Here is the full text of Buffett's letter to shareholders in 19972:
To the Shareholders of Berkshire Hathaway Inc.:
Our gain in net worth during 1997 was $8.0 billion, which increased the per - share book value of both our class A and class B stock by 34.1%. Over the last 33 years (that is, since present management took over), per - share book value has grown from $19 to $25,488, a rate of 24.1% compounded annually.
Given our gain of 34.1%, it is tempting to declare victory and move on. But last year's performance was no great triumph: any investor can chalk up large returns when stocks soar, as they did in 1997. In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in the world. A right - thinking duck would instead compare its position after the downpour to that of the other ducks on the pond. So what's our duck rating for 1997? The table on the facing page shows that though we paddled furiously last year, passive ducks that simply invested in the S&P index rose almost as fast as we did. Our appraisal of 1997's performance, then: quack.
When the market booms, we tend to suffer in comparison with the S&P index. The index bears no tax costs, nor do mutual funds, since they pass through all tax liabilities to their owners. Last year, on the other hand, Berkshire paid or accrued $4.2 billion for federal income tax, or about 18% of our beginning net worth. Berkshire will always have corporate taxes to pay, which means it needs to overcome their drag in order to justify its existence. Obviously, Charlie Munger, Berkshire's vice chairman and my partner, and I won't be able to lick that handicap every year. But we expect over time to maintain a modest advantage over the index, and that is the yardstick against which you should measure us. We will not ask you to adopt the philosophy of the Chicago Cubs fan who reacted to a string of lackluster seasons by saying, "Why get upset? Everyone has a bad century now and then."
Gains in book value are, of course, not the bottom line at Berkshire. What truly counts are gains in per - share intrinsic business value. Ordinarily, though, the two measures tend to move roughly in tandem, and in 1997 that was the case: led by a blow - out performance at Geico, Berkshire's intrinsic value (which far exceeds book value) grew at nearly the same pace as book value. For more explanation of the term, intrinsic value, you may wish to refer to our Owner's Manual, reprinted on pages 62 to 71. This manual sets forth our owner - related business principles, information that is important to all of Berkshire's shareholders.
In our last two annual reports, we furnished you a table that Charlie and I believe is central to estimating Berkshire's intrinsic value. In the updated version of that table, which follows, we trace our two key components of value. The first column lists our per - share ownership of investments (including cash and equivalents) and the second column shows our per - share earnings from Berkshire's operating businesses before taxes and purchase - accounting adjustments (discussed on pages 69 and 70), but after all interest and corporate expenses. The second column excludes all dividends, interest and capital gains that we realized from the investments presented in the first column. In effect, the columns show what Berkshire would look like were it split into two parts, with one entity holding our investments and the other operating all of our businesses and bearing all corporate costs.
Pundits who ignore what our 38,000 employees contribute to the company, and instead simply view Berkshire as a de facto investment company, should study the figures in the second column. We made our first business acquisition in 1967, and since then our pre - tax operating earnings have grown from $1 million to $888 million. Furthermore, as noted, in this exercise we have assigned all of Berkshire's corporate expenses -- overhead of $6.6 million, interest of $66.9 million and shareholder contributions of $15.4 million -- to our business operations, even though a portion of these could just as well have been assigned to the investment side.
Here are the growth rates of the two segments by decade:
[Growth rate data table is presented here]
During 1997, both parts of our business grew at a satisfactory rate, with investments increasing by $9,543 per share, or 33.5%, and operating earnings growing by $296.43 per share, or 70.3%. One important caveat: because we were lucky in our super - cat insurance business (to be discussed later) and because Geico's underwriting gain was well above what we can expect in most years, our 1997 operating earnings were much better than we anticipated and also more than we expect for 1998. Our rate of progress in both investments and operations is certain to fall in the future. For anyone deploying capital, nothing recedes like success.
My own history makes the point: back in 1951, when I was attending Ben Graham's class at Columbia, an idea giving me a $10,000 gain would have increased my annual performance for that year by a full 100 percentage points. Today, a $500 - million pre - tax idea for Berkshire would boost our results by only one percentage point. No wonder my annual results in the 1950s were better by nearly thirty percentage points than my annual gains in any subsequent decade. Charlie's experience has been similar. We weren't smarter back then, just smaller. At our present size, any performance edge we achieve will be titchy.
Nevertheless, we are helped by the magnificent long - term prospects of the businesses in which we have already deployed capital, both our operating subsidiaries and the companies in which we are passive investors. We also have a management team unrivaled in ability and focus. Most of these executives are wealthy and don't need Berkshire's compensation to maintain their lifestyles. Their motivation comes from the joy of achievement, not from fame or fortune.
Though we are happy with what we have, we are not happy with the prospects for deploying new capital. Prices of businesses and stocks are high. That doesn't mean that these prices will fall -- we have no view on that -- but it does mean that the prospective returns we get when we commit new money are relatively low.
In this situation, we try to practice Ted Williams - style discipline. In The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. He knew that he'd bat .400 by swinging only at balls in his "best" cells and that he'd bat .230 if he swung at balls in his "worst" cells, the low outside corner of the strike zone. In other words, waiting for the fat pitch meant a trip to the Hall of Fame; swinging at every pitch meant a ticket to the minors.
The business "pitches" we now see are, for the most part, just catching the lower outside corner. If we swing, we will be locked into low returns. But if we let all of today's pitches go by, we can't be sure that the next one will be more to our liking. Perhaps the alluring prices of the past were an aberration rather than today's full - price offerings. Unlike Ted, we won't be called out if we resist three pitches that are barely in the strike zone; nevertheless, standing there day after day with the bat on our shoulder isn't my idea of fun.
Unconventional Commitments
When we can't find our favorite investment - a well - run business with good economics selling at a sensible price -- we ordinarily put new money into high - quality short - term investment vehicles. Sometimes, however, we take a chance on something else. Obviously, we believe that our other commitments are more likely to produce profits than losses. But we also recognize that they do not offer the certain profits that come from an outstanding business acquired at an attractive price. When we find such a business, we know we will make money -- the only question is when. With our alternative investments, we think we will make money. But we also recognize that we may at times have losses, sometimes large ones.
At yearend, we had three unconventional positions. The first was a derivative contract for 14 million barrels of oil, a remnant of a 45.7 - million - barrel position we established in 1994 - 95. Contracts for 31.7 million barrels were settled in 1995 - 97, and these contracts produced pre - tax gains for us of about $61.9 million. Our remaining contracts will come due in 1998 and 1999.
[The letter continues with more details about Berkshire Hathaway's business operations, investments, and other relevant information. Due to space limitations, only the beginning part is shown here. If you want the full text, you can refer to the original source.]
