Warren Buffett's 1968 "Letter to Shareholders": Everyone makes mistakes at some point

Comprehensive Research by Xiao Qing from the Institute.

This article is Warren Buffett's year-end letter to shareholders in 1968.

In the letter, Buffett first humorously explains the "mistakes" he made in 1968 (predicting no opportunity beforehand but still making money). He still emphasizes the unpredictability of the market, the higher the expectations, the harder it is to predict the results, and once again insists on the judgment that opportunities are decreasing. This shareholder letter is Buffett's contemplation on the eve of the US stock market entering a major stagnation, and its content is worth pondering.

[Translator's note: This is Buffett's last performance summary letter to partners. Subsequent letters to partners are about the dissolution of the partnership company.]

Our Performance in 1968

Everyone makes mistakes.

At the beginning of 1968, I felt that Buffett Partnership's performance was going to be the worst in history. However, we stumbled upon a simple yet very effective idea (investment ideas are like women, never on time, but come unexpectedly), and as a result, we made a total of $40,032,691 this year.

Of course, everyone is smart and surely wants to skip the performance counted in US dollars and go straight to comparing our performance with the Dow Jones Industrial Average. We set a historical record with a 58.8% performance, while the Dow achieved a total return of 7.7%, including dividends received from holding the Dow throughout the year. This performance is entirely fortuitous, like drawing all 13 spades while playing bridge. At this point, you should make a grand slam bid, stay humble, put the money in your pocket, and continue playing. Remember, we will also have difficult times.

Below is a summary of the Dow's performance over the years, the performance of the partnership company before distributing profits to ordinary partners (25% of the excess over 6%), and the returns of limited partners:

If calculated on a compound basis, the performance results are as follows:

Other Investment Companies

The table below compares our usual performance with other investment companies, including the two largest open-end investment companies (which have consistently ranked at the top from 1957 to 1966, currently ranking second and third), investing 95%-100% of funds in common stocks; and the two largest diversified closed-end investment companies.

Interestingly, after 12 years, these four funds (currently managing over $5 billion in funds, accounting for over 10% of the investment industry) only outperform the Dow by about 1% on average each year.

Recently, some so-called "charge charge charge funds" have turned into "withdraw withdraw withdraw funds" In an example, Tsai Zhiyong's Manhattan Fund may be the most famous aggressive fund in the world, but its performance in 1968 was only -6.9%. In 1968, many smaller investment institutions continued to outperform the market, but to a much lesser extent than in 1966 and 1967.

In this part of the letter, I usually harshly criticize the lack of spirit in the asset management industry, but now they have suddenly become hypertensive. There is an investment manager who represents an institution that manages over $1 billion in mutual funds (a well-known institution that you must have heard of). When he launched a new advisory service in 1968, he said:

"The complexity of domestic and international economies has turned asset management into a full-time job. An excellent asset manager cannot limit their research on securities to a weekly or even daily basis. To research securities, one must do so by the minute."

Wow!

After reading this, I feel guilty every time I go out to buy a bottle of Pepsi. Once more and more people, with a very positive attitude, wave a large amount of money to buy a limited number of securities, the results are usually unpredictable. Sometimes the results are tantalizing, while other times they are shocking.

Analysis of the 1968 Performance

In 1968, all four categories of our investments performed very well. Our total profit was $40,032,691, coming from the following sources:

The phenomena I mentioned in my letter two years ago have reappeared: (for those who do not want a doctoral degree, you can skip to the next section)

1. In my letter dated January 18, 1965, I have explained the above types once. If anyone needs to reread it but cannot find the letter, we are happy to send a copy over.

2. These classifications are not set in stone. We have not made any changes, but if forced to classify, it can easily be divided into 125 categories. Sometimes, it is not easy to classify afterwards: for example, an "operational" investment may not have been successful, but I still decide to continue holding it, even though the reasons for holding (such as stubbornness) are different from the original reasons for buying.

3. Compared to the total return rate of the partnership companies calculated based on the initial investment amount, if calculated based on the average investment amount of each category, there will be a serious underestimation. For example, if we bought a $100 security on January 1 and it was worth $200 on December 31, we made 100%; but if calculated based on the average investment amount, it would be only $150, making only 66%. In other words, when calculating the average investment amount, we take the monthly average market value.

4. All performances are calculated only on the equity portion, excluding leverage. Interest and other operating expenses have been deducted from the total performance and are not classified by investment category. Expenses directly related to specific investment actions, such as dividends paid when shorting stocks, have been deducted by category. When we directly borrow securities to short, the net investment amount (long position minus short position) is included in the average investment amount of the corresponding category

5. The above table has limited utility. The performance of each type of investment is determined by one or two investment decisions. They are not a collection of stable data in large quantities (such as the death rate of all American males), and conclusions or predictions cannot be drawn from them. On the contrary, they reflect individual, heterogeneous phenomena, with very limited practical implications for action. This is how we view these performance data.

6. Finally, we do not meticulously calculate the performance of categories like counting money, and the results have not been fully checked, so there may be accounting or mathematical errors.

Control Type

Overall, the performance of the control type in 1968 was very good. The after-tax income of the diversified retail company (80% ownership) and Berkshire Hathaway (70% ownership) combined exceeded $5 million.

The performance of the subsidiary of the diversified retail company, the joint cotton store operated by Ben Rosner, was outstanding this year; as well as the subsidiary of Berkshire Hathaway, the National Indemnity Company operated by Jack Ringwalt. The capital return rates of these two companies are around 20%. In 1967, in the "Fortune 500" companies (consisting of the largest domestic manufacturing entities, led by General Motors), only 37 companies reached this level. Our young men at these companies have outperformed many more well-known (but not necessarily better) companies, such as IBM, General Electric, General Dynamics, Procter & Gamble, DuPont, Data Control Corporation, HP, and so on...

Partners still occasionally say to me, "Hey, Berkshire has gone up four points - great!" or "What's going on with Berkshire, why has it been falling for three weeks?" Market prices are completely irrelevant to the valuation of our holding companies. At the end of 1967, we valued Berkshire at $25, while the market price was $20; at the end of 1968, we valued Berkshire at $31, while the market price was $37. Even if the market price is $15 or $50, our valuation will not change at all. ("Price is what you pay, value is what you get"). Our profits and losses depend on the operating conditions of our holding companies - we do not profit from the game of the securities market.

General Type - Based on Privatization Value

In terms of average returns, this has been our best-performing category in recent years, and it currently accounts for the largest share of profits. This is how my teacher taught me to do business, and it accounts for a large part of our investment ideas. In the twelve-year history of Buffett Partnership Ltd., the profits brought by this category are at least fifty times our total losses. In 1968, our views on an industry (implemented in various ways) made us a lot of money. We even received a substantial amount for this (included in "other income" in the audit).

Our total investment in this category (so far, this is the method I believe is most likely to achieve stable profits in the long term) is currently less than $20 million and is unlikely to increase rapidly. If our performance in 1968 was like the Johnstown Flood, then the performance in 1969 was like a leaking faucet Common Type - Relatively Undervalued

In 1966 and 1967, this type of earnings accounted for about two-thirds of our total profits. I mentioned last year that most of these performances came from just one idea. I have said before, "No investment in size or potential return can compare to what it used to be." I am pleased to announce that I was right in saying this. However, what disappoints me is that this year I have to repeat it again.

Operational Type

In 1967, this type of investment was disastrous, but the performance was good in 1968. We do not cast a wide net, but focus on a few opportunities each year (some large arbitrage institutions may engage in over fifty operational trades per year), hence the annual performance fluctuates more. I believe that the average profit margin of our method is also higher, and the performance in 1968 gives me more confidence in this conclusion.

It needs to be emphasized again that if not calculated conventionally based on the initial capital and including borrowed money (operational types often borrow money), the performance of operational types (and other types of performance) is prone to undervaluation.

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I must emphasize that the quantity and quality of current investment opportunities have hit a new low - the factors I mentioned in my letter on October 9, 1967, are now becoming stronger.

Sometimes I feel that we should hang a plaque in the office like the headquarters of Texas Instruments in Dallas: "We don't believe in miracles - we rely on miracles." An old, fat, lame, and blind golfer may indeed hit a home run, but you wouldn't let him play because of that.

Our future faces many crucial negative factors, although it will not be in vain, it will certainly not yield returns far above average.

Key Events

An older friend said to me, "People are not so nostalgic anymore." Anyway, let's give it a try.

Buffett Partnership Ltd., the earliest predecessor of our partnership company, was founded on May 5, 1956. At that time, there were 7 limited partners (4 of them were my relatives, and 3 were good friends), with a total investment of $105,000; general partners also kept their word and invested $100. In 1956, two new partnership companies were established, each accommodating a family's funds. By January 1, 1957, our total net assets were $303,726. In 1957, our total earnings were $31,615.97, with a return rate of 10.4%. In 1968, I estimate that the opening hours of the New York Stock Exchange have disappeared by about 1,200, which means we earn $33,000 per hour (do you think they should stick to a system of opening 5 days a week, 5 and a half hours a day?), the same amount we earned in 1957 for the whole year.

On January 1, 1962, we merged the original partnership companies, moved the office out of my bedroom, and recruited our first full-time employee. At that time, our net assets were $7,178,500. Now, our net assets are $104,429,431, and we have added another employee to the payroll Since 1963 (net assets of $9,405,400), our rent has increased from $3,947 to $5,823 (if I signed a percentage lease, Ben Rosner would never forgive me), travel expenses have risen from $3,206 to $3,603, and other expenses and subscriptions have increased from $900 to $994. Even though Parkinson's Law still holds true, at least our expenses have not completely gotten out of control.

As we turn back to examine our financial assets, we do not need to come to the same conclusion as Gypsy Rose Lee. On her 55th birthday, she looked at her body and said, "What I have now is the same as what I had twenty years ago—just a little shorter."

Some Miscellaneous Matters

The investment environment is tough, but the office environment is excellent. Thanks to Donald, Gladys, Bill, and John, our organization operates efficiently and pleasantly. They are the best talents.

On January 1, 1969, our staff and their spouses (one each) and children had a total investment in Buffett Partnership exceeding $27 million. These aunts, uncles, parents, in-laws, siblings, and cousins on the partner list vary in height and size, as if they were "our big family"—which I think is a very appropriate way to put it.

In a few days, everyone will receive:

(1) For the convenience of everyone to file their 1968 federal income tax, the letter records the necessary information for Buffett Partnership in 1966. The only thing related to tax filing in the attachment is this letter.

(2) The 1968 audit report issued by KPMG (their work is as excellent as ever), outlining the operations and financial condition of Buffett Partnership, as well as everyone's capital situation.

(3) A letter signed by me, explaining everyone's equity position in Buffett Partnership as of January 1, 1969. The data in this letter matches the audit report.

If you have any questions about this letter or our operations for the year, please contact me. Our next letter will be sent around July 10th, summarizing the first half of the year.

Sincerely,

Warren E. Buffett

January 22, 1969

—End of 1968 Partner Letter—

Market Conditions in 1968:

U.S. Economic Situation:

Key Events of 1968:

• Buffett attempted to sell the troublesome Berkshire Hathaway but failed

• Intel Corporation was founded

• Martin Luther King Jr. was assassinated

• Republican Nixon won the U.S. presidential election

• Apollo 8 enters lunar orbit, humans see the far side of the moon for the first time

• The Treaty on the Non-Proliferation of Nuclear Weapons is officially open for signature

——End of 1968 Partner Letter——