1984
Click here to read the letter.🧠 Key Takeaways
When management chooses to buy back its shares when the share price is significantly below the intrinsic value, not only does it directly increase the per-share value for existing shareholders, but it also demonstrates a commitment to enhancing shareholder wealth. This contrasts with actions that might expand management's influence or domain but offer no benefits to shareholders.
Even if a newspaper is mediocre or third-rate in terms of its content, as long as it holds a dominant position within its community, it can still generate worthwhile profits. This is unlike many other businesses where inferior quality leads to poor financial performance.
It’s better to focus on fewer companies and have a strong understanding of them than to spread yourself thin across many without truly knowing them well.
There's only one legitimate reason for retaining unrestricted earnings: when there is a reasonable expectation that the retained earnings will create more than one dollar of market value for the owners. If not, then that money is best paid to shareholders to reinvest into other, better opportunities.
✍️ Memorable Quotes
“The companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value. As shareholders, we find this encouraging and rewarding for two important reasons - one that is obvious, and one that is subtle and not always understood. The obvious point involves basic arithmetic: major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, that value. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended. The other benefit of repurchases is less subject to precise measurement but can be fully as important over time. By making repurchases when a company’s market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth of shareholders, rather than to actions that expand management’s domain but that do nothing for (or even harm) shareholders. Seeing this, shareholders and potential shareholders increase their estimates of future returns from the business. This upward revision, in turn, produces market prices more in line with intrinsic business value. These prices are entirely rational. Investors should pay more for a business that is lodged in the hands of a manager with demonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drummer.”
When a company repurchases its own stock at prices below its intrinsic value, it directly increases the per-share value for existing shareholders (less shares outstanding results in each remaining share being a larger percentage of the business).
In such scenarios, companies can effectively get $2 of value for every $1 spent on repurchasing their own stock, which is in contrast to most acquisitions. These often fail to generate comparable value for shareholders, and can even do more harm than good.
That’s the obvious benefit to share repurchases. The less obvious (but equally important) benefit of share repurchases is the message it sends to shareholders.
When management chooses to buy back its shares when the share price is significantly below the intrinsic value, it demonstrates a commitment to enhancing shareholder wealth. This contrasts with actions that might expand management's influence or domain but offer no benefits to shareholders.
Buffett argues that investors are justified in paying more for a business managed by individuals who demonstrate a commitment to enhancing shareholder value compared to those managed by self-interested executives.
“I have been asked by a number of people just what secrets the Blumkins bring to their business. These are not very esoteric. All members of the family: (1) apply themselves with an enthusiasm and energy that would make Ben Franklin and Horatio Alger look like dropouts; (2) define with extraordinary realism their area of special competence and act decisively on all matters within it; (3) ignore even the most enticing propositions failing outside of that area of special competence; and, (4) unfailingly behave in a high-grade manner with everyone they deal with. (Mrs. B boils it down to “sell cheap and tell the truth”.)”
I don’t really have anything to add to this. I just thought these were good qualities to remember.
“The economics of a dominant newspaper are excellent, among the very best in the business world. Owners, naturally, would like to believe that their wonderful profitability is achieved only because they unfailingly turn out a wonderful product. That comfortable theory wilts before an uncomfortable fact. While first-class newspapers make excellent profits, the profits of third-rate papers are as good or better - as long as either class of paper is dominant within its community. Of course, product quality may have been crucial to the paper in achieving dominance. We believe this was the case at the News, in very large part because of people such as Alfred Kirchhofer who preceded us. Once dominant, the newspaper itself, not the marketplace, determines just how good or how bad the paper will be. Good or bad, it will prosper. That is not true of most businesses: inferior quality generally produces inferior economics. But even a poor newspaper is a bargain to most citizens simply because of its “bulletin board” value. Other things being equal, a poor product will not achieve quite the level of readership achieved by a first-class product. A poor product, however, will still remain essential to most citizens, and what commands their attention will command the attention of advertisers.”
Even if a newspaper is mediocre or third-rate in terms of its content, as long as it holds a dominant position within its community, it can still generate worthwhile profits. This is unlike many other businesses where inferior quality leads to poor financial performance.
Despite the potential for a decrease in readership compared to high-quality newspapers, even inferior newspapers are essential to most citizens. This is because newspapers serve as a primary source of information and act like a "bulletin board", providing essential news and announcements to the community.
Advertisers recognize this widespread attention and continue to invest in advertising space, ensuring the financial viability of even lower-quality newspapers.
“With our financial strength we can own large blocks of a few securities that we have thought hard about and bought at attractive prices. (Billy Rose described the problem of over-diversification: “If you have a harem of forty women, you never get to know any of them very well.”) Over time our policy of concentration should produce superior results, though these will be tempered by our large size. When this policy produces a really bad year, as it must, at least you will know that our money was committed on the same basis as yours.”
It’s better to focus on fewer companies and have a strong understanding of them than to spread yourself thin across many without truly knowing them well.
The Billy Rose quote hit the nail on the head. When investing your hard-earned money, it's imperative to thoroughly understand what you're investing in. That’s the only way you can be confident in what you’re buying.
The more investments you have, the more challenging it becomes to maintain a deep knowledge of each one.
“Restricted earnings need not concern us further in this dividend discussion. Let’s turn to the much-more-valued unrestricted variety. These earnings may, with equal feasibility, be retained or distributed. In our opinion, management should choose whichever course makes greater sense for the owners of the business. This principle is not universally accepted. For a number of reasons managers like to withhold unrestricted, readily distributable earnings from shareholders - to expand the corporate empire over which the managers rule, to operate from a position of exceptional financial comfort, etc. But we believe there is only one valid reason for retention. Unrestricted earnings should be retained only when there is a reasonable prospect - backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future - that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.”
First and foremost, restricted earnings typically have limitations on how they can be used, while unrestricted earnings can be used freely. They can either be kept within the company or distributed to shareholders.
Buffett suggests that management should choose the option that benefits the owners of the business the most. However, he says this idea is not universally accepted. Some managers prefer to withhold unrestricted earnings from shareholders for various reasons, such as “empire building” or operating from a position of financial comfort.
Buffett argues that there's only one legitimate reason for retaining unrestricted earnings: when there is a reasonable expectation that the retained earnings will create more than one dollar of market value for the owners. If not, then that money is best paid to shareholders to reinvest into other, better opportunities.