute in full 
measure to NFM’s amazing success.  The younger generation has 
attended the best business school of them all - that conducted by 
Mrs. B and Louie - and their training is evident in their 

     Last year NFM’s net sales increased by $14.3 million, 
bringing the total to $115 million, all from the one store in 
Omaha.  That is by far the largest volume produced by a single 
home furnishings store in the United States.  In fact, the gain 
in sales last year was itself greater than the annual volume of 
many good-sized successful stores.  The business achieves this 
success because it deserves this success.  A few figures will 
tell you why.

     In its fiscal 1984 10-K, the largest independent specialty 
retailer of home furnishings in the country, Levitz Furniture, 
described its prices as “generally lower than the prices charged 
by conventional furniture stores in its trading area”.  Levitz, 
in that year, operated at a gross margin of 44.4% (that is, on 
average, customers paid it $100 for merchandise that had cost it 
$55.60 to buy).  The gross margin at NFM is not much more than 
half of that.  NFM’s low mark-ups are possible because of its 
exceptional efficiency: operating expenses (payroll, occupancy, 
advertising, etc.) are about 16.5% of sales versus 35.6% at 

     None of this is in criticism of Levitz, which has a well-
managed operation.  But the NFM operation is simply extraordinary 
(and, remember, it all comes from a $500 investment by Mrs. B in 
1937).  By unparalleled efficiency and astute volume purchasing, 
NFM is able to earn excellent returns on capital while saving its 
customers at least $30 million annually from what, on average, it 
would cost them to buy the same merchandise at stores maintaining 
typical mark-ups.  Such savings enable NFM to constantly widen 
its geographical reach and thus to enjoy growth well beyond the 
natural growth of the Omaha market.

     I have been asked by a number of people just what secrets 
the Blumkins bring to their business.  These are not very 
esoteric.  All members of the family: (1) apply themselves with 
an enthusiasm and energy that would make Ben Franklin and Horatio 
Alger look like dropouts; (2) define with extraordinary realism 
their area of special competence and act decisively on all 
matters within it; (3) ignore even the most enticing propositions 
failing outside of that area of special competence; and, (4) 
unfailingly behave in a high-grade manner with everyone they deal 
with. (Mrs.  B boils it down to “sell cheap and tell the truth”.)

     Our evaluation of the integrity of Mrs. B and her family was 
demonstrated when we purchased 90% of the business: NFM had never 
had an audit and we did not request one; we did not take an 
inventory nor verify the receivables; we did not check property 
titles.  We gave Mrs. B a check for $55 million and she gave us 
her word.  That made for an even exchange.

     You and I are fortunate to be in partnership with the 
Blumkin family.

See’s Candy Shops, Inc.

     Below is our usual recap of See’s performance since the time 
of purchase by Blue Chip Stamps:

  52-53 Week Year                     Operating     Number of    Number of
    Ended About           Sales        Profits      Pounds of   Stores Open
    December 31         Revenues     After Taxes   Candy Sold   at Year End
-------------------   ------------   -----------   ----------   -----------
1984 ..............   $135,946,000   $13,380,000   24,759,000       214
1983 (53 weeks) ...    133,531,000    13,699,000   24,651,000       207
1982 ..............    123,662,000    11,875,000   24,216,000       202
1981 ..............    112,578,000    10,779,000   24,052,000       199
1980 ..............     97,715,000     7,547,000   24,065,000       191
1979 ..............     87,314,000     6,330,000   23,985,000       188
1978 ..............     73,653,000     6,178,000   22,407,000       182
1977 ..............     62,886,000     6,154,000   20,921,000       179
1976 (53 weeks) ...     56,333,000     5,569,000   20,553,000       173
1975 ..............     50,492,000     5,132,000   19,134,000       172
1974 ..............     41,248,000     3,021,000   17,883,000       170
1973 ..............     35,050,000     1,940,000   17,813,000       169
1972 ..............     31,337,000     2,083,000   16,954,000       167

     This performance has not been produced by a generally rising 
tide.  To the contrary, many well-known participants in the 
boxed-chocolate industry either have lost money in this same 
period or have been marginally profitable.  To our knowledge, 
only one good-sized competitor has achieved high profitability.  
The success of See’s reflects the combination of an exceptional 
product and an exceptional manager, Chuck Huggins.

     During 1984 we increased prices considerably less than has 
been our practice in recent years: per-pound realization was 
$5.49, up only 1.4% from 1983.  Fortunately, we made good 
progress on cost control, an area that has caused us problems in 
recent years.  Per-pound costs - other than those for raw 
materials, a segment of expense largely outside of our control - 
increased by only 2.2% last year.

     Our cost-control problem has been exacerbated by the problem 
of modestly declining volume (measured by pounds, not dollars) on 
a same-store basis.  Total pounds sold through shops in recent 
years has been maintained at a roughly constant level only by the 
net addition of a few shops annually.  This more-shops-to-get-
the-same-volume situation naturally puts heavy pressure on per-
pound selling costs.

     In 1984, same-store volume declined 1.1%. Total shop volume, 
however, grew 0.6% because of an increase in stores. (Both 
percentages are adjusted to compensate for a 53-week fiscal year 
in 1983.)

     See’s business tends to get a bit more seasonal each year.  
In the four weeks prior to Christmas, we do 40% of the year’s 
volume and earn about 75% of the year’s profits.  We also earn 
significant sums in the Easter and Valentine’s Day periods, but 
pretty much tread water the rest of the year.  In recent years, 
shop volume at Christmas has grown in relative importance, and so 
have quantity orders and mail orders.  The increased 
concentration of business in the Christmas period produces a 
multitude of managerial problems, all of which have been handled 
by Chuck and his associates with exceptional skill and grace.

     Their solutions have in no way involved compromises in 
either quality of service or quality of product.  Most of our 
larger competitors could not say the same.  Though faced with 
somewhat less extreme peaks and valleys in demand than we, they 
add preservatives or freeze the finished product in order to 
smooth the production cycle and thereby lower unit costs.  We 
reject such techniques, opting, in effect, for production 
headaches rather than product modification.

     Our mall stores face a host of new food and snack vendors 
that provide particularly strong competition at non-holiday 
periods.  We need new products to fight back and during 1984 we 
introduced six candy bars that, overall, met with a good 
reception.  Further product introductions are planned.

     In 1985 we will intensify our efforts to keep per-pound cost 
increases below the rate of inflation.  Continued success in 
these efforts, however, will require gains in same-store 
poundage.  Prices in 1985 should average 6% - 7% above those of 
1984.  Assuming no change in same-store volume, profits should 
show a moderate gain.

Buffalo Evening News

     Profits at the News in 1984 were considerably greater than 
we expected.  As at See’s, excellent progress was made in 
controlling costs.  Excluding hours worked in the newsroom, total 
hours worked decreased by about 2.8%. With this productivity 
improvement, overall costs increased only 4.9%. This performance 
by Stan Lipsey and his management team was one of the best in the 

     However, we now face an acceleration in costs.  In mid-1984 
we entered into new multi-year union contracts that provided for 
a large “catch-up” wage increase.  This catch-up is entirely 
appropriate: the cooperative spirit of our unions during the 
unprofitable 1977-1982 period was an important factor in our 
success in remaining cost competitive with The Courier-Express.  
Had we not kept costs down, the outcome of that struggle might 
well have been different.

     Because our new union contracts took effect at varying 
dates, little of the catch-up increase was reflected in our 1984 
costs.  But the increase will be almost totally effective in 1985 
and, therefore, our unit labor costs will rise this year at a 
rate considerably greater than that of the industry.  We expect 
to mitigate this increase by continued small gains in 
productivity, but we cannot avoid significantly higher wage costs 
this year.  Newsprint price trends also are less favorable now 
than they were in 1984.  Primarily because of these two factors, 
we expect at least a minor contraction in margins at the News.

     Working in our favor at the News are two factors of major 
economic importance:

     (1) Our circulation is concentrated to an unusual degree 
         in the area of maximum utility to our advertisers.  
         “Regional” newspapers with wide-ranging circulation, on 
         the other hand, have a significant portion of their 
         circulation in areas that are of negligible utility to 
         most advertisers.  A subscriber several hundred miles 
         away is not much of a prospect for the puppy you are 
         offering to sell via a classified ad - nor for the 
         grocer with stores only in the metropolitan area.  
         “Wasted” circulation - as the advertisers call it - 
         hurts profitability: expenses of a newspaper are 
         determined largely by gross circulation while 
         advertising revenues (usually 70% - 80% of total 
         revenues) are responsive only to useful circulation; 

     (2) Our penetration of the Buffalo retail market is 
         exceptional; advertisers can reach almost all of their 
         potential customers using only the News.

     Last year I told you about this unusual reader acceptance: 
among the 100 largest newspapers in the country, we were then 
number one, daily, and number three, Sunday, in penetration.  The 
most recent figures show us number one in penetration on weekdays 
and number two on Sunday.  (Even so, the number of households in 
Buffalo has declined, so our current weekday circulation is down 
slightly; on Sundays it is unchanged.)

     I told you also that one of the major reasons for this 
unusual acceptance by readers was the unusual quantity of news 
that we delivered to them: a greater percentage of our paper is 
devoted to news than is the case at any other dominant paper in 
our size range.  In 1984 our “news hole” ratio was 50.9%, (versus 
50.4% in 1983), a level far above the typical 35% - 40%.  We will 
continue to maintain this ratio in the 50% area.  Also, though we 
last year reduced total hours worked in other departments, we 
maintained the level of employment in the newsroom and, again, 
will continue to do so.  Newsroom costs advanced 9.1% in 1984, a 
rise far exceeding our overall cost increase of 4.9%.

     Our news hole policy costs us significant extra money for 
newsprint.  As a result, our news costs (newsprint for the news 
hole plus payroll and expenses of the newsroom) as a percentage 
of revenue run higher than those of most dominant papers of our 
size.  There is adequate room, however, for our paper or any 
other dominant paper to sustain these costs: the difference 
between “high” and “low” news costs at papers of comparable size 
runs perhaps three percentage points while pre-tax profit margins 
are often ten times that amount.

     The economics of a dominant newspaper are excellent, among 
the very best in the business world.  Owners, naturally, would 
like to believe that their wonderful profitability is achieved 
only because they unfailingly turn out a wonderful product.  That 
comfortable theory wilts before an uncomfortable fact.  While 
first-class newspapers make excellent profits, the profits of 
third-rate papers are as good or better - as long as either class 
of paper is dominant within its community.  Of course, product 
quality may have been crucial to the paper in achieving 
dominance.  We believe this was the case at the News, in very 
large part because of people such as Alfred Kirchhofer who 
preceded us.

     Once dominant, the newspaper itself, not the marketplace, 
determines just how good or how bad the paper will be.  Good or 
bad, it will prosper.  That is not true of most businesses: 
inferior quality generally produces inferior economics.  But even 
a poor newspaper is a bargain to most citizens simply because of 
its “bulletin board” value.  Other things being equal, a poor 
product will not achieve quite the level of readership achieved 
by a first-class product.  A poor product, however, will still 
remain essential to most citizens, and what commands their 
attention will command the attention of advertisers.

     Since high standards are not imposed by the marketplace, 
management must impose its own.  Our commitment to an above-
average expenditure for news represents an important quantitative 
standard.  We have confidence that Stan Lipsey and Murray Light 
will continue to apply the far-more important qualitative 
standards.  Charlie and I believe that newspapers are very 
special institutions in society.  We are proud of the News, and 
intend an even greater pride to be justified in the years ahead.

Insurance Operations

     Shown below is an updated version of our usual table listing 
two key figures for the insurance industry:

                                    Yearly Change       Combined Ratio
                                     in Premiums      after Policy-holder
                                     Written (%)           Dividends
                                    -------------     -------------------
1972 ..............................     10.2                  96.2
1973 ..............................      8.0                  99.2
1974 ..............................      6.2                 105.4
1975 ..............................     11.0                 107.9
1976 ..............................     21.9                 102.4
1977 ..............................     19.8                  97.2
1978 ..............................     12.8                  97.5
1979 ..............................     10.3                 100.6
1980 ..............................      6.0                 103.1
1981 ..............................      3.9                 106.0
1982 ..............................      4.4                 109.7
1983 (Revised) ....................      4.5                 111.9
1984 (Estimated) ..................      8.1                 117.7
Source: Best’s Aggregates and Averages

     Best’s data reflect the experience of practically the entire 
industry, including stock, mutual, and reciprocal companies.  The 
combined ratio represents total insurance costs (losses incurred 
plus expenses) compared to revenue from premiums; a ratio below 
100 indicates an underwriting profit, and one above 100 indicates 
a loss.

     For a number of years, we have told you that an annual 
increase by the industry of about 10% per year in premiums 
written is necessary for the combined ratio to remain roughly 
unchanged.  We assumed in making that assertion that expenses as 
a percentage of premium volume would stay relatively stable and 
that losses would grow at about 10% annually because of the 
combined influence of unit volume increases, inflation, and 
judicial rulings that expand what is covered by the insurance 

     Our opinion is proving dismayingly accurate: a premium 
increase of 10% per year since 1979 would have produced an 
aggregate increase through 1984 of 61% and a combined ratio in 
1984 almost identical to the 100.6 of 1979.  Instead, the 
industry had only a 30% increase in premiums and a 1984 combined 
ratio of 117.7. Today, we continue to believe that the key index 
to the trend of underwriting profitability is the year-to-year 
percentage change in industry premium volume.

     It now appears that premium volume in 1985 will grow well 
over 10%.  Therefore, assuming that catastrophes are at a 
“normal” level, we would expect the combined ratio to begin 
easing downward toward the end of the year.  However, under our 
industrywide loss assumptions (i.e., increases of 10% annually), 
five years of 15%-per-year increases in premiums would be 
required to get the combined ratio back to 100.  This would mean 
a doubling of industry volume by 1989, an outcome that seems 
highly unlikely to us.  Instead, we expect several years of 
premium gains somewhat above the 10% level, followed by highly-
competitive pricing that generally will produce combined ratios 
in the 108-113 range.

     Our own combined ratio in 1984 was a humbling 134. (Here, as 
throughout this report, we exclude structured settlements and the 
assumption of loss reserves in reporting this ratio.  Much 
additional detail, including the effect of discontinued 
operations on the ratio, appears on pages 42-43).  This is the 
third year in a row that our underwriting performance has been 
far poorer than that of the industry.  We expect an improvement 
in the combined ratio in 1985, and also expect our improvement to 
be substantially greater than that of the industry.  Mike 
Goldberg has corrected many of the mistakes I made before he took 
over insurance operations.  Moreover, our business is 
concentrated in lines that have experienced poorer-than-average 
results during the past several years, and that circumstance has 
begun to subdue many of our competitors and even eliminate some.  
With the competition shaken, we were able during the last half of 
1984 to raise prices significantly in certain important lines 
with little loss of business.

     For some years I have told you that there could be a day 
coming when our premier financial strength would make a real 
difference in the competitive position of our insurance 
operation.  That day may have arrived.  We are almost without 
question the strongest property/casualty insurance operation in 
the country, with a capital position far superior to that of 
well-known companies of much greater size.

     Equally important, our corporate policy is to retain that 
superiority.  The buyer of insurance receives only a promise in 
exchange for his cash.  The value of that promise should be 
appraised against the possibility of adversity, not prosperity.  
At a minimum, the promise should appear able to withstand a 
prolonged combination of depressed financial markets and 
exceptionally unfavorable underwriting results.  Our insurance 
subsidiaries are both willing and able to keep their promises in 
any such environment - and not too many other companies clearly 

     Our financial strength is a particular asset in the business 
of structured settlements and loss reserve assumptions that we 
reported on last year.  The claimant in a structured settlement 
and the insurance company that has reinsured loss reserves need 
to be completely confident that payments will be forthcoming for 
decades to come.  Very few companies in the property/casualty 
field can meet this test of unquestioned long-term strength. (In 
fact, only a handful of companies exists with which we will 
reinsure our own liabilities.)

     We have grown in these new lines of business: funds that we 
hold to offset assumed liabilities grew from $16.2 million to 
$30.6 million during the year.  We expect growth to continue and 
perhaps to greatly accelerate.  To support this projected growth 
we have added substantially to the capital of Columbia Insurance 
Company, our reinsurance unit specializing in structured 
settlements and loss reserve assumptions.  While these businesses 
are very competitive, returns should be satisfactory.

     At GEICO the news, as usual, is mostly good.  That company 
achieved excellent unit growth in its primary insurance business 
during 1984, and the performance of its investment portfolio 
continued to be extraordinary.  Though underwriting results 
deteriorated late in the year, they still remain far better than 
those of the industry.  Our ownership in GEICO at yearend 
amounted to 36% and thus our interest in their direct 
property/casualty volume of $885 million amounted to $320 
million, or well over double our own premium volume.

     I have reported to you in the past few years that the 
performance of GEICO’s stock has considerably exceeded that 
company’s business performance, brilliant as the latter has been.  
In those years, the carrying value of our GEICO investment on our 
balance sheet grew at a rate greater than the growth in GEICO’s 
intrinsic business value.  I warned you that over performance by 
the stock relative to the performance of the business obviously 
could not occur every year, and that in some years the stock must 
under perform the business.  In 1984 that occurred and the 
carrying value of our interest in GEICO changed hardly at all, 
while the intrinsic business value of that interest increased 
substantially.  Since 27% of Berkshire’s net worth at the 
beginning of 1984 was represented by GEICO, its static market 
value had a significant impact upon our rate of gain for the 
year.  We are not at all unhappy with such a result: we would far 
rather have the business value of GEICO increase by X during the 
year, while market value decreases, than have the intrinsic value 
increase by only 1/2 X with market value soaring.  In GEICO’s 
case, as in all of our investments, we look to business 
performance, not market performance.  If we are correct in 
expectations regarding the business, the market eventually will 
follow along.

     You, as shareholders of Berkshire, have benefited in 
enormous measure from the talents of GEICO’s Jack Byrne, Bill 
Snyder, and Lou Simpson.  In its core business - low-cost auto 
and homeowners insurance - GEICO has a major, sustainable 
competitive advantage.  That is a rare asset in business 
generally, and it’s almost non-existent in the field of financial 
services. (GEICO, itself, illustrates this point: despite the 
company’s excellent management, superior profitability has eluded 
GEICO in all endeavors other than its core business.) In a large 
industry, a competitive advantage such as GEICO’s provides the 
potential for unusual economic rewards, and Jack and Bill 
continue to exhibit great skill in realizing that potential.

     Most of the funds generated by GEICO’s core insurance 
operation are made available to Lou for investment.  Lou has the 
rare combination of temperamental and intellectual 
characteristics that produce outstanding long-term investment 
performance.  Operating with below-average risk, he has generated 
returns that have been by far the best in the insurance industry.  
I applaud and appreciate the efforts and talents of these three 
outstanding managers.

Errors in Loss Reserving

     Any shareholder in a company with important interests in the 
property/casualty insurance business should have some 
understanding of the weaknesses inherent in the reporting of 
current earnings in that industry.  Phil Graham, when publisher 
of the Washington Post, described the daily newspaper as “a first 
rough draft of history”.  Unfortunately, the financial statements 
of a property/casualty insurer provide, at best, only a first 
rough draft of earnings and financial condition.

     The determination of costs is the main problem.  Most of an 
insurer’s costs result from losses on claims, and many of the 
losses that should be charged against the current year’s revenue 
are exceptionally difficult to estimate.  Sometimes the extent of 
these losses, or even their existence, is not known for decades.

     The loss expense charged in a property/casualty company’s 
current income statement represents: (1) losses that occurred and 
were paid during the year; (2) estimates for losses that occurred 
and were reported to the insurer during the year, but which have 
yet to be settled; (3) estimates of ultimate dollar costs for 
losses that occurred during the year but of which the insurer is 
unaware (termed “IBNR”: incurred but not reported); and (4) the 
net effect of revisions this year of similar estimates for (2) 
and (3) made in past years.

     Such revisions may be long delayed, but eventually any 
estimate of losses that causes the income for year X to be 
misstated must be corrected, whether it is in year X + 1, or     
X + 10.  This, perforce, means that earnings in the year of 
correction also are misstated.  For example, assume a claimant 
was injured by one of our insureds in 1979 and we thought a 
settlement was likely to be made for $10,000.  That year we would 
have charged $10,000 to our earnings statement for the estimated 
cost of the loss and, correspondingly, set up a liability reserve 
on the balance sheet for that amount.  If we settled the claim in 
1984 for $100,000, we would charge earnings with a loss cost of 
$90,000 in 1984, although that cost was truly an expense of 1979.  
And if that piece of business was our only activity in 1979, we 
would have badly misled ourselves as to costs, and you as to 

     The necessarily-extensive use of estimates in assembling the 
figures that appear in such deceptively precise form in the 
income statement of property/casualty companies means that some 
error must seep in, no matter how proper the intentions of 
management.  In an attempt to minimize error, most insurers use 
various statistical techniques to adjust the thousands of 
individual loss evaluations (called case reserves) that comprise 
the raw data for estimation of aggregate liabilities.  The extra 
reserves created by these adjustments are variously labeled 
“bulk”, “development”, or “supplemental” reserves.  The goal of 
the adjustments should be a loss-reserve total that has a 50-50 
chance of being proved either slightly too high or slightly too 
low when all losses that occurred prior to the date of the 
financial statement are ultimately paid.

     At Berkshire, we have added what we thought were appropriate 
supplemental reserves but in recent years they have not been 
adequate.  It is important that you understand the magnitude of 
the errors that have been involved in our reserving.  You can 
thus see for yourselves just how imprecise the process is, and 
also judge whether we may have some systemic bias that should 
make you wary of our current and future figures.

     The following table shows the results from insurance 
underwriting as we have reported them to you in recent years, and 
also gives you calculations a year later on an “if-we-knew-then-
what-we think-we-know-now” basis.  I say “what we think we know 
now” because the adjusted figures still include a great many 
estimates for losses that occurred in the earlier years.  
However, many claims from the earlier years have been settled so 
that our one-year-later estimate contains less guess work than 
our earlier estimate:

                Underwriting Results       Corrected Figures
                    as Reported            After One Year’s
     Year              to You                 Experience
     ----       --------------------       -----------------
     1980           $  6,738,000             $ 14,887,000
     1981              1,478,000               (1,118,000)
     1982            (21,462,000)             (25,066,000)
     1983            (33,192,000)             (50,974,000)
     1984            (45,413,000)                  ?

     Our structured settlement and loss-reserve assumption 
     businesses are not included in this table.  Important 
     additional information on loss reserve experience appears 
     on pages 43-45.

     To help you understand this table, here is an explanation of 
the most recent figures: 1984’s reported pre-tax underwriting 
loss of $45.4 million consists of $27.6 million we estimate that 
we lost on 1984’s business, plus the increased loss of $17.8 
million reflected in the corrected figure for 1983.

     As you can see from reviewing the table, my errors in 
reporting to you have been substantial and recently have always 
presented a better underwriting picture than was truly the case.  
This is a source of particular chagrin to me because: (1) I like 
for you to be able to count on what I say; (2) our insurance 
managers and I undoubtedly acted with less urgency than we would 
have had we understood the full extent of our losses; and (3) we 
paid income taxes calculated on overstated earnings and thereby 
gave the government money that we didn’t need to.  (These 
overpayments eventually correct themselves, but the delay is long 
and we don’t receive interest on the amounts we overpaid.)

     Because our business is weighted toward casualty and 
reinsurance lines, we have more problems in estimating loss costs 
than companies that specialize in property insurance. (When a 
building that you have insured burns down, you get a much faster 
fix on your costs than you do when an employer you have insured 
finds out that one of his retirees has contracted a disease 
attributable to work he did decades earlier.) But I still find 
our errors embarrassing.  In our direct business, we have far 
underestimated the mushrooming tendency of juries and courts to 
make the “deep pocket” pay, regardless of the factual situation 
and the past precedents for establishment of liability.  We also 
have underestimated the contagious effect that publicity 
regarding giant awards has on juries.  In the reinsurance area, 
where we have had our worst experience in under reserving, our 
customer insurance companies have made the same mistakes.  Since 
we set reserves based on information they supply us, their 
mistakes have become our mistakes.

     I heard a story recently that is applicable to our insurance 
accounting problems: a man was traveling abroad when he received 
a call from his sister informing him that their father had died 
unexpectedly.  It was physically impossible for the brother to 
get back home for the funeral, but he told his sister to take 
care of the funeral arrangements and to send the bill to him.  
After returning home he received a bill for several thousand 
dollars, which he promptly paid.  The following month another 
bill came along for $15, and he paid that too.  Another month 
followed, with a similar bill.  When, in the next month, a third 
bill for $15 was presented, he called his sister to ask what was 
going on.  “Oh”, she said.  “I forgot to tell you.  We buried Dad 
in a rented suit.”

     If you’ve been in the insurance business in recent years - 
particularly the reinsurance business - this story hurts.  We 
have tried to include all of our “rented suit” liabilities in our 
current financial statement, but our record of past error should 
make us humble, and you suspicious.  I will continue to report to 
you the errors, plus or minus, that surface each year.

     Not all reserving errors in the industry have been of the 
innocent-but-dumb variety.  With underwriting results as bad as 
they have been in recent years - and with managements having as 
much discretion as they do in the presentation of financial 
statements - some unattractive aspects of human nature have 
manifested themselves.  Companies that would be out of business 
if they realistically appraised their loss costs have, in some 
cases, simply preferred to take an extraordinarily optimistic 
view about these yet-to-be-paid sums.  Others have engaged in 
various transactions to hide true current loss costs.

     Both of these approaches can “work” for a considerable time: 
external auditors cannot effectively police the financial 
statements of property/casualty insurers.  If liabilities of an 
insurer, correctly stated, would exceed assets, it falls to the 
insurer to volunteer this morbid information.  In other words, 
the corpse is supposed to file the death certificate.  Under this 
“honor system” of mortality, the corpse sometimes gives itself 
the benefit of the doubt.

     In most businesses, of course, insolvent companies run out 
of cash.  Insurance is different: you can be broke but flush.  
Since cash comes in at the inception of an insurance policy and 
losses are paid much later, insolvent insurers don’t run out of 
cash until long after they have run out of net worth.  In fact, 
these “walking dead” often redouble their efforts to write 
business, accepting almost any price or risk, simply to keep the 
cash flowing in.  With an attitude like that of an embezzler who 
has gambled away his purloined funds, these companies hope that 
somehow they can get lucky on the next batch of business and 
thereby cover up earlier shortfalls.  Even if they don’t get 
lucky, the penalty to managers is usually no greater for a $100 
million shortfall than one of $10 million; in the meantime, while 
the losses mount, the managers keep their jobs and perquisites.

     The loss-reserving errors of other property/casualty 
companies are of more than academic interest to Berkshire.  Not 
only does Berkshire suffer from sell-at-any-price competition by 
the “walking dead”, but we also suffer when their insolvency is 
finally acknowledged.  Through various state guarantee funds that 
levy assessments, Berkshire ends up paying a portion of the 
insolvent insurers’ asset deficiencies, swollen as they usually 
are by the delayed detection that results from wrong reporting.  
There is even some potential for cascading trouble.  The 
insolvency of a few large insurers and the assessments by state 
guarantee funds that would follow could imperil weak-but-
previously-solvent insurers.  Such dangers can be mitigated if 
state regulators become better at prompt identification and 
termination of insolvent insurers, but progress on that front has 
been slow.

Washington Public Power Supply System

     From October, 1983 through June, 1984 Berkshire’s insurance 
subsidiaries continuously purchased large quantities of bonds of 
Projects 1, 2, and 3 of Washington Public Power Supply System 
(“WPPSS”).  This is the same entity that, on July 1, 1983, 
defaulted on $2.2 billion of bonds issued to finance partial 
construction of the now-abandoned Projects 4 and 5. While there 
are material differences in the obligors, promises, and 
properties underlying the two categories of bonds, the problems 
of Projects 4 and 5 have cast a major cloud over Projects 1, 2, 
and 3, and might possibly cause serious problems for the latter 
issues.  In addition, there have been a multitude of problems 
related directly to Projects 1, 2, and 3 that could weaken or 
destroy an otherwise strong credit position arising from 
guarantees by Bonneville Power Administration.

     Despite these important negatives, Charlie and I judged the 
risks at the time we purchased the bonds and at the prices 
Berkshire paid (much lower than present prices) to be 
considerably more than compensated for by prospects of profit.

     As you know, we buy marketable stocks for our insurance 
companies based upon the criteria we would apply in the purchase 
of an entire business.  This business-valuation approach is not 
widespread among professional money managers and is scorned by 
many academics.  Nevertheless, it has served its followers well 
(to which the academics seem to say, “Well, it may be all right 
in practice, but it will never work in theory.”) Simply put, we 
feel that if we can buy small pieces of businesses with 
satisfactory underlying economics at a fraction of the per-share 
value of the entire business, something good is likely to happen 
to us - particularly if we own a group of such securities.

     We extend this business-valuation approach even to bond 
purchases such as WPPSS.  We compare the $139 million cost of our 
yearend investment in WPPSS to a similar $139 million investment 
in an operating business.  In the case of WPPSS, the “business” 
contractually earns $22.7 million after tax (via the interest 
paid on the bonds), and those earnings are available to us 
currently in cash.  We are unable to buy operating businesses 
with economics close to these.  Only a relatively few businesses 
earn the 16.3% after tax on unleveraged capital that our WPPSS 
investment does and those businesses, when available for 
purchase, sell at large premiums to that capital.  In the average 
negotiated business transaction, unleveraged corporate earnings 
of $22.7 million after-tax (equivalent to about $45 million pre-
tax) might command a price of $250 - $300 million (or sometimes 
far more).  For a business we understand well and strongly like, 
we will gladly pay that much.  But it is double the price we paid 
to realize the same earnings from WPPSS bonds.

     However, in the case of WPPSS, there is what we view to be a 
very slight risk that the “business” could be worth nothing 
within a year or two.  There also is the risk that interest 
payments might be interrupted for a considerable period of time.  
Furthermore, the most that the “business” could be worth is about 
the $205 million face value of the bonds that we own, an amount 
only 48% higher than the price we paid.

     This ceiling on upside potential is an important minus.  It 
should be realized, however, that the great majority of operating 
businesses have a limited upside potential also unless more 
capital is continuously invested in them.  That is so because 
most businesses are unable to significantly improve their average 
returns on equity - even under inflationary conditions, though 
these were once thought to automatically raise returns.

     (Let’s push our bond-as-a-business example one notch 
further: if you elect to “retain” the annual earnings of a 12% 
bond by using the proceeds from coupons to buy more bonds, 
earnings of that bond “business” will grow at a rate comparable 
to that of most operating businesses that similarly reinvest all 
earnings.  In the first instance, a 30-year, zero-coupon, 12% 
bond purchased today for $10 million will be worth $300 million 
in 2015.  In the second, a $10 million business that regularly 
earns 12% on equity and retains all earnings to grow, will also 
end up with $300 million of capital in 2015.  Both the business 
and the bond will earn over $32 million in the final year.)

     Our approach to bond investment - treating it as an unusual 
sort of “business” with special advantages and disadvantages - 
may strike you as a bit quirky.  However, we believe that many 
staggering errors by investors could have been avoided if they 
had viewed bond investment with a businessman’s perspective.  For 
example, in 1946, 20-year AAA tax-exempt bonds traded at slightly 
below a 1% yield.  In effect, the buyer of those bonds at that 
time bought a “business” that earned about 1% on “book value” 
(and that, moreover, could never earn a dime more than 1% on 
book), and paid 100 cents on the dollar for that abominable 

     If an investor had been business-minded enough to think in 
those terms - and that was the precise reality of the bargain 
struck - he would have laughed at the proposition and walked 
away.  For, at the same time, businesses with excellent future 
prospects could have been bought at, or close to, book value 
while earning 10%, 12%, or 15% after tax on book.  Probably no 
business in America changed hands in 1946 at book value that the 
buyer believed lacked the ability to earn more than 1% on book.  
But investors with bond-buying habits eagerly made economic 
commitments throughout the year on just that basis.  Similar, 
although less extreme, conditions prevailed for the next two 
decades as bond investors happily signed up for twenty or thirty 
years on terms outrageously inadequate by business standards. 
(In what I think is by far the best book on investing ever 
written - “The Intelligent Investor”, by Ben Graham - the last 
section of the last chapter begins with, “Investment is most 
intelligent when it is most businesslike.” This section is called 
“A Final Word”, and it is appropriately titled.)

     We will emphasize again that there is unquestionably some 
risk in the WPPSS commitment.  It is also the sort of risk that 
is difficult to evaluate.  Were Charlie and I to deal with 50 
similar evaluations over a lifetime, we would expect our judgment 
to prove reasonably satisfactory.  But we do not get the chance 
to make 50 or even 5 such decisions in a single year.  Even 
though our long-term results may turn out fine, in any given year 
we run a risk that we will look extraordinarily foolish. (That’s 
why all of these sentences say “Charlie and I”, or “we”.)

     Most managers have very little incentive to make the 
decision.  Their personal gain/loss ratio is all too obvious: if 
an unconventional decision works out well, they get a pat on the 
back and, if it works out poorly, they get a pink slip. (Failing 
conventionally is the route to go; as a group, lemmings may have 
a rotten image, but no individual lemming has ever received bad 

     Our equation is different.  With 47% of Berkshire’s stock, 
Charlie and I don’t worry about being fired, and we receive our 
rewards as owners, not managers.  Thus we behave with Berkshire’s 
money as we would with our own.  That frequently leads us to 
unconventional behavior both in investments and general business 

     We remain unconventional in the degree to which we 
concentrate the investments of our insurance companies, including 
those in WPPSS bonds.  This concentration makes sense only 
because our insurance business is conducted from a position of 
exceptional financial strength.  For almost all other insurers, a 
comparable degree of concentration (or anything close to it) 
would be totally inappropriate.  Their capital positions are not 
strong enough to withstand a big error, no matter how attractive 
an investment opportunity might appear when analyzed on the basis 
of probabilities.

     With our financial strength we can own large blocks of a few 
securities that we have thought hard about and bought at 
attractive prices. (Billy Rose described the problem of over-
diversification: “If you have a harem of forty women, you never 
get to know any of them very well.”) Over time our policy of 
concentration should produce superior results, though these will 
be tempered by our large size.  When this policy produces a 
really bad year, as it must, at least you will know that our 
money was committed on the same basis as yours.

     We made the major part of our WPPSS investment at different 
prices and under somewhat different factual circumstances than 
exist at present.  If we decide to change our position, we will 
not inform shareholders until long after the change has been 
completed. (We may be buying or selling as you read this.) The 
buying and selling of securities is a competitive business, and 
even a modest amount of added competition on either side can cost 
us a great deal of money.  Our WPPSS purchases illustrate this 
principle.  From October, 1983 through June, 1984, we attempted 
to buy almost all the bonds that we could of Projects 1, 2, and 
3. Yet we purchased less than 3% of the bonds outstanding.  Had 
we faced even a few additional well-heeled investors, stimulated 
to buy because they knew we were, we could have ended up with a 
materially smaller amount of bonds, purchased at a materially 
higher price. (A couple of coat-tail riders easily could have 
cost us $5 million.) For this reason, we will not comment about 
our activities in securities - neither to the press, nor 
shareholders, nor to anyone else - unless legally required to do 

     One final observation regarding our WPPSS purchases: we 
dislike the purchase of most long-term bonds under most 
circumstances and have bought very few in recent years.  That’s 
because bonds are as sound as a dollar - and we view the long-
term outlook for dollars as dismal.  We believe substantial 
inflation lies ahead, although we have no idea what the average 
rate will turn out to be.  Furthermore, we think there is a 
small, but not insignificant, chance of runaway inflation.

     Such a possibility may seem absurd, considering the rate to 
which inflation has dropped.  But we believe that present fiscal 
policy - featuring a huge deficit - is both extremely dangerous 
and difficult to reverse. (So far, most politicians in both 
parties have followed Charlie Brown’s advice: “No problem is so 
big that it can’t be run away from.”) Without a reversal, high 
rates of inflation may be delayed (perhaps for a long time), but 
will not be avoided.  If high rates materialize, they bring with 
them the potential for a runaway upward spiral.

     While there is not much to choose between bonds and stocks 
(as a class) when annual inflation is in the 5%-10% range, 
runaway inflation is a different story.  In that circumstance, a 
diversified stock portfolio would almost surely suffer an 
enormous loss in real value.  But bonds already outstanding would 
suffer far more.  Thus, we think an all-bond portfolio carries a 
small but unacceptable “wipe out” risk, and we require any 
purchase of long-term bonds to clear a special hurdle.  Only when 
bond purchases appear decidedly superior to other business 
opportunities will we engage in them.  Those occasions are likely 
to be few and far between.

Dividend Policy

     Dividend policy is often reported to shareholders, but 
seldom explained.  A company will say something like, “Our goal 
is to pay out 40% to 50% of earnings and to increase dividends at 
a rate at least equal to the rise in the CPI”.  And that’s it - 
no analysis will be supplied as to why that particular policy is 
best for the owners of the business.  Yet, allocation of capital 
is crucial to business and investment management.  Because it is, 
we believe managers and owners should think hard about the 
circumstances under which earnings should be retained and under 
which they should be distributed.

     The first point to understand is that all earnings are not 
created equal.  In many businesses particularly those that have 
high asset/profit ratios - inflation causes some or all of the 
reported earnings to become ersatz.  The ersatz portion - let’s 
call these earnings “restricted” - cannot, if the business is to 
retain its economic position, be distributed as dividends.  Were 
these earnings to be paid out, the business would lose ground in 
one or more of the following areas: its ability to maintain its 
unit volume of sales, its long-term competitive position, its 
financial strength.  No matter how conservative its payout ratio, 
a company that consistently distributes restricted earnings is 
destined for oblivion unless equity capital is otherwise infused.

     Restricted earnings are seldom valueless to owners, but they 
often must be discounted heavily.  In effect, they are 
conscripted by the business, no matter how poor its economic 
potential. (This retention-no-matter-how-unattractive-the-return 
situation was communicated unwittingly in a marvelously ironic 
way by Consolidated Edison a decade ago.  At the time, a punitive 
regulatory policy was a major factor causing the company’s stock 
to sell as low as one-fourth of book value; i.e., every time a 
dollar of earnings was retained for reinvestment in the business, 
that dollar was transformed into only 25 cents of market value.  
But, despite this gold-into-lead process, most earnings were 
reinvested in the business rather than paid to owners.  
Meanwhile, at construction and maintenance sites throughout New 
York, signs proudly proclaimed the corporate slogan, “Dig We 

     Restricted earnings need not concern us further in this 
dividend discussion.  Let’s turn to the much-more-valued 
unrestricted variety.  These earnings may, with equal 
feasibility, be retained or distributed.  In our opinion, 
management should choose whichever course makes greater sense for 
the owners of the business.

     This principle is not universally accepted.  For a number of 
reasons managers like to withhold unrestricted, readily 
distributable earnings from shareholders - to expand the 
corporate empire over which the managers rule, to operate from a 
position of exceptional financial comfort, etc.  But we believe 
there is only one valid reason for retention.  Unrestricted 
earnings should be retained only when there is a reasonable 
prospect - backed preferably by historical evidence or, when 
appropriate, by a thoughtful analysis of the future - that for 
every dollar retained by the corporation, at least one dollar of 
market value will be created for owners.  This will happen only 
if the capital retained produces incremental earnings equal to, 
or above, those generally available to investors.

     To illustrate, let’s assume that an investor owns a risk-
free 10% perpetual bond with one very unusual feature.  Each year 
the investor can elect either to take his 10% coupon in cash, or 
to reinvest the coupon in more 10% bonds with identical terms; 
i.e., a perpetual life and coupons offering the same cash-or-
reinvest option.  If, in any given year, the prevailing interest 
rate on long-term, risk-free bonds is 5%, it would be foolish for 
the investor to take his coupon in cash since the 10% bonds he 
could instead choose would be worth considerably more than 100 
cents on the dollar.  Under these circumstances, the investor 
wanting to get his hands on cash should take his coupon in 
additional bonds and then immediately sell them.  By doing that, 
he would realize more cash than if he had taken his coupon 
directly in cash.  Assuming all bonds were held by rational 
investors, no one would opt for cash in an era of 5% interest 
rates, not even those bondholders needing cash for living 

     If, however, interest rates were 15%, no rational investor 
would want his money invested for him at 10%.  Instead, the 
investor would choose to take his coupon in cash, even if his 
personal cash needs were nil.  The opposite course - reinvestment 
of the coupon - would give an investor additional bonds with 
market value far less than the cash he could have elected.  If he 
should want 10% bonds, he can simply take the cash received 
and buy them in the market, where they will be available at a 
large discount.

     An analysis similar to that made by our hypothetical 
bondholder is appropriate for owners in thinking about whether a 
company’s unrestricted earnings should be retained or paid out.  
Of course, the analysis is much more difficult and subject to 
error because the rate earned on reinvested earnings is not a 
contractual figure, as in our bond case, but rather a fluctuating 
figure.  Owners must guess as to what the rate will average over 
the intermediate future.  However, once an informed guess is 
made, the rest of the analysis is simple: you should wish your 
earnings to be reinvested if they can be expected to earn high 
returns, and you should wish them paid to you if low returns are 
the likely outcome of reinvestment.

     Many corporate managers reason very much along these lines 
in determining whether subsidiaries should distribute earnings to 
their parent company.  At that level,. the managers have no 
trouble thinking like intelligent owners.  But payout decisions 
at the parent company level often are a different story.  Here 
managers frequently have trouble putting themselves in the shoes 
of their shareholder-owners.

     With this schizoid approach, the CEO of a multi-divisional 
company will instruct Subsidiary A, whose earnings on incremental 
capital may be expected to average 5%, to distribute all 
available earnings in order that they may be invested in 
Subsidiary B, whose earnings on incremental capital are expected 
to be 15%.  The CEO’s business school oath will allow no lesser 
behavior.  But if his own long-term record with incremental 
capital is 5% - and market rates are 10% - he is likely to impose 
a dividend policy on shareholders of the parent company that 
merely follows some historical or industry-wide payout pattern.  
Furthermore, he will expect managers of subsidiaries to give him 
a full account as to why it makes sense for earnings to be 
retained in their operations rather than distributed to the 
parent-owner.  But seldom will he supply his owners with a 
similar analysis pertaining to the whole company.

     In judging whether managers should retain earnings, 
shareholders should not simply compare total incremental earnings 
in recent years to total incremental capital because that 
relationship may be distorted by what is going on in a core 
business.  During an inflationary period, companies with a core 
business characterized by extraordinary economics can use small 
amounts of incremental capital in that business at very high 
rates of return (as was discussed in last year’s section on 
Goodwill).  But, unless they are experiencing tremendous unit 
growth, outstanding businesses by definition generate large 
amounts of excess cash.  If a company sinks most of this money in 
other businesses that earn low returns, the company’s overall 
return on retained capital may nevertheless appear excellent 
because of the extraordinary returns being earned by the portion 
of earnings incrementally invested in the core business.  The 
situation is analogous to a Pro-Am golf event: even if all of the 
amateurs are hopeless duffers, the team’s best-ball score will be 
respectable because of the dominating skills of the professional.

     Many corporations that consistently show good returns both 
on equity and on overall incremental capital have, indeed, 
employed a large portion of their retained earnings on an 
economically unattractive, even disastrous, basis.  Their 
marvelous core businesses, however, whose earnings grow year 
after year, camouflage repeated failures in capital allocation 
elsewhere (usually involving high-priced acquisitions of 
businesses that have inherently mediocre economics).  The 
managers at fault periodically report on the lessons they have 
learned from the latest disappointment.  They then usually seek 
out future lessons. (Failure seems to go to their heads.)

     In such cases, shareholders would be far better off if 
earnings were retained only to expand the high-return business, 
with the balance paid in dividends or used to repurchase stock 
(an action that increases the owners’ interest in the exceptional 
business while sparing them participation in subpar businesses).  
Managers of high-return businesses who consistently employ much 
of the cash thrown off by those businesses in other ventures with 
low returns should be held to account for those allocation 
decisions, regardless of how profitable the overall enterprise 

     Nothing in this discussion is intended to argue for 
dividends that bounce around from quarter to quarter with each 
wiggle in earnings or in investment opportunities.  Shareholders 
of public corporations understandably prefer that dividends be 
consistent and predictable.  Payments, therefore, should reflect 
long-term expectations for both earnings and returns on 
incremental capital.  Since the long-term corporate outlook 
changes only infrequently, dividend patterns should change no 
more often.  But over time distributable earnings that have been 
withheld by managers should earn their keep.  If earnings have 
been unwisely retained, it is likely that managers, too, have 
been unwisely retained.

     Let’s now turn to Berkshire Hathaway and examine how these 
dividend principles apply to it.  Historically, Berkshire has 
earned well over market rates on retained earnings, thereby 
creating over one dollar of market value for every dollar 
retained.  Under such circumstances, any distribution would have 
been contrary to the financial interest of shareholders, large or 

     In fact, significant distributions in the early years might 
have been disastrous, as a review of our starting position will 
show you.  Charlie and I then controlled and managed three 
companies, Berkshire Hathaway Inc., Diversified Retailing 
Company, Inc., and Blue Chip Stamps (all now merged into our 
present operation).  Blue Chip paid only a small dividend, 
Berkshire and DRC paid nothing.  If, instead, the companies had 
paid out their entire earnings, we almost certainly would have no 
earnings at all now - and perhaps no capital as well.  The three 
companies each originally made their money from a single 
business: (1) textiles at Berkshire; (2) department stores at 
Diversified; and (3) trading stamps at Blue Chip.  These 
cornerstone businesses (carefully chosen, it should be noted, by 
your Chairman and Vice Chairman) have, respectively, (1) survived 
but earned almost nothing, (2) shriveled in size while incurring 
large losses, and (3) shrunk in sales volume to about 5% its size 
at the time of our entry.  (Who says “you can’t lose ‘em all”?) 
Only by committing available funds to much better businesses were 
we able to overcome these origins. (It’s been like overcoming a 
misspent youth.) Clearly, diversification has served us well.

     We expect to continue to diversify while also supporting the 
growth of current operations though, as we’ve pointed out, our 
returns from these efforts will surely be below our historical 
returns.  But as long as prospective returns are above the rate 
required to produce a dollar of market value per dollar retained, 
we will continue to retain all earnings.  Should our estimate of 
future returns fall below that point, we will distribute all 
unrestricted earnings that we believe can not be effectively 
used.  In making that judgment, we will look at both our 
historical record and our prospects.  Because our year-to-year 
results are inherently volatile, we believe a five-year rolling 
average to be appropriate for judging the historical record.

     Our present plan is to use our retained earnings to further 
build the capital of our insurance companies.  Most of our 
competitors are in weakened financial condition and reluctant to 
expand substantially.  Yet large premium-volume gains for the 
industry are imminent, amounting probably to well over $15 
billion in 1985 versus less than $5 billion in 1983.  These 
circumstances could produce major amounts of profitable business 
for us.  Of course, this result is no sure thing, but prospects 
for it are far better than they have been for many years.


     This is the spot where each year I run my small “business 
wanted” ad.  In 1984 John Loomis, one of our particularly 
knowledgeable and alert shareholders, came up with a company that 
met all of our tests.  We immediately pursued this idea, and only 
a chance complication prevented a deal.  Since our ad is pulling, 
we will repeat it in precisely last year’s form:

     We prefer:
     (1) large purchases (at least $5 million of after-tax 
     (2) demonstrated consistent earning power (future 
         projections are of little interest to us, nor are 
         “turn-around” situations),
     (3) businesses earning good returns on equity while 
         employing little or no debt,
     (4) management in place (we can’t supply it),
     (5) simple businesses (if there’s lots of technology, we 
         won’t understand it),
     (6) an offering price (we don’t want to waste our time or 
         that of the seller by talking, even preliminarily, 
         about a transaction when price is unknown).

     We will not engage in unfriendly takeovers.  We can promise 
complete confidentiality and a very fast answer - customarily 
within five minutes - as to whether we’re interested.  We prefer 
to buy for cash, but will consider issuance of stock when we 
receive as much in intrinsic business value as we give.  We 
invite potential sellers to check us out by contacting people 
with whom we have done business in the past.  For the right 
business - and the right people - we can provide a good home.

                           *  *  *

     A record 97.2% of all eligible shares participated in 
Berkshire’s 1984 shareholder-designated contributions program.  
Total contributions made through this program were $3,179,000, 
and 1,519 charities were recipients.  Our proxy material for the 
annual meeting will allow you to cast an advisory vote expressing 
your views about this program - whether you think we should 
continue it and, if so, at what per-share level. (You may be 
interested to learn that we were unable to find a precedent for 
an advisory vote in which management seeks the opinions of 
shareholders about owner-related corporate policies.  Managers 
who put their trust in capitalism seem in no hurry to put their 
trust in capitalists.)

     We urge new shareholders to read the description of our 
shareholder-designated contributions program that appears on 
pages 60 and 61.  If you wish to participate in future programs, 
we strongly urge that you immediately make sure that your shares 
are registered in the name of the actual owner, not in “street” 
name or nominee name.  Shares not so registered on September 30, 
1985 will be ineligible for the 1985 program.

                           *  *  *

     Our annual meeting will be on May 21, 1985 in Omaha, and I 
hope that you attend.  Many annual meetings are a waste of time, 
both for shareholders and for management.  Sometimes that is true 
because management is reluctant to open up on matters of business 
substance.  More often a nonproductive session is the fault of 
shareholder participants who are more concerned about their own 
moment on stage than they are about the affairs of the 
corporation.  What should be a forum for business discussion 
becomes a forum for theatrics, spleen-venting and advocacy of 
issues. (The deal is irresistible: for the price of one share you 
get to tell a captive audience your ideas as to how the world 
should be run.) Under such circumstances, the quality of the 
meeting often deteriorates from year to year as the antics of 
those interested in themselves discourage attendance by those 
interested in the business.

     Berkshire’s meetings are a different story.  The number of 
shareholders attending grows a bit each year and we have yet to 
experience a silly question or an ego-inspired commentary.  
Instead, we get a wide variety of thoughtful questions about the 
business.  Because the annual meeting is the time and place for 
these, Charlie and I are happy to answer them all, no matter how 
long it takes. (We cannot, however, respond to written or phoned 
questions at other times of the year; one-person-at-a time 
reporting is a poor use of management time in a company with 3000 
shareholders.) The only business matters that are off limits at 
the annual meeting are those about which candor might cost our 
company real money.  Our activities in securities would be the 
main example.

     We always have bragged a bit on these pages about the 
quality of our shareholder-partners.  Come to the annual meeting 
and you will see why.  Out-of-towners should schedule a stop at 
Nebraska Furniture Mart.  If you make some purchases, you’ll save 
far more than enough to pay for your trip, and you’ll enjoy the 

                                           Warren E. Buffett
February 25, 1985                          Chairman of the Board

     Subsequent Event: On March 18, a week after copy for this 
report went to the typographer but shortly before production, we 
agreed to purchase three million shares of Capital Cities 
Communications, Inc. at $172.50 per share.  Our purchase is 
contingent upon the acquisition of American Broadcasting 
Companies, Inc. by Capital Cities, and will close when that 
transaction closes.  At the earliest, that will be very late in 
1985.  Our admiration for the management of Capital Cities, led 
by Tom Murphy and Dan Burke, has been expressed several times in 
previous annual reports.  Quite simply, they are tops in both 
ability and integrity.  We will have more to say about this 
investment in next year’s report.

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