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Buffett Shareholder Letters - 1985 Letter

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BERKSHIRE HATHAWAY INC. 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 carefullycrafted 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 twentyone 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 past. 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 highreturn 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

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