To the Shareholders of Berkshire Hathaway Inc.:

     Operating earnings improved to $41.9 million in 1980 from 
$36.0 million in 1979, but return on beginning equity capital 
(with securities valued at cost) fell to 17.8% from 18.6%. We 
believe the latter yardstick to be the most appropriate measure 
of single-year managerial economic performance.  Informed use of 
that yardstick, however, requires an understanding of many 
factors, including accounting policies, historical carrying 
values of assets, financial leverage, and industry conditions.

     In your evaluation of our economic performance, we suggest 
that two factors should receive your special attention - one of a 
positive nature peculiar, to a large extent, to our own 
operation, and one of a negative nature applicable to corporate 
performance generally.  Let’s look at the bright side first.

Non-Controlled Ownership Earnings

     When one company owns part of another company, appropriate 
accounting procedures pertaining to that ownership interest must 
be selected from one of three major categories.  The percentage 
of voting stock that is owned, in large part, determines which 
category of accounting principles should be utilized.

     Generally accepted accounting principles require (subject to 
exceptions, naturally, as with our former bank subsidiary) full 
consolidation of sales, expenses, taxes, and earnings of business 
holdings more than 50% owned.  Blue Chip Stamps, 60% owned by 
Berkshire Hathaway Inc., falls into this category.  Therefore, 
all Blue Chip income and expense items are included in full in 
Berkshire’s Consolidated Statement of Earnings, with the 40% 
ownership interest of others in Blue Chip’s net earnings 
reflected in the Statement as a deduction for “minority 

     Full inclusion of underlying earnings from another class of 
holdings, companies owned 20% to 50% (usually called 
“investees”), also normally occurs.  Earnings from such companies 
- for example, Wesco Financial, controlled by Berkshire but only 
48% owned - are included via a one-line entry in the owner’s 
Statement of Earnings.  Unlike the over-50% category, all items 
of revenue and expense are omitted; just the proportional share 
of net income is included.  Thus, if Corporation A owns one-third 
of Corporation B, one-third of B’s earnings, whether or not 
distributed by B, will end up in A’s earnings.  There are some 
modifications, both in this and the over-50% category, for 
intercorporate taxes and purchase price adjustments, the 
explanation of which we will save for a later day. (We know you 
can hardly wait.)

     Finally come holdings representing less than 20% ownership 
of another corporation’s voting securities.  In these cases, 
accounting rules dictate that the owning companies include in 
their earnings only dividends received from such holdings.  
Undistributed earnings are ignored.  Thus, should we own 10% of 
Corporation X with earnings of $10 million in 1980, we would 
report in our earnings (ignoring relatively minor taxes on 
intercorporate dividends) either (a) $1 million if X declared the 
full $10 million in dividends; (b) $500,000 if X paid out 50%, or 
$5 million, in dividends; or (c) zero if X reinvested all 

     We impose this short - and over-simplified - course in 
accounting upon you because Berkshire’s concentration of 
resources in the insurance field produces a corresponding 
concentration of its assets in companies in that third (less than 
20% owned) category.  Many of these companies pay out relatively 
small proportions of their earnings in dividends.  This means 
that only a small proportion of their current earning power is 
recorded in our own current operating earnings.  But, while our 
reported operating earnings reflect only the dividends received 
from such companies, our economic well-being is determined by 
their earnings, not their dividends.

     Our holdings in this third category of companies have 
increased dramatically in recent years as our insurance business 
has prospered and as securities markets have presented 
particularly attractive opportunities in the common stock area.  
The large increase in such holdings, plus the growth of earnings 
experienced by those partially-owned companies, has produced an 
unusual result; the part of “our” earnings that these companies 
retained last year (the part not paid to us in dividends) 
exceeded the total reported annual operating earnings of 
Berkshire Hathaway.  Thus, conventional accounting only allows 
less than half of our earnings “iceberg” to appear above the 
surface, in plain view.  Within the corporate world such a result 
is quite rare; in our case it is likely to be recurring.

     Our own analysis of earnings reality differs somewhat from 
generally accepted accounting principles, particularly when those 
principles must be applied in a world of high and uncertain rates 
of inflation. (But it’s much easier to criticize than to improve 
such accounting rules.  The inherent problems are monumental.) We 
have owned 100% of businesses whose reported earnings were not 
worth close to 100 cents on the dollar to us even though, in an 
accounting sense, we totally controlled their disposition. (The 
“control” was theoretical.  Unless we reinvested all earnings, 
massive deterioration in the value of assets already in place 
would occur.  But those reinvested earnings had no prospect of 
earning anything close to a market return on capital.) We have 
also owned small fractions of businesses with extraordinary 
reinvestment possibilities whose retained earnings had an 
economic value to us far in excess of 100 cents on the dollar.

     The value to Berkshire Hathaway of retained earnings is not 
determined by whether we own 100%, 50%, 20% or 1% of the 
businesses in which they reside.  Rather, the value of those 
retained earnings is determined by the use to which they are put 
and the subsequent level of earnings produced by that usage.  
This is true whether we determine the usage, or whether managers 
we did not hire - but did elect to join - determine that usage. 
(It’s the act that counts, not the actors.) And the value is in 
no way affected by the inclusion or non-inclusion of those 
retained earnings in our own reported operating earnings.  If a 
tree grows in a forest partially owned by us, but we don’t record 
the growth in our financial statements, we still own part of the 

     Our view, we warn you, is non-conventional.  But we would 
rather have earnings for which we did not get accounting credit 
put to good use in a 10%-owned company by a management we did not 
personally hire, than have earnings for which we did get credit 
put into projects of more dubious potential by another management 
- even if we are that management.

     (We can’t resist pausing here for a short commercial.  One 
usage of retained earnings we often greet with special enthusiasm 
when practiced by companies in which we have an investment 
interest is repurchase of their own shares.  The reasoning is 
simple: if a fine business is selling in the market place for far 
less than intrinsic value, what more certain or more profitable 
utilization of capital can there be than significant enlargement 
of the interests of all owners at that bargain price?  The 
competitive nature of corporate acquisition activity almost 
guarantees the payment of a full - frequently more than full 
price when a company buys the entire ownership of another 
enterprise.  But the auction nature of security markets often 
allows finely-run companies the opportunity to purchase portions 
of their own businesses at a price under 50% of that needed to 
acquire the same earning power through the negotiated acquisition 
of another enterprise.)

Long-Term Corporate Results

     As we have noted, we evaluate single-year corporate 
performance by comparing operating earnings to shareholders’ 
equity with securities valued at cost.  Our long-term yardstick 
of performance, however, includes all capital gains or losses, 
realized or unrealized.  We continue to achieve a long-term 
return on equity that considerably exceeds the average of our 
yearly returns.  The major factor causing this pleasant result is 
a simple one: the retained earnings of those non-controlled 
holdings we discussed earlier have been translated into gains in 
market value.

     Of course, this translation of retained earnings into market 
price appreciation is highly uneven (it goes in reverse some 
years), unpredictable as to timing, and unlikely to materialize 
on a precise dollar-for-dollar basis.  And a silly purchase price 
for a block of stock in a corporation can negate the effects of a 
decade of earnings retention by that corporation.  But when 
purchase prices are sensible, some long-term market recognition 
of the accumulation of retained earnings almost certainly will 
occur.  Periodically you even will receive some frosting on the 
cake, with market appreciation far exceeding post-purchase 
retained earnings.

     In the sixteen years since present management assumed 
responsibility for Berkshire, book value per share with 
insurance-held equities valued at market has increased from 
$19.46 to $400.80, or 20.5% compounded annually. (You’ve done 
better: the value of the mineral content in the human body 
compounded at 22% annually during the past decade.) It is 
encouraging, moreover, to realize that our record was achieved 
despite many mistakes.  The list is too painful and lengthy to 
detail here.  But it clearly shows that a reasonably competitive 
corporate batting average can be achieved in spite of a lot of 
managerial strikeouts.

     Our insurance companies will continue to make large 
investments in well-run, favorably-situated, non-controlled 
companies that very often will pay out in dividends only small 
proportions of their earnings.  Following this policy, we would 
expect our long-term returns to continue to exceed the returns 
derived annually from reported operating earnings.  Our 
confidence in this belief can easily be quantified: if we were to 
sell the equities that we hold and replace them with long-term 
tax-free bonds, our reported operating earnings would rise 
immediately by over $30 million annually.  Such a shift tempts us 
not at all.  

     So much for the good news.

Results for Owners

     Unfortunately, earnings reported in corporate financial 
statements are no longer the dominant variable that determines 
whether there are any real earnings for you, the owner.  For only 
gains in purchasing power represent real earnings on investment.  
If you (a) forego ten hamburgers to purchase an investment; (b) 
receive dividends which, after tax, buy two hamburgers; and (c) 
receive, upon sale of your holdings, after-tax proceeds that will 
buy eight hamburgers, then (d) you have had no real income from 
your investment, no matter how much it appreciated in dollars.  
You may feel richer, but you won’t eat richer.

     High rates of inflation create a tax on capital that makes 
much corporate investment unwise - at least if measured by the 
criterion of a positive real investment return to owners.  This 
“hurdle rate” the return on equity that must be achieved by a 
corporation in order to produce any real return for its 
individual owners - has increased dramatically in recent years.  
The average tax-paying investor is now running up a down 
escalator whose pace has accelerated to the point where his 
upward progress is nil.

     For example, in a world of 12% inflation a business earning 
20% on equity (which very few manage consistently to do) and 
distributing it all to individuals in the 50% bracket is chewing 
up their real capital, not enhancing it. (Half of the 20% will go 
for income tax; the remaining 10% leaves the owners of the 
business with only 98% of the purchasing power they possessed at 
the start of the year - even though they have not spent a penny 
of their “earnings”).  The investors in this bracket would 
actually be better off with a combination of stable prices and 
corporate earnings on equity capital of only a few per cent.

     Explicit income taxes alone, unaccompanied by any implicit 
inflation tax, never can turn a positive corporate return into a 
negative owner return. (Even if there were 90% personal income 
tax rates on both dividends and capital gains, some real income 
would be left for the owner at a zero inflation rate.) But the 
inflation tax is not limited by reported income.  Inflation rates 
not far from those recently experienced can turn the level of 
positive returns achieved by a majority of corporations into 
negative returns for all owners, including those not required to 
pay explicit taxes. (For example, if inflation reached 16%, 
owners of the 60% plus of corporate America earning less than 
this rate of return would be realizing a negative real return - 
even if income taxes on dividends and capital gains were 

     Of course, the two forms of taxation co-exist and interact 
since explicit taxes are levied on nominal, not real, income.  
Thus you pay income taxes on what would be deficits if returns to 
stockholders were measured in constant dollars.

     At present inflation rates, we believe individual owners in 
medium or high tax brackets (as distinguished from tax-free 
entities such as pension funds, eleemosynary institutions, etc.) 
should expect no real long-term return from the average American 
corporation, even though these individuals reinvest the entire 
after-tax proceeds from all dividends they receive.  The average 
return on equity of corporations is fully offset by the 
combination of the implicit tax on capital levied by inflation 
and the explicit taxes levied both on dividends and gains in 
value produced by retained earnings.

     As we said last year, Berkshire has no corporate solution to 
the problem. (We’ll say it again next year, too.) Inflation does 
not improve our return on equity.

     Indexing is the insulation that all seek against inflation.  
But the great bulk (although there are important exceptions) of 
corporate capital is not even partially indexed.  Of course, 
earnings and dividends per share usually will rise if significant 
earnings are “saved” by a corporation; i.e., reinvested instead 
of paid as dividends.  But that would be true without inflation.  
A thrifty wage earner, likewise, could achieve regular annual 
increases in his total income without ever getting a pay increase 
- if he were willing to take only half of his paycheck in cash 
(his wage “dividend”) and consistently add the other half (his 
“retained earnings”) to a savings account.  Neither this high-
saving wage earner nor the stockholder in a high-saving 
corporation whose annual dividend rate increases while its rate 
of return on equity remains flat is truly indexed.

     For capital to be truly indexed, return on equity must rise, 
i.e., business earnings consistently must increase in proportion 
to the increase in the price level without any need for the 
business to add to capital - including working capital - 
employed.  (Increased earnings produced by increased investment 
don’t count.) Only a few businesses come close to exhibiting this 
ability.  And Berkshire Hathaway isn’t one of them.

     We, of course, have a corporate policy of reinvesting 
earnings for growth, diversity and strength, which has the 
incidental effect of minimizing the current imposition of 
explicit taxes on our owners.  However, on a day-by-day basis, 
you will be subjected to the implicit inflation tax, and when you 
wish to transfer your investment in Berkshire into another form 
of investment, or into consumption, you also will face explicit 

Sources of Earnings

     The table below shows the sources of Berkshire’s reported 
earnings.  Berkshire owns about 60% of Blue Chip Stamps, which in 
turn owns 80% of Wesco Financial Corporation.  The table shows 
aggregate earnings of the various business entities, as well as 
Berkshire’s share of those earnings.  All of the significant 
capital gains and losses attributable to any of the business 
entities are aggregated in the realized securities gains figure 
at the bottom of the table, and are not included in operating 
earnings.  Our calculation of operating earnings also excludes 
the gain from sale of Mutual’s branch offices.  In this respect 
it differs from the presentation in our audited financial 
statements that includes this item in the calculation of 
“Earnings Before Realized Investment Gain”.

                                                                         Net Earnings
                                   Earnings Before Income Taxes            After Tax
                              --------------------------------------  ------------------
                                    Total          Berkshire Share     Berkshire Share
                              ------------------  ------------------  ------------------
(in thousands of dollars)       1980      1979      1980      1979      1980      1979
                              --------  --------  --------  --------  --------  --------
Total Earnings - all entities $ 85,945  $ 68,632  $ 70,146  $ 56,427  $ 53,122  $ 42,817
                              ========  ========  ========  ========  ========  ========
Earnings from Operations:
  Insurance Group:
    Underwriting ............ $  6,738  $  3,742  $  6,737  $  3,741  $  3,637  $  2,214
    Net Investment Income ...   30,939    24,224    30,927    24,216    25,607    20,106
  Berkshire-Waumbec Textiles      (508)    1,723      (508)    1,723       202       848
  Associated Retail Stores ..    2,440     2,775     2,440     2,775     1,169     1,280
  See’s Candies .............   15,031    12,785     8,958     7,598     4,212     3,448
  Buffalo Evening News ......   (2,805)   (4,617)   (1,672)   (2,744)     (816)   (1,333)
  Blue Chip Stamps - Parent      7,699     2,397     4,588     1,425     3,060     1,624
  Illinois National Bank ....    5,324     5,747     5,200     5,614     4,731     5,027
  Wesco Financial - Parent ..    2,916     2,413     1,392     1,098     1,044       937
  Mutual Savings and Loan ...    5,814    10,447     2,775     4,751     1,974     3,261
  Precision Steel ...........    2,833     3,254     1,352     1,480       656       723
  Interest on Debt ..........  (12,230)   (8,248)   (9,390)   (5,860)   (4,809)   (2,900)
  Other .....................    2,170     1,342     1,590       996     1,255       753
                              --------  --------  --------  --------  --------  --------
    Total Earnings from
       Operations ........... $ 66,361  $ 57,984  $ 54,389  $ 46,813  $ 41,922  $ 35,988
  Mutual Savings and Loan -
     sale of branches .......    5,873      --       2,803      --       1,293      --
Realized Securities Gain ....   13,711    10,648    12,954     9,614     9,907     6,829
                              --------  --------  --------  --------  --------  --------
Total Earnings - all entities $ 85,945  $ 68,632  $ 70,146  $ 56,427  $ 53,122  $ 42,817
                              ========  ========  ========  ========  ========  ========

     Blue Chip Stamps and Wesco are public companies with 
reporting requirements of their own.  On pages 40 to 53 of this 
report we have reproduced the narrative reports of the principal 
executives of both companies, in which they describe 1980 
operations.  We recommend a careful reading, and suggest that you 
particularly note the superb job done by Louie Vincenti and 
Charlie Munger in repositioning Mutual Savings and Loan.  A copy 
of the full annual report of either company will be mailed to any 
Berkshire shareholder upon request to Mr. Robert H. Bird for Blue 
Chip Stamps, 5801 South Eastern Avenue, Los Angeles, California 
90040, or to Mrs. Bette Deckard for Wesco Financial Corporation, 
315 East Colorado Boulevard, Pasadena, California 91109.

     As indicated earlier, undistributed earnings in companies we 
do not control are now fully as important as the reported 
operating earnings detailed in the preceding table.  The 
distributed portion, of course, finds its way into the table 
primarily through the net investment income section of Insurance 
Group earnings.

     We show below Berkshire’s proportional holdings in those 
non-controlled businesses for which only distributed earnings 
(dividends) are included in our own earnings.

No. of Shares                                            Cost       Market
-------------                                         ----------  ----------
                                                          (000s omitted)
  434,550 (a)  Affiliated Publications, Inc. ......... $  2,821    $ 12,222
  464,317 (a)  Aluminum Company of America ...........   25,577      27,685
  475,217 (b)  Cleveland-Cliffs Iron Company .........   12,942      15,894
1,983,812 (b)  General Foods, Inc. ...................   62,507      59,889
7,200,000 (a)  GEICO Corporation .....................   47,138     105,300
2,015,000 (a)  Handy & Harman ........................   21,825      58,435
  711,180 (a)  Interpublic Group of Companies, Inc. ..    4,531      22,135
1,211,834 (a)  Kaiser Aluminum & Chemical Corp. ......   20,629      27,569
  282,500 (a)  Media General .........................    4,545       8,334
  247,039 (b)  National Detroit Corporation ..........    5,930       6,299
  881,500 (a)  National Student Marketing ............    5,128       5,895
  391,400 (a)  Ogilvy & Mather Int’l. Inc. ...........    3,709       9,981
  370,088 (b)  Pinkerton’s, Inc. .....................   12,144      16,489
  245,700 (b)  R. J. Reynolds Industries .............    8,702      11,228
1,250,525 (b)  SAFECO Corporation ....................   32,062      45,177
  151,104 (b)  The Times Mirror Company ..............    4,447       6,271
1,868,600 (a)  The Washington Post Company ...........   10,628      42,277
  667,124 (b)  E W Woolworth Company .................   13,583      16,511
                                                      ----------  ----------
                                                       $298,848    $497,591
               All Other Common Stockholdings ........   26,313      32,096
                                                      ----------  ----------
               Total Common Stocks ................... $325,161    $529,687
                                                      ==========  ==========

(a) All owned by Berkshire or its insurance subsidiaries.
(b) Blue Chip and/or Wesco own shares of these companies.  All 
    numbers represent Berkshire’s net interest in the larger 
    gross holdings of the group.

     From this table, you can see that our sources of underlying 
earning power are distributed far differently among industries 
than would superficially seem the case.  For example, our 
insurance subsidiaries own approximately 3% of Kaiser Aluminum, 
and 1 1/4% of Alcoa.  Our share of the 1980 earnings of those 
companies amounts to about $13 million. (If translated dollar for 
dollar into a combination of eventual market value gain and 
dividends, this figure would have to be reduced by a significant, 
but not precisely determinable, amount of tax; perhaps 25% would 
be a fair assumption.) Thus, we have a much larger economic 
interest in the aluminum business than in practically any of the 
operating businesses we control and on which we report in more 
detail.  If we maintain our holdings, our long-term performance 
will be more affected by the future economics of the aluminum 
industry than it will by direct operating decisions we make 
concerning most companies over which we exercise managerial 


     Our largest non-controlled holding is 7.2 million shares of 
GEICO Corp., equal to about a 33% equity interest.  Normally, an 
interest of this magnitude (over 20%) would qualify as an 
“investee” holding and would require us to reflect a 
proportionate share of GEICO’s earnings in our own.  However, we 
purchased our GEICO stock pursuant to special orders of the 
District of Columbia and New York Insurance Departments, which 
required that the right to vote the stock be placed with an 
independent party.  Absent the vote, our 33% interest does not 
qualify for investee treatment. (Pinkerton’s is a similar 

     Of course, whether or not the undistributed earnings of 
GEICO are picked up annually in our operating earnings figure has 
nothing to do with their economic value to us, or to you as 
owners of Berkshire.  The value of these retained earnings will 
be determined by the skill with which they are put to use by 
GEICO management.

     On this score, we simply couldn’t feel better.  GEICO 
represents the best of all investment worlds - the coupling of a 
very important and very hard to duplicate business advantage with 
an extraordinary management whose skills in operations are 
matched by skills in capital allocation.

     As you can see, our holdings cost us $47 million, with about 
half of this amount invested in 1976 and most of the remainder 
invested in 1980.  At the present dividend rate, our reported 
earnings from GEICO amount to a little over $3 million annually.  
But we estimate our share of its earning power is on the order of 
$20 million annually.  Thus, undistributed earnings applicable to 
this holding alone may amount to 40% of total reported operating 
earnings of Berkshire.

     We should emphasize that we feel as comfortable with GEICO 
management retaining an estimated $17 million of earnings 
applicable to our ownership as we would if that sum were in our 
own hands.  In just the last two years GEICO, through repurchases 
of its own stock, has reduced the share equivalents it has 
outstanding from 34.2 million to 21.6 million, dramatically 
enhancing the interests of shareholders in a business that simply 
can’t be replicated.  The owners could not have been better 

     We have written in past reports about the disappointments 
that usually result from purchase and operation of “turnaround” 
businesses.  Literally hundreds of turnaround possibilities in 
dozens of industries have been described to us over the years 
and, either as participants or as observers, we have tracked 
performance against expectations.  Our conclusion is that, with 
few exceptions, when a management with a reputation for 
brilliance tackles a business with a reputation for poor 
fundamental economics, it is the reputation of the business that 
remains intact.

     GEICO may appear to be an exception, having been turned 
around from the very edge of bankruptcy in 1976.  It certainly is 
true that managerial brilliance was needed for its resuscitation, 
and that Jack Byrne, upon arrival in that year, supplied that 
ingredient in abundance.

     But it also is true that the fundamental business advantage 
that GEICO had enjoyed - an advantage that previously had 
produced staggering success - was still intact within the 
company, although submerged in a sea of financial and operating 

     GEICO was designed to be the low-cost operation in an 
enormous marketplace (auto insurance) populated largely by 
companies whose marketing structures restricted adaptation.  Run 
as designed, it could offer unusual value to its customers while 
earning unusual returns for itself.  For decades it had been run 
in just this manner.  Its troubles in the mid-70s were not 
produced by any diminution or disappearance of this essential 
economic advantage.

     GEICO’s problems at that time put it in a position analogous 
to that of American Express in 1964 following the salad oil 
scandal.  Both were one-of-a-kind companies, temporarily reeling 
from the effects of a fiscal blow that did not destroy their 
exceptional underlying economics.  The GEICO and American Express 
situations, extraordinary business franchises with a localized 
excisable cancer (needing, to be sure, a skilled surgeon), should 
be distinguished from the true “turnaround” situation in which 
the managers expect - and need - to pull off a corporate 

     Whatever the appellation, we are delighted with our GEICO 
holding which, as noted, cost us $47 million.  To buy a similar 
$20 million of earning power in a business with first-class 
economic characteristics and bright prospects would cost a 
minimum of $200 million (much more in some industries) if it had 
to be accomplished through negotiated purchase of an entire 
company.  A 100% interest of that kind gives the owner the 
options of leveraging the purchase, changing managements, 
directing cash flow, and selling the business.  It may also 
provide some excitement around corporate headquarters (less 
frequently mentioned).

     We find it perfectly satisfying that the nature of our 
insurance business dictates we buy many minority portions of 
already well-run businesses (at prices far below our share of the 
total value of the entire business) that do not need management 
change, re-direction of cash flow, or sale.  There aren’t many 
Jack Byrnes in the managerial world, or GEICOs in the business 
world.  What could be better than buying into a partnership with 
both of them?

Insurance Industry Conditions

     The insurance industry’s underwriting picture continues to 
unfold about as we anticipated, with the combined ratio (see 
definition on page 37) rising from 100.6 in 1979 to an estimated 
103.5 in 1980.  It is virtually certain that this trend will 
continue and that industry underwriting losses will mount, 
significantly and progressively, in 1981 and 1982.  To understand 
why, we recommend that you read the excellent analysis of 
property-casualty competitive dynamics done by Barbara Stewart of 
Chubb Corp. in an October 1980 paper. (Chubb’s annual report 
consistently presents the most insightful, candid and well-
written discussion of industry conditions; you should get on the 
company’s mailing list.) Mrs. Stewart’s analysis may not be 
cheerful, but we think it is very likely to be accurate.

     And, unfortunately, a largely unreported but particularly 
pernicious problem may well prolong and intensify the coming 
industry agony.  It is not only likely to keep many insurers 
scrambling for business when underwriting losses hit record 
levels - it is likely to cause them at such a time to redouble 
their efforts.

     This problem arises from the decline in bond prices and the 
insurance accounting convention that allows companies to carry 
bonds at amortized cost, regardless of market value.  Many 
insurers own long-term bonds that, at amortized cost, amount to 
two to three times net worth.  If the level is three times, of 
course, a one-third shrink from cost in bond prices - if it were 
to be recognized on the books - would wipe out net worth.  And 
shrink they have.  Some of the largest and best known property-
casualty companies currently find themselves with nominal, or 
even negative, net worth when bond holdings are valued at market.  
Of course their bonds could rise in price, thereby partially, or 
conceivably even fully, restoring the integrity of stated net 
worth.  Or they could fall further. (We believe that short-term 
forecasts of stock or bond prices are useless.  The forecasts may 
tell you a great deal about the forecaster; they tell you nothing 
about the future.)

     It might strike some as strange that an insurance company’s 
survival is threatened when its stock portfolio falls 
sufficiently in price to reduce net worth significantly, but that 
an even greater decline in bond prices produces no reaction at 
all.  The industry would respond by pointing out that, no matter 
what the current price, the bonds will be paid in full at 
maturity, thereby eventually eliminating any interim price 
decline.  It may take twenty, thirty, or even forty years, this 
argument says, but, as long as the bonds don’t have to be sold, 
in the end they’ll all be worth face value.  Of course, if they 
are sold even if they are replaced with similar bonds offering 
better relative value - the loss must be booked immediately.  
And, just as promptly, published net worth must be adjusted 
downward by the amount of the loss.

     Under such circumstances, a great many investment options 
disappear, perhaps for decades.  For example, when large 
underwriting losses are in prospect, it may make excellent 
business logic for some insurers to shift from tax-exempt bonds 
into taxable bonds.  Unwillingness to recognize major bond losses 
may be the sole factor that prevents such a sensible move.

     But the full implications flowing from massive unrealized 
bond losses are far more serious than just the immobilization of 
investment intellect.  For the source of funds to purchase and 
hold those bonds is a pool of money derived from policyholders 
and claimants (with changing faces) - money which, in effect, is 
temporarily on deposit with the insurer.  As long as this pool 
retains its size, no bonds must be sold.  If the pool of funds 
shrinks - which it will if the volume of business declines 
significantly - assets must be sold to pay off the liabilities.  
And if those assets consist of bonds with big unrealized losses, 
such losses will rapidly become realized, decimating net worth in 
the process.

     Thus, an insurance company with a bond market value 
shrinkage approaching stated net worth (of which there are now 
many) and also faced with inadequate rate levels that are sure to 
deteriorate further has two options.  One option for management 
is to tell the underwriters to keep pricing according to the 
exposure involved - “be sure to get a dollar of premium for every 
dollar of expense cost plus expectable loss cost”.

     The consequences of this directive are predictable: (a) with 
most business both price sensitive and renewable annually, many 
policies presently on the books will be lost to competitors in 
rather short order; (b) as premium volume shrinks significantly, 
there will be a lagged but corresponding decrease in liabilities 
(unearned premiums and claims payable); (c) assets (bonds) must 
be sold to match the decrease in liabilities; and (d) the 
formerly unrecognized disappearance of net worth will become 
partially recognized (depending upon the extent of such sales) in 
the insurer’s published financial statements.

     Variations of this depressing sequence involve a smaller 
penalty to stated net worth.  The reaction of some companies at 
(c) would be to sell either stocks that are already carried at 
market values or recently purchased bonds involving less severe 
losses.  This ostrich-like behavior - selling the better assets 
and keeping the biggest losers - while less painful in the short 
term, is unlikely to be a winner in the long term.

     The second option is much simpler: just keep writing 
business regardless of rate levels and whopping prospective 
underwriting losses, thereby maintaining the present levels of 
premiums, assets and liabilities - and then pray for a better 
day, either for underwriting or for bond prices.  There is much 
criticism in the trade press of “cash flow” underwriting; i.e., 
writing business regardless of prospective underwriting losses in 
order to obtain funds to invest at current high interest rates.  
This second option might properly be termed “asset maintenance” 
underwriting - the acceptance of terrible business just to keep 
the assets you now have.

     Of course you know which option will be selected.  And it 
also is clear that as long as many large insurers feel compelled 
to choose that second option, there will be no better day for 
underwriting.  For if much of the industry feels it must maintain 
premium volume levels regardless of price adequacy, all insurers 
will have to come close to meeting those prices.  Right behind 
having financial problems yourself, the next worst plight is to 
have a large group of competitors with financial problems that 
they can defer by a “sell-at-any-price” policy.

     We mentioned earlier that companies that were unwilling - 
for any of a number of reasons, including public reaction, 
institutional pride, or protection of stated net worth - to sell 
bonds at price levels forcing recognition of major losses might 
find themselves frozen in investment posture for a decade or 
longer.  But, as noted, that’s only half of the problem.  
Companies that have made extensive commitments to long-term bonds 
may have lost, for a considerable period of time, not only many 
of their investment options, but many of their underwriting 
options as well.

     Our own position in this respect is satisfactory.  We 
believe our net worth, valuing bonds of all insurers at amortized 
cost, is the strongest relative to premium volume among all large 
property-casualty stockholder-owned groups.  When bonds are 
valued at market, our relative strength becomes far more 
dramatic. (But lest we get too puffed up, we remind ourselves 
that our asset and liability maturities still are far more 
mismatched than we would wish and that we, too, lost important 
sums in bonds because your Chairman was talking when he should 
have been acting.)

     Our abundant capital and investment flexibility will enable 
us to do whatever we think makes the most sense during the 
prospective extended period of inadequate pricing.  But troubles 
for the industry mean troubles for us.  Our financial strength 
doesn’t remove us from the hostile pricing environment now 
enveloping the entire property-casualty insurance industry.  It 
just gives us more staying power and more options.

Insurance Operations

     The National Indemnity managers, led by Phil Liesche with 
the usual able assistance of Roland Miller and Bill Lyons, outdid 
themselves in 1980.  While volume was flat, underwriting margins 
relative to the industry were at an all-time high.  We expect 
decreased volume from this operation in 1981.  But its managers 
will hear no complaints from corporate headquarters, nor will 
employment or salaries suffer.  We enormously admire the National 
Indemnity underwriting discipline - embedded from origin by the 
founder, Jack Ringwalt - and know that this discipline, if 
suspended, probably could not be fully regained.

     John Seward at Home and Auto continues to make good progress 
in replacing a diminishing number of auto policies with volume 
from less competitive lines, primarily small-premium general 
liability.  Operations are being slowly expanded, both 
geographically and by product line, as warranted by underwriting 

     The reinsurance business continues to reflect the excesses 
and problems of the primary writers.  Worse yet, it has the 
potential for magnifying such excesses.  Reinsurance is 
characterized by extreme ease of entry, large premium payments in 
advance, and much-delayed loss reports and loss payments.  
Initially, the morning mail brings lots of cash and few claims.  
This state of affairs can produce a blissful, almost euphoric, 
feeling akin to that experienced by an innocent upon receipt of 
his first credit card.

     The magnetic lure of such cash-generating characteristics, 
currently enhanced by the presence of high interest rates, is 
transforming the reinsurance market into “amateur night”.  
Without a super catastrophe, industry underwriting will be poor 
in the next few years.  If we experience such a catastrophe, 
there could be a bloodbath with some companies not able to live 
up to contractual commitments.  George Young continues to do a 
first-class job for us in this business.  Results, with 
investment income included, have been reasonably profitable.  We 
will retain an active reinsurance presence but, for the 
foreseeable future, we expect no premium growth from this 

     We continue to have serious problems in the Homestate 
operation.  Floyd Taylor in Kansas has done an outstanding job 
but our underwriting record elsewhere is considerably below 
average.  Our poorest performer has been Insurance Company of 
Iowa, at which large losses have been sustained annually since 
its founding in 1973.  Late in the fall we abandoned underwriting 
in that state, and have merged the company into Cornhusker 
Casualty.  There is potential in the homestate concept, but much 
work needs to be done in order to realize it.

     Our Workers Compensation operation suffered a severe loss 
when Frank DeNardo died last year at 37. Frank instinctively 
thought like an underwriter.  He was a superb technician and a 
fierce competitor; in short order he had straightened out major 
problems at the California Workers Compensation Division of 
National Indemnity.  Dan Grossman, who originally brought Frank 
to us, stepped in immediately after Frank’s death to continue 
that operation, which now utilizes Redwood Fire and Casualty, 
another Berkshire subsidiary, as the insuring vehicle.

     Our major Workers Compensation operation, Cypress Insurance 
Company, run by Milt Thornton, continues its outstanding record.  
Year after year Milt, like Phil Liesche, runs an underwriting 
operation that far outpaces his competition.  In the industry he 
is admired and copied, but not matched.

     Overall, we look for a significant decline in insurance 
volume in 1981 along with a poorer underwriting result.  We 
expect underwriting experience somewhat superior to that of the 
industry but, of course, so does most of the industry.  There 
will be some disappointments.

Textile and Retail Operations

     During the past year we have cut back the scope of our 
textile business.  Operations at Waumbec Mills have been 
terminated, reluctantly but necessarily.  Some equipment was 
transferred to New Bedford but most has been sold, or will be, 
along with real estate.  Your Chairman made a costly mistake in 
not facing the realities of this situation sooner.

     At New Bedford we have reduced the number of looms operated 
by about one-third, abandoning some high-volume lines in which 
product differentiation was insignificant.  Even assuming 
everything went right - which it seldom did - these lines could 
not generate adequate returns related to investment.  And, over a 
full industry cycle, losses were the most likely result.

     Our remaining textile operation, still sizable, has been 
divided into a manufacturing and a sales division, each free to 
do business independent of the other.  Thus, distribution 
strengths and mill capabilities will not be wedded to each other.  
We have more than doubled capacity in our most profitable textile 
segment through a recent purchase of used 130-inch Saurer looms.  
Current conditions indicate another tough year in textiles, but 
with substantially less capital employed in the operation.

     Ben Rosner’s record at Associated Retail Stores continues to 
amaze us.  In a poor retailing year, Associated’s earnings 
continued excellent - and those earnings all were translated into 
cash.  On March 7, 1981 Associated will celebrate its 50th 
birthday.  Ben has run the business (along with Leo Simon, his 
partner from 1931 to 1966) in each of those fifty years.

Disposition of Illinois National Bank and Trust of Rockford

     On December 31, 1980 we completed the exchange of 41,086 
shares of Rockford Bancorp Inc. (which owns 97.7% of Illinois 
National Bank) for a like number of shares of Berkshire Hathaway 

     Our method of exchange allowed all Berkshire shareholders to 
maintain their proportional interest in the Bank (except for me; 
I was permitted 80% of my proportional share).  They were thus 
guaranteed an ownership position identical to that they would 
have attained had we followed a more conventional spinoff 
approach.  Twenty-four shareholders (of our approximate 1300) 
chose this proportional exchange option.

     We also allowed overexchanges, and thirty-nine additional 
shareholders accepted this option, thereby increasing their 
ownership in the Bank and decreasing their proportional ownership 
in Berkshire.  All got the full amount of Bancorp stock they 
requested, since the total shares desired by these thirty-nine 
holders was just slightly less than the number left available by 
the remaining 1200-plus holders of Berkshire who elected not to 
part with any Berkshire shares at all.  As the exchanger of last 
resort, I took the small balance (3% of Bancorp’s stock).  These 
shares, added to shares I received from my basic exchange 
allotment (80% of normal), gave me a slightly reduced 
proportional interest in the Bank and a slightly enlarged 
proportional interest in Berkshire.

     Management of the Bank is pleased with the outcome.  Bancorp 
will operate as an inexpensive and uncomplicated holding company 
owned by 65 shareholders.  And all of those shareholders will 
have become Bancorp owners through a conscious affirmative 


     In August we sold $60 million of 12 3/4% notes due August 1, 
2005, with a sinking fund to begin in 1991.

     The managing underwriters, Donaldson, Lufkin & Jenrette 
Securities Corporation, represented by Bill Fisher, and Chiles, 
Heider & Company, Inc., represented by Charlie Heider, did an 
absolutely first-class job from start to finish of the financing.

     Unlike most businesses, Berkshire did not finance because of 
any specific immediate needs.  Rather, we borrowed because we 
think that, over a period far shorter than the life of the loan, 
we will have many opportunities to put the money to good use.  
The most attractive opportunities may present themselves at a 
time when credit is extremely expensive - or even unavailable.  
At such a time we want to have plenty of financial firepower.

     Our acquisition preferences run toward businesses that 
generate cash, not those that consume it.  As inflation 
intensifies, more and more companies find that they must spend 
all funds they generate internally just to maintain their 
existing physical volume of business.  There is a certain mirage-
like quality to such operations.  However attractive the earnings 
numbers, we remain leery of businesses that never seem able to 
convert such pretty numbers into no-strings-attached cash.

     Businesses meeting our standards are not easy to find. (Each 
year we read of hundreds of corporate acquisitions; only a 
handful would have been of interest to us.) And logical expansion 
of our present operations is not easy to implement.  But we’ll 
continue to utilize both avenues in our attempts to further 
Berkshire’s growth.

     Under all circumstances we plan to operate with plenty of 
liquidity, with debt that is moderate in size and properly 
structured, and with an abundance of capital strength.  Our 
return on equity is penalized somewhat by this conservative 
approach, but it is the only one with which we feel comfortable.

               *  *  *  *  *  *  *  *  *  *  *  *                

     Gene Abegg, founder of our long-owned bank in Rockford, died 
on July 2, 1980 at the age of 82.  As a friend, banker and 
citizen, he was unsurpassed.

     You learn a great deal about a person when you purchase a 
business from him and he then stays on to run it as an employee 
rather than as an owner.  Before the purchase the seller knows 
the business intimately, whereas you start from scratch.  The 
seller has dozens of opportunities to mislead the buyer - through 
omissions, ambiguities, and misdirection.  After the check has 
changed hands, subtle (and not so subtle) changes of attitude can 
occur and implicit understandings can evaporate.  As in the 
courtship-marriage sequence, disappointments are not infrequent.

     From the time we first met, Gene shot straight 100% of the 
time - the only behavior pattern he had within him.  At the 
outset of negotiations, he laid all negative factors face up on 
the table; on the other hand, for years after the transaction was 
completed he would tell me periodically of some previously 
undiscussed items of value that had come with our purchase.

     Though he was already 71 years of age when he sold us the 
Bank, Gene subsequently worked harder for us than he had for 
himself.  He never delayed reporting a problem for a minute, but 
problems were few with Gene.  What else would you expect from a 
man who, at the time of the bank holiday in 1933, had enough cash 
on the premises to pay all depositors in full?  Gene never forgot 
he was handling other people’s money.  Though this fiduciary 
attitude was always dominant, his superb managerial skills 
enabled the Bank to regularly achieve the top position nationally 
in profitability.

     Gene was in charge of the Illinois National for close to 
fifty years - almost one-quarter of the lifetime of our country.  
George Mead, a wealthy industrialist, brought him in from Chicago 
to open a new bank after a number of other banks in Rockford had 
failed.  Mr. Mead put up the money and Gene ran the show.  His 
talent for leadership soon put its stamp on virtually every major 
civic activity in Rockford.

     Dozens of Rockford citizens have told me over the years of 
help Gene extended to them.  In some cases this help was 
financial; in all cases it involved much wisdom, empathy and 
friendship.  He always offered the same to me.  Because of our 
respective ages and positions I was sometimes the junior partner, 
sometimes the senior.  Whichever the relationship, it always was 
a special one, and I miss it.

                                          Warren E. Buffett
February 27, 1981                         Chairman of the Board