Berkshire 1990 Shareholder Letter - Cliff's Notes Version

This is the fourteenth in a series of blog posts that will analyze / summarize Warren Buffett's shareholder letters from 1977-2015. For all of the prior shareholder letters, see here.

The 1990 letter weighs in at 16,020 words, an 11% increase from 14,420 words the prior year. Berkshire's gain in net worth during 1990 was $362 million, or 7.3% of beginning book value, down from a $1.515 billion gain in 1988. Berkshire's growth rate was lackluster in 1990 because their four major common stock holdings, in aggregate, showed little change in market value.

DECLINE OF MEDIA FRANCHISES

Buffett in the 1990 letter first notes that the traditional dominant media businesses, whose franchises had previously appeared unassailable, were no longer as dominant as previously believed...

Charlie and I were surprised at developments this past year in the media industry, including newspapers such as our Buffalo News. The business showed far more vulnerability to the early stages of a recession than has been the case in the past. The question is whether this erosion is just part of an aberrational cycle--to be fully made up in the next upturn--or whether the business has slipped in a way that permanently reduces intrinsic business values. Since I didn't predict what has happened, you may question the value of my prediction about what will happen. Nevertheless, I'll proffer a judgment: While many media businesses will remain economic marvels in comparison with American industry generally, they will prove considerably less marvelous than I, the industry, or lenders thought would be the case only a few years ago.

The reason media businesses have been so outstanding in the past was not physical growth, but rather the unusual pricing power that most participants wielded. Now, however, advertising dollars are growing slowly. In addition, retailers that do little or no media advertising (though they sometimes use the Postal Service) have gradually taken market share in certain merchandise categories. Most important of all, the number of both print and electronic advertising channels has substantially increased. As a consequence, advertising dollars are more widely dispersed and the pricing power of ad vendors has diminished. These circumstances materially reduce the intrinsic value of our major media investments and also the value of our operating unit, Buffalo News - though all remain fine businesses. [emphasis added]

Fast forward an additional 27 years and we observe that traditional newspapers are all but obsolete. The Buffalo News, for example, now sees its circulation at about 139,000/day [source], down around 34 percent from just 9 years ago [source]. Meanwhile Facebook has something like 1,400,000,000 users, 10,000X the circulation of the Buffalo News. An economic moat, no matter how wide, is always in danger of narrowing. So to traditional media such as newspapers, we hereby assign the following verdict...

BUYING WELLS FARGO WHEN THERE IS BLOOD IN THE STREETS

Buffett also mentions for the first time Berkshire's involvement with Wells Fargo...

Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled--often on the heels of managerial assurances that all was well--investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings. Wells Fargo is big--it has $56 billion in assets--and has been earning more than 20% on equity and 1.25% on assets. Our purchase of one-tenth of the bank may be thought of as roughly equivalent to our buying 100% of a $5 billion bank with identical financial characteristics.

Fast forward an additional 27 years and we observe that Wells Fargo is bigger than ever, albeit suffering from serious adverse media coverage recently for opening fake accounts in its customers' names. At the end of 1990, Berkshire owned just 5,000,000 shares of WFC; that number today is over 500,000,000, thanks to stock splits and subsequent purchases. Wells Fargo's return on equity and return on assets numbers are also quite a bit lower than in 1990, thanks in large part to the raft of financial regulations passed in the wake of the financial crisis.

The following is contemporary news coverage of Buffett's Wells Fargo purchase [note Dick Bove's somewhat laughable suggestion that Buffett timed the revelation of his Wells purchase in order to pump the stock price]...

Buffett Discloses 9.8% Stake in Wells Fargo; Bank Pleased

October 25, 1990 | MARTHA GROVES | TIMES STAFF WRITER

SAN FRANCISCO — Warren E. Buffett, a savvy stock picker known for investing in undervalued companies with strong fundamentals, has amassed a 9.8% stake in Wells Fargo & Co. The big San Francisco-based banking company, which has seen its stock battered in recent months because of concerns over real estate loans, on Wednesday expressed delight at having Buffett as its biggest shareholder, with 5.03 million shares now worth $250 million.

"This is good news indeed," Wells Chairman Carl E. Reichardt and President Paul Hazen crowed to employees in a memo. Reichardt, who talks with Buffett from time to time and met with him in San Francisco two weeks ago, called the purchase "an endorsement from one of the most astute investors in the country."

The holding was revealed Tuesday in a filing with the Securities and Exchange Commission in Washington. It did not disclose when the shares were purchased or at what prices. Wells Fargo shares have been trading recently in the high $40s. On the New York Stock Exchange on Wednesday, the price rose $1.375 to $50.50. The stock reached a high of about $87 a year ago.

Buffett, chairman of Berkshire Hathaway Inc. in Omaha, has a reputation for taking large positions in undervalued stocks, then holding on to let them appreciate. Buffett, 60, who got interested in investing at age 9, favors well-run companies with familiar brands or franchises. He has said his "favorite holding period is forever."

The investments are made through Berkshire Hathaway, a former textile manufacturer, and various insurance subsidiaries. Berkshire Hathaway owns See's, the candy maker, and World Book encyclopedias.

Occasionally, Buffett will take an active role by joining a company's board. He now serves on the boards of Coca-Cola Co., Salomon Inc., Capital Cities/ABC Inc. and Gillette Co., companies in which he holds sizable stakes. Hazen said in a telephone interview that there has been no discussion about Buffett's joining the Wells board. Wells' announcement of Buffett's purchase confirmed speculation that had circulated on Wall Street for months.

"This is not new news," agreed Livia S. Asher, a bank analyst with Merrill Lynch Capital Markets in New York. "But in today's bank stock market, I guess anything that can be perceived as a positive will be taken to heart."

Richard X. Bove, an analyst with Dean Witter in New York, agreed that "it is highly probable that this (holding) was built up over a long time." If so, it is possible that Buffett bought many of his shares in the high $60s, well above current levels. Bove speculated that Wells' recent report of improved third-quarter earnings might have "emboldened" Buffett to disclose his holding with the hope that other investors would follow his lead and help boost the stock price.

Buffett's revelation follows filings by Laurence A. Tisch and members of his multibillionaire family, who recently bought stakes in Continental Bank Corp., Baybanks Inc. and Equimark Corp. The three bank holding companies' stocks had been among those in disfavor in the recent banking-stock blood bath. Like Buffett, Tisch, the chief executive and largest stockholder of CBS Inc. and chairman of Loews Corp., is known for spotting undervalued issues.

MARGIN OF SAFETY - THE THREE MOST IMPORTANT WORDS IN INVESTING

Buffett goes on to discuss junk bonds and how they were supposed to keep companies honest, with the view that the management of a highly-indebted company would be extra motivated to produce outstanding business results. However, economic theories tend to wilt in the face of real-life events...

A kind of bastardized fallen angel burst onto the investment scene in the 1980s--"junk bonds" that were far below investment-grade when issued. As the decade progressed, new offerings of manufactured junk became ever junkier and ultimately the predictable outcome occurred: Junk bonds lived up to their name. In 1990--even before the recession dealt its blows--the financial sky became dark with the bodies of failing corporations.

The disciples of debt assured us that this collapse wouldn't happen: Huge debt, we were told, would cause operating managers to focus their efforts as never before, much as a dagger mounted on the steering wheel of a car could be expected to make its driver proceed with intensified care. We'll acknowledge that such an attention-getter would produce a very alert driver. But another certain consequence would be a deadly--and unnecessary--accident if the car hit even the tiniest pothole or sliver of ice. The roads of business are riddled with potholes; a plan that requires dodging them all is a plan for disaster.

In the final chapter of The Intelligent Investor Ben Graham forcefully rejected the dagger thesis: "Confronted with a challenge to distill the secret of sound investment into three words, we venture the motto, Margin of Safety." Forty-two years after reading that, I still think those are the right three words. The failure of investors to heed this simple message caused them staggering losses as the 1990s began. [emphasis added]

Not only are junk bonds financial dangerous to the companies that issue them, they can also end up causing the promoter thereof to do a high profile perp walk...