Here is the full text of Buffett's letter to shareholders in 1993:
To the Shareholders of Berkshire Hathaway Inc.:
Our book value per share increased 14.3% in 1993. Over the last 29 years (that is, since present management took over), book value has grown from $19 to $8,854, a rate of 23.3% compounded annually.
During the year, Berkshire's net worth increased by $1.5 billion, a figure affected by two negative and two positive non - operating items. For the sake of completeness, I will explain these factors here. However, if you are not interested in accounting, feel free to skim the following discussion:
- The first negative factor was created by a change in Generally Accepted Accounting Principles (GAAP) related to the taxes on the unrealized appreciation of our market - valued securities. The old rule stated that the tax rate on the gain on securities should be calculated based on the rate in effect when the appreciation actually occurred. Therefore, at the end of 1992, we used a 34% tax rate for the $6.4 billion of securities gains that occurred after 1986 and a 28% rate for the $1.2 billion of gains that occurred before 1986. The new rule requires that the current tax rate be applied to all gains. So in the first quarter of 1993, when the new rule took effect, our net worth decreased by $70 million due to the 34% tax rate applied to the pre - 1987 gains.
- The second negative factor was related to the previous one and was caused by the increase in the corporate tax rate to 35% in the third quarter of 1993. This change required us to charge an additional 1% on all unrealized gains, which reduced our net worth by $75 million. Strangely, GAAP requires that this charge and the one described above be deducted from our reported earnings, even though the unrealized appreciation that caused these charges was never included in our earnings but was directly credited to net worth.
- Another change in GAAP in 1993 affected the value of the securities we hold. In recent years, the common stocks and certain common - stock - equivalent securities (convertible preferred stocks) held by our insurance companies have been valued at market, while the stocks held by our non - insurance subsidiaries or the parent company have been valued at the lower of their cost or market value. Now, starting in the fourth quarter of 1993, we are following GAAP and valuing all common stocks at market value, a change that increased Berkshire's reported net worth by about $172 million.
- The final factor was the issuance of some shares by us last year. As described in last year's annual report, we issued 3,944 shares in early January 1993 to replace $46 million of convertible bonds that we were about to be required to redeem. In addition, we issued 25,203 shares in the acquisition of Dexter Shoe, which will be discussed later in this report. The overall result was that our outstanding shares increased by 29,147, and our net worth increased by about $478 million. The book value per share also increased because the shares issued in these transactions were priced above their book value.
Of course, what matters is per - share intrinsic value, not book value. Book value is an accounting term that measures the capital, including retained earnings, that has been put into a business. Intrinsic value is a present - value estimate of the cash that can be taken out of a business during its remaining life. In most companies, the two values are not related. However, Berkshire is an exception: although our book value is far lower than our intrinsic value, it serves as a useful tool for tracking the all - important figure of intrinsic value. In 1993, both book value and intrinsic value increased by about 14%. While this rate of increase is satisfactory, it does not excite me. However, both values were surpassed by the market price of Berkshire's stock, which increased by 39%. Over time, of course, market price and intrinsic value will arrive at about the same destination. But in the short term, the two often diverge to a large extent, a phenomenon I have discussed in the past.
Two years ago, the stock prices of Coca - Cola and Gillette, two companies in which we have large positions, rose much more than their earnings. In the 1991 annual report, I said that it was impossible for the stocks of these two companies to continue to outperform their businesses. From 1991 to 1993, the annual earnings per share of Coca - Cola and Gillette increased by 38% and 37%, respectively, but their market prices rose only 11% and 6%. In other words, the performance of these companies exceeded that of their stocks, a result that undoubtedly reflects, to some extent, Wall Street's new concerns about brands. Whatever the reason, over time, what matters is the earnings performance of these companies. If these companies succeed, Berkshire will succeed, although not in a synchronous manner.
Let me add another lesson from history: Coca - Cola went public in 1919 at $40 per share. By the end of 1920, the market had coolly re - evaluated Coca - Cola's future prospects, and the stock price fell by more than 50% to $19.50. By the end of 1993, one share of Coca - Cola, with dividends reinvested, was worth more than $2.1 million. As Ben Graham put it, "In the short run, the market is a voting machine - reflecting a voter - registration test that requires only money, not intelligence or emotional stability - but in the long run, the market is a weighing machine."
So, what should we make of Berkshire's over - performance in the stock market last year? Obviously, Berkshire sold its shares at the end of 1993 at a price higher than their intrinsic value at the beginning of the year. On the other hand, at long - term interest rates of 6% or 7%, if - and this is a very important if - Berkshire's vice - chairman Charlie Munger and I can achieve our long - standing goal of increasing Berkshire's per - share intrinsic value at an average annual rate of 15%, then Berkshire's market price is undervalued. We have not given up on this goal. But we again emphasize, as we have for years, that our growing capital makes a 15% growth rate an increasingly difficult goal to achieve. What we need to do is to assemble more and more large - scale enterprises that have economic characteristics ranging from good to excellent and are managed by managers whose performance ranges from great to superb. For such a dream combination, you don't have to worry about them. The result of the capital - allocation work that Charlie and I do at the parent company with the funds handed over to us by managers is uncertain: it is not easy to find new enterprises and managers that are comparable to our existing ones. Despite the difficulties, Charlie and I are happy to pursue this.
We are also pleased to announce a major success in 1993.
Dexter Shoe
Our acquisition last year was a sequel to the 1991 acquisition of H. H. Brown Shoe, a large manufacturer of work shoes, boots, and other footwear. Brown is a real winner: although we had high hopes for it from the start, under the efforts of Frank Rooney, Jim Issler, and the talented managers who work with them, Brown Shoe's performance has far exceeded our expectations. Because we have full confidence in Frank's team, we acquired Lowell Shoe in late 1992. Lowell is a long - established manufacturer of women's shoes and nurse's shoes, but its business needed some adjustments. Once again, the results at Lowell exceeded our expectations. Therefore, we immediately seized the opportunity last year to acquire Dexter Shoe Company of Maine, which manufactures popular - priced men's and women's shoes. I can assure you that Dexter does not need adjustment: it is one of the best - managed companies that Charlie and I have ever seen in our business careers.
Harold Alfond earned 25 cents an hour in a shoe factory at the age of 20 and founded Dexter Shoe in 1956 with $10,000 in capital. In 1958, his nephew Peter Lunder joined the company. Since then, the two of them have built a business that produces more than 7.5 million pairs of shoes a year, most of them in Maine and the rest in Puerto Rico. As you may know, the domestic shoe - making industry in the United States is generally considered unable to compete with imports from low - wage countries. But someone forgot to tell this to the shrewd management and skilled workers at Dexter and Brown Shoe.
Corporate Governance
Though the legal responsibility of directors is always the same, the ability for directors to effect change depends on the situation. Buffett writes a nice case study on what he sees are three fundamentally different manager / owner situations that exist in publicly - held companies, that didn’t get enough attention in the public debate about corporate governance.
- No controlling shareholder: The first, and by far most common, board situation is one in which a company has no controlling shareholder. In that case, directors should behave as if there is a single absentee owner, whose “long - term interest they should try to further in all proper ways.” The problem is “long - term” gives directors a lot of wiggle room. “If they lack either integrity or the ability to think independently, directors can do great violence to shareholders while still claiming to be acting in their long - term interest.” If the board is functioning well and must deal with a mediocre or weak management team then directors have the responsibility for changing that management, “just as an intelligent owner would do” if they were present. On the other hand, if management is talented but greedy or where managers “over - reach and try to dip too deeply into the shareholders' pockets,” it is again up to directors to act. The board has the power to make appropriate changes. If, however, an unhappy director can't get other directors to agree with him, the director should then feel free to make his views known to the absentee owners. Unfortunately, directors seldom do that.
Buffett recommends that boards should have relatively few directors in number “say, 10 or less” and should come mostly from the outside. They should establish standards for the CEO's performance and should meet periodically, without the CEO being present, to evaluate CEO performance against those standards. Buffett also recommends board membership criterion should be business acumen, interest in the job and owner - orientation. Mistakes in selecting directors are particularly serious because appointments are so hard to undo. “The pleasant but vacuous director need never worry about job security.” - Where the controlling owner is also the manager: The second situation, which existed at Berkshire at the time, is where the controlling owner is also the manager. At some companies, this arrangement is facilitated by the existence of two classes of stock endowed with disproportionate voting power. “In these situations, it's obvious that the board does not act as an agent between owners and management and that the directors cannot effect change except through persuasion. Therefore, if the owner / manager is mediocre or worse - or is over - reaching - there is little a director can do about it except object. If the directors having no connections to the owner / manager make a united front, they may have some influence, but usually they will find it difficult to change the owner / manager's behavior.”
- Where the controlling owner is not the manager: The third situation is one in which there is a controlling owner who is not the manager. This is the ideal situation for shareholders, as the controlling owner has the power and the incentive to ensure that the company is run in the best interests of shareholders. The board of directors in this situation can act as a true representative of the shareholders and can hold management accountable. However, even in this situation, there are potential problems. If the controlling owner is not interested in the day - to - day management of the company or if he or she delegates too much authority to management, there is a risk that management will act in its own interests rather than those of the shareholders.
Miscellaneous
- Mrs. B's 100th birthday: Mrs. B - Rose Blumkin - had her 100th birthday on December 3, 1993. (The candles cost more than the cake.) That was a day on which the store was scheduled to be open in the evening. Mrs. B, who works seven days a week, for however many hours the store operates, found the proper decision quite obvious: she simply postponed her party until an evening when the store was closed. Our part in all of this began ten years ago when Mrs. B sold control of the business to Berkshire Hathaway, a deal we completed without obtaining audited financial statements, checking real estate records, or getting any warranties. In short, her word was good enough for us.
- Annual meeting: The annual meeting was held, and 2,200 people turned up. There will have the holding’s consumer products displayed. At the meeting, they have a ferry to the Nebraska Furniture Mart. Buffett also mentioned that he would throw the first pitch on the 23rd and hoped to improve on last year's humiliating performance.
- Charitable contributions: Berkshire's charitable contributions were mentioned, and shareholders were informed about the program. To participate in future programs, shareholders must make sure their shares are registered in the name of the actual owner, not in the nominee name of a broker, bank, or depository. Shares not so registered on August 31, 1994, will be ineligible for the 1994 program.
- Investment in Coca - Cola: Buffett talked about the investment in Coca - Cola. He mentioned that the impressions he formed about Don Keough in the past were a factor in his decision to have Berkshire make a record $1 billion investment in Coca - Cola in 1988 - 89. Roberto Goizueta had become CEO of Coke in 1981, with Don alongside as his partner. The two of them took hold of a company that had stagnated during the previous decade and moved it from $4.4 billion of market value to $58 billion in less than 13 years.
In conclusion, we are pleased with Berkshire's progress in 1993 but remain focused on the long - term. We will continue to seek out great businesses and managers and to allocate capital in a way that maximizes shareholder value. Thank you for your continued support.
Warren E. Buffett
Chairman of the Board
February 28, 1994
