we are incorrectly rumored to be buying. If we deny those
reports but say no comment?on other occasions, the no-comments
become confirmation.
That completes the catechism, and we can now move on to the
high point of 1983 - the acquisition of a majority interest in
Nebraska Furniture Mart and our association with Rose Blumkin and
her family.
Nebraska Furniture Mart
Last year, in discussing how managers with bright, but
adrenalin-soaked minds scramble after foolish acquisitions, I
quoted Pascal: it has struck me that all the misfortunes of men
spring from the single cause that they are unable to stay quietly
in one room.?
Even Pascal would have left the room for Mrs. Blumkin.
About 67 years ago Mrs. Blumkin, then 23, talked her way
past a border guard to leave Russia for America. She had no
formal education, not even at the grammar school level, and knew
no English. After some years in this country, she learned the
language when her older daughter taught her, every evening, the
words she had learned in school during the day.
In 1937, after many years of selling used clothing, Mrs.
Blumkin had saved $500 with which to realize her dream of opening
a furniture store. Upon seeing the American Furniture Mart in
Chicago - then the center of the nation’s wholesale furniture
activity - she decided to christen her dream Nebraska Furniture
Mart.
She met every obstacle you would expect (and a few you
wouldn’t) when a business endowed with only $500 and no
locational or product advantage goes up against rich, longentrenched
competition. At one early point, when her tiny
resources ran out, .rs. B?(a personal trademark now as well
recognized in Greater Omaha as Coca-Cola or Sanka) coped in a way
not taught at business schools: she simply sold the furniture and
appliances from her home in order to pay creditors precisely as
promised.
Omaha retailers began to recognize that Mrs. B would offer
customers far better deals than they had been giving, and they
pressured furniture and carpet manufacturers not to sell to her.
But by various strategies she obtained merchandise and cut prices
sharply. Mrs. B was then hauled into court for violation of Fair
Trade laws. She not only won all the cases, but received
invaluable publicity. At the end of one case, after
demonstrating to the court that she could profitably sell carpet
at a huge discount from the prevailing price, she sold the judge
$1400 worth of carpet.
Today Nebraska Furniture Mart generates over $100 million of
sales annually out of one 200,000 square-foot store. No other
home furnishings store in the country comes close to that volume.
That single store also sells more furniture, carpets, and
appliances than do all Omaha competitors combined.
One question I always ask myself in appraising a business is
how I would like, assuming I had ample capital and skilled
personnel, to compete with it. I. rather wrestle grizzlies than
compete with Mrs. B and her progeny. They buy brilliantly, they
operate at expense ratios competitors don’t even dream about, and
they then pass on to their customers much of the savings. It’s
the ideal business - one built upon exceptional value to the
customer that in turn translates into exceptional economics for
its owners.
Mrs. B is wise as well as smart and, for far-sighted family
reasons, was willing to sell the business last year. I had
admired both the family and the business for decades, and a deal
was quickly made. But Mrs. B, now 90, is not one to go home and
risk, as she puts it, losing her marbles? She remains Chairman
and is on the sales floor seven days a week. Carpet sales are
her specialty. She personally sells quantities that would be a
good departmental total for other carpet retailers.
We purchased 90% of the business - leaving 10% with members
of the family who are involved in management - and have optioned
10% to certain key young family managers.
And what managers they are. Geneticists should do
handsprings over the Blumkin family. Louie Blumkin, Mrs. B’s
son, has been President of Nebraska Furniture Mart for many years
and is widely regarded as the shrewdest buyer of furniture and
appliances in the country. Louie says he had the best teacher,
and Mrs. B says she had the best student. Theye both right.
Louie and his three sons all have the Blumkin business ability,
work ethic, and, most important, character. On top of that, they
are really nice people. We are delighted to be in partnership
with them.
Corporate Performance
During 1983 our book value increased from $737.43 per share
to $975.83 per share, or by 32%. We never take the one-year
figure very seriously. After all, why should the time required
for a planet to circle the sun synchronize precisely with the
time required for business actions to pay off? Instead, we
recommend not less than a five-year test as a rough yardstick of
economic performance. Red lights should start flashing if the
five-year average annual gain falls much below the return on
equity earned over the period by American industry in aggregate.
(Watch out for our explanation if that occurs as Goethe observed,
.hen ideas fail, words come in very handy.?
During the 19-year tenure of present management, book value
has grown from $19.46 per share to $975.83, or 22.6% compounded
annually. Considering our present size, nothing close to this
rate of return can be sustained. Those who believe otherwise
should pursue a career in sales, but avoid one in mathematics.
We report our progress in terms of book value because in our
case (though not, by any means, in all cases) it is a
conservative but reasonably adequate proxy for growth in
intrinsic business value - the measurement that really counts.
Book value’s virtue as a score-keeping measure is that it is easy
to calculate and doesn’t involve the subjective (but important)
judgments employed in calculation of intrinsic business value.
It is important to understand, however, that the two terms - book
value and intrinsic business value - have very different
meanings.
Book value is an accounting concept, recording the
accumulated financial input from both contributed capital and
retained earnings. Intrinsic business value is an economic
concept, estimating future cash output discounted to present
value. Book value tells you what has been put in; intrinsic
business value estimates what can be taken out.
An analogy will suggest the difference. Assume you spend
identical amounts putting each of two children through college.
The book value (measured by financial input) of each child’s
education would be the same. But the present value of the future
payoff (the intrinsic business value) might vary enormously -
from zero to many times the cost of the education. So, also, do
businesses having equal financial input end up with wide
variations in value.
At Berkshire, at the beginning of fiscal 1965 when the
present management took over, the $19.46 per share book value
considerably overstated intrinsic business value. All of that
book value consisted of textile assets that could not earn, on
average, anything close to an appropriate rate of return. In the
terms of our analogy, the investment in textile assets resembled
investment in a largely-wasted education.
Now, however, our intrinsic business value considerably
exceeds book value. There are two major reasons:
(1) Standard accounting principles require that common
stocks held by our insurance subsidiaries be stated on
our books at market value, but that other stocks we own
be carried at the lower of aggregate cost or market.
At the end of 1983, the market value of this latter
group exceeded carrying value by $70 million pre-tax,
or about $50 million after tax. This excess belongs in
our intrinsic business value, but is not included in
the calculation of book value;
(2) More important, we own several businesses that possess
economic Goodwill (which is properly includable in
intrinsic business value) far larger than the
accounting Goodwill that is carried on our balance
sheet and reflected in book value.
Goodwill, both economic and accounting, is an arcane subject
and requires more explanation than is appropriate here. The
appendix that follows this letter - .oodwill and its
Amortization: The Rules and The Realities?- explains why
economic and accounting Goodwill can, and usually do, differ
enormously.
You can live a full and rewarding life without ever thinking
about Goodwill and its amortization. But students of investment
and management should understand the nuances of the subject. My
own thinking has changed drastically from 35 years ago when I was
taught to favor tangible assets and to shun businesses whose
value depended largely upon economic Goodwill. This bias caused
me to make many important business mistakes of omission, although
relatively few of commission.
Keynes identified my problem: .he difficulty lies not in
the new ideas but in escaping from the old ones.?My escape was
long delayed, in part because most of what I had been taught by
the same teacher had been (and continues to be) so
extraordinarily valuable. Ultimately, business experience,
direct and vicarious, produced my present strong preference for
businesses that possess large amounts of enduring Goodwill and
that utilize a minimum of tangible assets.
I recommend the Appendix to those who are comfortable with
accounting terminology and who have an interest in understanding
the business aspects of Goodwill. Whether or not you wish to
tackle the Appendix, you should be aware that Charlie and I
believe that Berkshire possesses very significant economic
Goodwill value above that reflected in our book value.
Sources of Reported Earnings
The table below shows the sources of Berkshire’s reported
earnings. In 1982, Berkshire owned about 60% of Blue Chip Stamps
whereas, in 1983, our ownership was 60% throughout the first six
months and 100% thereafter. In turn, Berkshire’s net interest in
Wesco was 48% during 1982 and the first six months of 1983, and
80% for the balance of 1983. Because of these changed ownership
percentages, the first two columns of the table provide the best
measure of underlying business performance.
All of the significant gains and losses attributable to
unusual sales of assets by any of the business entities are
aggregated with securities transactions on the line near the
bottom of the table, and are not included in operating earnings.
(We regard any annual figure for realized capital gains or losses
as meaningless, but we regard the aggregate realized and
unrealized capital gains over a period of years as very
important.) Furthermore, amortization of Goodwill is not charged
against the specific businesses but, for reasons outlined in the
Appendix, is set forth as a separate item.
Net Earnings
Earnings Before Income Taxes After Tax
-------------------------------------- ------------------
Total Berkshire Share Berkshire Share
------------------ ------------------ ------------------
1983 1982 1983 1982 1983 1982
-------- -------- -------- -------- -------- --------
(000s omitted)
Operating Earnings:
Insurance Group:
Underwriting ............ $(33,872) $(21,558) $(33,872) $(21,558) $(18,400) $(11,345)
Net Investment Income ... 43,810 41,620 43,810 41,620 39,114 35,270
Berkshire-Waumbec Textiles (100) (1,545) (100) (1,545) (63) (862)
Associated Retail Stores .. 697 914 697 914 355 446
Nebraska Furniture Mart(1) 3,812 -- 3,049 -- 1,521 --
See’s Candies ............. 27,411 23,884 24,526 14,235 12,212 6,914
Buffalo Evening News ...... 19,352 (1,215) 16,547 (724) 8,832 (226)
Blue Chip Stamps(2) ....... (1,422) 4,182 (1,876) 2,492 (353) 2,472
Wesco Financial - Parent .. 7,493 6,156 4,844 2,937 3,448 2,210
Mutual Savings and Loan ... (798) (6) (467) (2) 1,917 1,524
Precision Steel ........... 3,241 1,035 2,102 493 1,136 265
Interest on Debt .......... (15,104) (14,996) (13,844) (12,977) (7,346) (6,951)
Special GEICO Distribution 21,000 -- 21,000 -- 19,551 --
Shareholder-Designated
Contributions .......... (3,066) (891) (3,066) (891) (1,656) (481)
Amortization of Goodwill .. (532) 151 (563) 90 (563) 90
Other ..................... 10,121 3,371 9,623 2,658 8,490 2,171
-------- -------- -------- -------- -------- --------
Operating Earnings .......... 82,043 41,102 72,410 27,742 68,195 31,497
Sales of securities and
unusual sales of assets .. 67,260 36,651 65,089 21,875 45,298 14,877
-------- -------- -------- -------- -------- --------
Total Earnings .............. $149,303 $ 77,753 $137,499 $ 49,617 $113,493 $ 46,374
======== ======== ======== ======== ======== ========
(1) October through December
(2) 1982 and 1983 are not comparable; major assets were
transferred in the merger.
For a discussion of the businesses owned by Wesco, please
read Charlie Munger’s report on pages 46-51. Charlie replaced
Louie Vincenti as Chairman of Wesco late in 1983 when health
forced Louie’s retirement at age 77. In some instances, .ealth?
is a euphemism, but in Louie’s case nothing but health would
cause us to consider his retirement. Louie is a marvelous man
and has been a marvelous manager.
The special GEICO distribution reported in the table arose
when that company made a tender offer for a portion of its stock,
buying both from us and other shareholders. At GEICO’s request,
we tendered a quantity of shares that kept our ownership
percentage the same after the transaction as before. The
proportional nature of our sale permitted us to treat the
proceeds as a dividend. Unlike individuals, corporations net
considerably more when earnings are derived from dividends rather
than from capital gains, since the effective Federal income tax
rate on dividends is 6.9% versus 28% on capital gains.
