1978
Click here to read the letter.🧠 Key Takeaways
In capital intensive industries where the differences between the offerings of participating companies are hard to distinguish, inadequate returns should be expected, and price is one of the only ways to be competitive. But there is only so far you can go with that.
Buffett typically doesn't struggle to identify businesses with solid growth prospects that are within his circle of competence. The challenge lies in finding them at a price that he considers attractive enough. However, good things tend to come to those who wait.
If you’re going to be a “net buyer” of stocks, the best scenario would be to invest in a stock and then see its price drop. Assuming the drop wasn’t due to anything catastrophic, a lower share price means you can buy more shares with the same amount of money, which benefits “net buyers.”
Buffett is okay with companies keeping their earnings if they can reinvest them at attractive rates of return, regardless of whether Berkshire owns the entire company or just a small part of it. However, if the company isn't able to generate high returns on reinvested capital, then it's better for them to return those earnings to shareholders through dividends or share buybacks.
✍️ Memorable Quotes
“The textile industry illustrates in textbook style how producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage. As long as excess productive capacity exists, prices tend to reflect direct operating costs rather than capital employed.”
This makes me think of the telecommunications industry. Consider how the telecommunications industry parallels the challenges of operating in a sector with similar products and hefty capital demands. Think about the widespread reach of services offered by companies like AT&T and Verizon — whether it's phone plans or internet access, the differences between their offerings are often hard to distinguish, making price a major factor in consumer decisions.
In standard market conditions, competitive pricing, attractive signup offers, and network reliability are what determine consumers' decisions about which company to choose. Because of that, it’s difficult for any of these companies to have a durable competitive advantage over one another.
“…Only when we find (1) businesses we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively. We usually can identify a small number of potential investments meeting requirements (1), (2) and (3), but (4) often prevents action.”
These criteria outline Buffett's approach to investing in a company. He typically doesn't struggle to identify businesses with solid growth prospects that are within his circle of competence. The challenge lies in finding them at a price that he considers attractive enough. However, good things tend to come to those who wait.
“We are not concerned with whether the market quickly revalues upward securities that we believe are selling at bargain prices. In fact, we prefer just the opposite since, in most years, we expect to have funds available to be a net buyer of securities. And consistent attractive purchasing is likely to prove to be of more eventual benefit to us than any selling opportunities provided by a short-term run up in stock prices to levels at which we are unwilling to continue buying.”
The main goal of investing is to acquire and collect assets, especially if you're looking to build a steady stream of passive income. Now, if you’re going to be a “net buyer” of stocks, the best scenario would be to invest in a stock and then see its price drop.
Of course, this would depend on **why the price went down. But assuming it wasn’t anything catastrophic, a lower share price means you can buy more shares with the same amount of money.
What's more, when you calculate the dividend yield, which is how much the dividend pays out compared to the current share price, buying at a lower price means you get a better cash-flow return on your investment. As the share price goes down, the dividend yield goes up.
“Our policy is to concentrate holdings. We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to attractiveness, we believe in buying worthwhile amounts.”
Buffett believes in concentrating investments in companies he truly believes in, rather than spreading himself too thin across various lukewarm opportunities. When he finds something he’s truly enthusiastic about, he’s not afraid to make a big bet on it.
“We are not at all unhappy when our wholly-owned businesses retain all of their earnings if they can utilize internally those funds at attractive rates. Why should we feel differently about retention of earnings by companies in which we hold small equity interests, but where the record indicates even better prospects for profitable employment of capital? (This proposition cuts the other way, of course, in industries with low capital requirements, or if management has a record of plowing capital into projects of low profitability; then earnings should be paid out or used to repurchase shares - often by far the most attractive option for capital utilization.)”
If the companies Berkshire Hathaway fully owns can reinvest their profits back into the business and generate high returns on that investment, then Buffett is perfectly content to let them do so without paying out dividends.
Similarly, if Berkshire has smaller stakes in companies but they have a track record of using retained earnings effectively to grow the business, Buffett sees no reason to push for dividend payments.
However, in industries where companies don't need much capital to grow, or if management has a history of investing in projects that don't generate high returns, then it's better for them to pay out earnings as dividends or use them to buy back shares, which can be more beneficial for shareholders.
Overall, Buffett is okay with companies keeping their earnings if they can reinvest them at attractive rates of return, regardless of whether Berkshire owns the entire company or just a small part of it. However, if the company isn't able to generate high returns on reinvested capital, then it's better for them to return those earnings to shareholders through dividends or share buybacks.