Warren Buffet Letter

Every year, Warren Buffet writes a letter to his shareholders. This letter is read by a lot of investors. It offers insight, examples, and is a wonderful teaching tool. I really like Buffet's humorous and direct style of writing.

All of his letters can be found at this link.

Below are the highlights of his most recent letter.

Businesses – The Great, the Good and the Gruesome

Let’s take a look at what kind of businesses turn us on. And while we’re at it, let’s also discuss what we wish to avoid.

Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stock market purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.

A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the lowcost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed.

Our criterion of “enduring” causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all.

Additionally, this criterion eliminates the business whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOs had been running their businesses.

But if a business requires a superstar to produce great results, the business itself cannot be deemed great. A medical partnership led by your area’s premier brain surgeon may enjoy outsized and growing earnings, but that tells little about its future. The partnership’s moat will go when the surgeon goes. You can count, though, on the moat of the Mayo Clinic to endure, even though you can’t name its CEO.

Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.

Let’s look at the prototype of a dream business, our own See’s Candy. The boxed-chocolates industry in which it operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn’t grow. Many once-important brands have disappeared, and only three companies have earned more than token profits over the last forty years. Indeed, I believe that See’s, though it obtains the bulk of its revenues from only a few states, accounts for nearly half of the entire industry’s earnings.

At See’s, annual sales were 16 million pounds of candy when Blue Chip Stamps purchased the company in 1972. (Charlie and I controlled Blue Chip at the time and later merged it into Berkshire.) Last year See’s sold 31 million pounds, a growth rate of only 2% annually. Yet its durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire.

We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. (Modest seasonal debt was also needed for a few months each year.) Consequently, the company was earning 60% pre-tax on invested capital. Two factors helped to minimize the funds required for operations. First, the product was sold for cash, and that eliminated accounts receivable. Second, the production and distribution cycle was short, which minimized inventories.

Last year See’s sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire (or, in the early years, to Blue Chip). After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses. Just as Adam and Eve kick-started an activity that led to six billion humans, See’s has given birth to multiple new streams of cash for us. (The biblical command to “be fruitful and multiply” is one we take seriously at Berkshire.)

There aren’t many See’s in Corporate America. Typically, companies that increase their earnings from $5 million to $82 million require, say, $400 million or so of capital investment to finance their growth. That’s because growing businesses have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments.

A company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment. There is, to follow through on our example, nothing shabby about earning $82 million pre-tax on $400 million of net tangible assets. But that equation for the owner is vastly different from the See’s situation. It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google.

One example of good, but far from sensational, business economics is our own FlightSafety. This company delivers benefits to its customers that are the equal of those delivered by any business that I know of. It also possesses a durable competitive advantage: Going to any other flight-training provider than the best is like taking the low bid on a surgical procedure.

Nevertheless, this business requires a significant reinvestment of earnings if it is to grow. When we purchased FlightSafety in 1996, its pre-tax operating earnings were $111 million, and its net investment in fixed assets was $570 million. Since our purchase, depreciation charges have totaled $923 million. But capital expenditures have totaled $1.635 billion, most of that for simulators to match the new airplane models that are constantly being introduced. (A simulator can cost us more than $12 million, and we have 273 of them.) Our fixed assets, after depreciation, now amount to $1.079 billion. Pre-tax operating earnings in 2007 were $270 million, a gain of $159 million since 1996. That gain gave us a good, but far from See’s-like, return on our incremental investment of $509 million.

Consequently, if measured only by economic returns, FlightSafety is an excellent but not extraordinary business. Its put-up-more-to-earn-more experience is that faced by most corporations. For example, our large investment in regulated utilities falls squarely in this category. We will earn considerably more money in this business ten years from now, but we will invest many billions to make it. Now let’s move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.

The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it. And I, to my shame, participated in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt. Twice.

To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

And now it’s confession time. It should be noted that no consultant, board of directors or investment banker pushed me into the mistakes I will describe. In tennis parlance, they were all unforced errors.

To begin with, I almost blew the See’s purchase. The seller was asking $30 million, and I was adamant about not going above $25 million. Fortunately, he caved. Otherwise I would have balked, and that $1.35 billion would have gone to somebody else.

About the time of the See’s purchase, Tom Murphy, then running Capital Cities Broadcasting, called and offered me the Dallas-Fort Worth NBC station for $35 million. The station came with the Fort Worth paper that Capital Cities was buying, and under the “cross-ownership” rules Murph had to divest it. I knew that TV stations were See’s-like businesses that required virtually no capital investment and had excellent prospects for growth. They were simple to run and showered cash on their owners.

Moreover, Murph, then as now, was a close friend, a man I admired as an extraordinary manager and outstanding human being. He knew the television business forward and backward and would not have called me unless he felt a purchase was certain to work. In effect Murph whispered “buy” into my ear. But I didn’t listen.

In 2006, the station earned $73 million pre-tax, bringing its total earnings since I turned down the deal to at least $1 billion – almost all available to its owner for other purposes. Moreover, the property now has a capital value of about $800 million. Why did I say “no”? The only explanation is that my brain had gone on vacation and forgot to notify me. (My behavior resembled that of a politician Molly Ivins once described: “If his I.Q. was any lower, you would have to water him twice a day.”)

Finally, I made an even worse mistake when I said “yes” to Dexter, a shoe business I bought in 1993 for $433 million in Berkshire stock (25,203 shares of A). What I had assessed as durable competitive advantage vanished within a few years. But that’s just the beginning: By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion– to buy a worthless business.

To date, Dexter is the worst deal that I’ve made. But I’ll make more mistakes in the future – you can bet on that. A line from Bobby Bare’s country song explains what too often happens with acquisitions: “I’ve never gone to bed with an ugly woman, but I’ve sure woke up with a few.”

The Eating List

Recently, one of my students returned from the U.S. Before she came back to Korea, she made a list of Korean food that she planned on eating. "I had one page list of food I missed. I ate several things already, but still, I have long way to go!" :) Usually, I think about the food in the U.S. I'm going to eat when I go home, but I've never made a list.

So here goes:

Dry Aged Beef (These are the best steaks in the world.) Usually, I'll get a filet or a bone-in rib eye. Cost: $30-$40 per steak

Carne Asada Tacos (I love Mexican food. And this is my favorite.)
Cost: $1.50 each

An In-N-Out Burger and fries. This chain started in Los Angeles.
Cost: $1.75 burger $1.00 fries

Dim Sum (This is my favorite brunch. Literally, hundreds of different tasty little dishes.)
Cost: $1.25-$2.00 per dish


Salmon Collar (This is the part of the fish behind the head.) The fish is sooooo tender.
Cost: $7

Beef Tendon (This is really expensive in Korea, so I can't afford to eat it here.)
Cost: $5
Pizza (from Buca Di Beppo) This is my personal favorite. The crust is very thin and there is a lot of spicy Italian sausage and pepperoni. It's also HUGE. This picture is only 1/3 of the actual pizza.
Cost: $20

Sushi and Sashimi (I eat Japanese food in Korea and in the U.S. I love it.)
Cost: $12-$15

Uni (Sea Urchin)
Cost: $4

Pastrami sandwich from The Hat. This thing is huge, hot, and delicious. Pastrami is salted and smoked beef.
Cost: $6

Pho (Vietnamese noodles) I sometimes eat this in Seoul at Little Saigon Restaurant.
Cost: $4.50

Bahn Mi (Vietnamese sandwich) I think Koreans would really like this sandwich. It has peppers, fermented carrots and radish. With a choice of charbroiled pork, chicken, or beef.
Cost: $3

Chinese beef noodles
Cost: $5

Tommy's Chili Cheeseburger (It looks gross, but it's soooo good.) This chain also started in Los Angeles. The burger is smothered in a spicy chili.
Cost: $2.25

A steak, 2 eggs, and hash browns for breakfast. :) I like my eggs over easy. This is standard American fare.
Cost: $6

Ox Tail Soup I will cook this for my family. Ox tails are cheap in the U.S.
Cost: $6 for 1 kilo

When I'm home, I usually go to the gym and exercise for 1 hour everyday, but I still gain about 3-5 kilos in 2 weeks. >.<

For Teachers

We have to visit the immigration office in Sejongno every year. Most of you know that place can be a zoo. (What kind of visa are the pretty Russian girls applying for?) The usual wait time is around 2-3 hours. However, thanks to "Hi Korea: E-government for foreigners" we can make a reservation online.

Here are the steps:

1. First you need to join. Just click here and fill out the information. You'll need to choose a user name and password. (I chose "Damien" and 666 for mine.)
2. Make an appointment by clicking here.

3. Print out a receipt for your reservation. You'll need to show this to the immigration officer.
No more waiting in line. =) In addition, you can make a reservation for your friend(s) as well. Do you have friends?

Now, if only I could make a reservation for Woori Bank...

Inflasia

Recently, the Bank of Korea (BOK) decided to keep "the base rate" at 5%. "The BOK is expected to freeze the rate until the end of this year as it is facing conflicting risks of higher inflation and a slowing economy," said Lee Sung-kwon, an economist at Goodmorning Shinhan Securities Co. The average individual can feel the effects of inflation when you buy gas, rice, or instant noodles. One of my favorite restaurants recently raised their price for a meal from 8,000 won to 9,000 won. That's about a 12% increase. T_T

High inflation does a couple of things:

1. It weakens the local currency. The Korean won has dropped around 10% this year against the U.S. dollar.

2. It slows economic growth.

3. It is bad for stocks.

In order to fight inflation, governments need to raise their interest rates. Korea's inflation is running at 4.9% and the BOK set the base rate at 5%. However, if inflation increases to 5.5% the BOK will have to raise the base rate. Why? Because you don't want to end up like Vietnam.

If you look at the chart above, Vietnam is totally screwed. Their currency (the Vietnamese dong) will soon become toilet paper. This will be similar to the Mexican Peso Crisis of 1994. Does anyone ever learn from history?

In 1979, the U.S. inflation rate was 13.3% By 1980, the U.S. Federal Reserve had to raise the prime rate to 21% to curb inflation. lol Recently, the cost of rice (+8%) and gasoline (+10%) have been increasing in the U.S. However, the price of TVs (-16%) , computers (-13%), cars (-1.2%), and women's clothing (-5%) have been declining. This is good news for those Sex and the City ladies.

In China, inflation is running at 8%. The Chinese government has a weak yuan policy because it's good for exports. Sound familiar? I don't believe this can continue. Therefore, I am still very bullish on the Chinese yuan. Take a look at this graph. I wish all of my stocks looked like that. If you want to protect your money, the Chinese yuan is a good place to be.

Disclosure: I opened up a yuan account while I was vacationing in China two years ago.

Some of My Favorite Music Videos

1981 was a defining moment in music history. MTV appeared on television screens all over the U.S. The music world would never be the same. Now, singers have to be beautiful and sexy. Their sound wasn't as important. I'm not sure if bands like The Eagles or The Rolling Stones would be popular today. None of them are really handsome. I really hate that aspect of music today. They're musicians. Not cover models. However, I still enjoy watching some videos.

So much creativity in this one.


This video reminds me of the movie "Cinema Paradiso." (All the kissing.)


These guys really crack me up.


This Madonna video created a controversy.


Do you like aerobics?


The first "virtual band" was Alvin and the Chipmunks, but I actually listen
to the Gorillaz.


Is it a man or a "wo-man?" lol

Do You Protest the Protests?

Recently, there has been extensive media coverage of the protests going on in Seoul.

Just take a look at these recent articles.

Here are a few questions that I have:

1. Some of the protests are becoming violent. The people in the photos above do not look peaceful to me. I think one guy is wielding a steel pipe. Are these protests really candlelight vigils?

2. Protesters and police officers have been wounded. According to a recent article in Chosun-Ilbo,"13 police officers sustained serious injuries, including a 22-year-old police officer identified as Kim who suffered facial paralysis." A lot of my current and former students are police officers in Korea. Police officers have wives, fathers, mothers, daughters, and sons. They fear for their own lives and the family that depends on them. Who will cry for them?

3. I think we've been very fortunate that no deaths have occurred. What will happen if someone (a protester or a police officer) is killed? Will the entire country plunge into chaos?

4. The current administration has to deal with a lot of issues: inflation (oil and food), the economy, youth unemployment, housing, education, the DPRK, and possible stagflation. These obstacles did not appear overnight. They've been festering for quite some time. The entire cabinet of President Lee offered to resign on Tuesday. Today, people are talking about impeaching the president. How can these problems be solved if the government is paralyzed?

5. How will I get to Incheon airport for my vacation? My airport bus goes through Jongno and Gwanghwamun. Should I take the subway instead?

I welcome your opinions, suggestions, and remarks. =)

The Icahn vs. Yahoo! War

Here's an e-mail from Jerry Yang CEO of Yahoo! to all his employees.

To: Yahoo global staff
From: jerry
Subject: proxy contest update

yahoos,

over the last few weeks, i'm sure you've read a lot about a potential proxy contest leading up to our august 1, 2008 annual meeting of stockholders. the proxy contest has now begun.

so what is a proxy contest?

a proxy contest happens when one or more stockholders proposes nominees for the board of directors other than the nominees proposed by the company. and as you know, carl icahn has also announced his intention to nominate an alternate slate of directors for election to our board.

in a proxy contest, it is typical for a variety of positive and negative statements to be made about a company's board and management. we expect these kinds of statements about yahoo! to intensify in the weeks ahead. we intend to respond to statements that we believe are unfair or misleading, and we did so with the press releases we issued this week.

what should you expect in the coming weeks?

we have already filed our proxy statement with the SEC, which includes the board's nominees for election as directors and the other matters to be voted on at the annual meeting. next, we'll mail our proxy statement to all stockholders as soon as it's cleared by the SEC . in our proxy statement, our board unanimously recommends that all stockholders vote for all of yahoo!'s board of director nominees.

we believe the yahoo! board has the independence, knowledge and commitment to navigate the company through the rapidly changing internet environment and to deliver value for yahoo! and its stockholders. as we've said repeatedly, the entire yahoo! board is fully committed to doing what is in our stockholders' best interests. as yahoos, it's more important than ever that we put aside the rhetoric and continue to focus on strategic objectives and our efforts to maximize stockholder value. i want to thank all of you for your continued hard work and dedication through this distracting time. you are our most valued asset.

please remember that there are certain requirements that apply to communications during a proxy contest, but we'll do our best to keep you as informed as possible.

jerry