To the Shareholders of Berkshire Hathaway Inc.:

     Our gain in net worth during 1988 was $569 million, or 
20.0%.  Over the last 24 years (that is, since present management 
took over), our per-share book value has grown from $19.46 to 
$2,974.52, or at a rate of 23.0% compounded annually.

     We’ve emphasized in past reports that what counts, however, 
is intrinsic business value - the figure, necessarily an 
estimate, indicating what all of our constituent businesses are 
worth.  By our calculations, Berkshire’s intrinsic business value 
significantly exceeds its book value.  Over the 24 years, 
business value has grown somewhat faster than book value; in 
1988, however, book value grew the faster, by a bit.

     Berkshire’s past rates of gain in both book value and 
business value were achieved under circumstances far different 
from those that now exist.  Anyone ignoring these differences 
makes the same mistake that a baseball manager would were he to 
judge the future prospects of a 42-year-old center fielder on the 
basis of his lifetime batting average.

     Important negatives affecting our prospects today are: (1) a 
less attractive stock market than generally existed over the past 
24 years; (2) higher corporate tax rates on most forms of 
investment income; (3) a far more richly-priced market for the 
acquisition of businesses; and (4) industry conditions for 
Capital Cities/ABC, Inc., GEICO Corporation, and The Washington 
Post Company - Berkshire’s three permanent investments, 
constituting about one-half of our net worth - that range from 
slightly to materially less favorable than those existing five to 
ten years ago.  All of these companies have superb management and 
strong properties.  But, at current prices, their upside 
potential looks considerably less exciting to us today than it 
did some years ago.

     The major problem we face, however, is a growing capital 
base.  You’ve heard that from us before, but this problem, like 
age, grows in significance each year. (And also, just as with 
age, it’s better to have this problem continue to grow rather 
than to have it “solved.”)

     Four years ago I told you that we needed profits of $3.9 
billion to achieve a 15% annual return over the decade then 
ahead.  Today, for the next decade, a 15% return demands profits 
of $10.3 billion.  That seems like a very big number to me and to 
Charlie Munger, Berkshire’s Vice Chairman and my partner. (Should 
that number indeed prove too big, Charlie will find himself, in 
future reports, retrospectively identified as the senior 

     As a partial offset to the drag that our growing capital 
base exerts upon returns, we have a very important advantage now 
that we lacked 24 years ago.  Then, all our capital was tied up 
in a textile business with inescapably poor economic 
characteristics.  Today part of our capital is invested in some 
really exceptional businesses.

     Last year we dubbed these operations the Sainted Seven: 
Buffalo News, Fechheimer, Kirby, Nebraska Furniture Mart, Scott 
Fetzer Manufacturing Group, See’s, and World Book.  In 1988 the 
Saints came marching in.  You can see just how extraordinary 
their returns on capital were by examining the historical-cost 
financial statements on page 45, which combine the figures of the 
Sainted Seven with those of several smaller units.  With no 
benefit from financial leverage, this group earned about 67% on 
average equity capital.

     In most cases the remarkable performance of these units 
arises partially from an exceptional business franchise; in all 
cases an exceptional management is a vital factor.  The 
contribution Charlie and I make is to leave these managers alone.

     In my judgment, these businesses, in aggregate, will 
continue to produce superb returns.  We’ll need these: Without 
this help Berkshire would not have a chance of achieving our 15% 
goal.  You can be sure that our operating managers will deliver; 
the question mark in our future is whether Charlie and I can 
effectively employ the funds that they generate.

     In that respect, we took a step in the right direction early 
in 1989 when we purchased an 80% interest in Borsheim’s, a 
jewelry business in Omaha.  This purchase, described later in 
this letter, delivers exactly what we look for: an outstanding 
business run by people we like, admire, and trust.  It’s a great 
way to start the year.

Accounting Changes

     We have made a significant accounting change that was 
mandated for 1988, and likely will have another to make in 1990.  
When we move figures around from year to year, without any change 
in economic reality, one of our always-thrilling discussions of 
accounting is necessary.

     First, I’ll offer my customary disclaimer: Despite the 
shortcomings of generally accepted accounting principles (GAAP), 
I would hate to have the job of devising a better set of rules.  
The limitations of the existing set, however, need not be 
inhibiting: CEOs are free to treat GAAP statements as a beginning 
rather than an end to their obligation to inform owners and 
creditors - and indeed they should.  After all, any manager of a 
subsidiary company would find himself in hot water if he reported 
barebones GAAP numbers that omitted key information needed by his 
boss, the parent corporation’s CEO.  Why, then, should the CEO 
himself withhold information vitally useful to his bosses - the 
shareholder-owners of the corporation?

     What needs to be reported is data - whether GAAP, non-GAAP, 
or extra-GAAP - that helps financially-literate readers answer 
three key questions: (1) Approximately how much is this company 
worth?  (2) What is the likelihood that it can meet its future 
obligations? and (3) How good a job are its managers doing, given 
the hand they have been dealt?

     In most cases, answers to one or more of these questions are 
somewhere between difficult and impossible to glean from the 
minimum GAAP presentation.  The business world is simply too 
complex for a single set of rules to effectively describe 
economic reality for all enterprises, particularly those 
operating in a wide variety of businesses, such as Berkshire.

     Further complicating the problem is the fact that many 
managements view GAAP not as a standard to be met, but as an 
obstacle to overcome.  Too often their accountants willingly 
assist them. (“How much,” says the client, “is two plus two?” 
Replies the cooperative accountant, “What number did you have in 
mind?”) Even honest and well-intentioned managements sometimes 
stretch GAAP a bit in order to present figures they think will 
more appropriately describe their performance.  Both the 
smoothing of earnings and the “big bath” quarter are “white lie” 
techniques employed by otherwise upright managements.

     Then there are managers who actively use GAAP to deceive and 
defraud.  They know that many investors and creditors accept GAAP 
results as gospel.  So these charlatans interpret the rules 
“imaginatively” and record business transactions in ways that 
technically comply with GAAP but actually display an economic 
illusion to the world.

     As long as investors - including supposedly sophisticated 
institutions - place fancy valuations on reported “earnings” that 
march steadily upward, you can be sure that some managers and 
promoters will exploit GAAP to produce such numbers, no matter 
what the truth may be.  Over the years, Charlie and I have 
observed many accounting-based frauds of staggering size.  Few of 
the perpetrators have been punished; many have not even been 
censured.  It has been far safer to steal large sums with a pen 
than small sums with a gun.

     Under one major change mandated by GAAP for 1988, we have 
been required to fully consolidate all our subsidiaries in our 
balance sheet and earnings statement.  In the past, Mutual 
Savings and Loan, and Scott Fetzer Financial (a credit company 
that primarily finances installment sales of World Book and Kirby 
products) were consolidated on a “one-line” basis.  That meant we 
(1) showed our equity in their combined net worths as a single-
entry asset on Berkshire’s consolidated balance sheet and (2) 
included our equity in their combined annual earnings as a 
single-line income entry in our consolidated statement of 
earnings.  Now the rules require that we consolidate each asset 
and liability of these companies in our balance sheet and each 
item of their income and expense in our earnings statement.

     This change underscores the need for companies also to 
report segmented data: The greater the number of economically 
diverse business operations lumped together in conventional 
financial statements, the less useful those presentations are and 
the less able investors are to answer the three questions posed 
earlier.  Indeed, the only reason we ever prepare consolidated 
figures at Berkshire is to meet outside requirements.  On the 
other hand, Charlie and I constantly study our segment data.

     Now that we are required to bundle more numbers in our GAAP 
statements, we have decided to publish additional supplementary 
information that we think will help you measure both business 
value and managerial performance. (Berkshire’s ability to 
discharge its obligations to creditors - the third question we 
listed - should be obvious, whatever statements you examine.) In 
these supplementary presentations, we will not necessarily follow 
GAAP procedures, or even corporate structure.  Rather, we will 
attempt to lump major business activities in ways that aid 
analysis but do not swamp you with detail.  Our goal is to give 
you important information in a form that we would wish to get it 
if our roles were reversed.

     On pages 41-47 we show separate combined balance sheets and 
earnings statements for: (1) our subsidiaries engaged in finance-
type operations, which are Mutual Savings and Scott Fetzer 
Financial; (2) our insurance operations, with their major 
investment positions itemized; (3) our manufacturing, publishing 
and retailing businesses, leaving aside certain non-operating 
assets and purchase-price accounting adjustments; and (4) an all-
other category that includes the non-operating assets (primarily 
marketable securities) held by the companies in (3) as well as 
various assets and debts of the Wesco and Berkshire parent 

     If you combine the earnings and the net worths of these four 
segments, you will derive totals matching those shown on our GAAP 
statements.  However, we want to emphasize that our new 
presentation does not fall within the purview of our auditors, 
who in no way bless it. (In fact, they may be horrified; I don’t 
want to ask.)

     I referred earlier to a major change in GAAP that is 
expected in 1990.  This change relates to the calculation of 
deferred taxes, and is both complicated and controversial - so 
much so that its imposition, originally scheduled for 1989, was 
postponed for a year.

     When implemented, the new rule will affect us in various 
ways.  Most important, we will be required to change the way we 
calculate our liability for deferred taxes on the unrealized 
appreciation of stocks held by our insurance companies.

     Right now, our liability is layered.  For the unrealized 
appreciation that dates back to 1986 and earlier years, $1.2 
billion, we have booked a 28% tax liability.  For the unrealized 
appreciation built up since, $600 million, the tax liability has 
been booked at 34%.  The difference reflects the increase in tax 
rates that went into effect in 1987.

     It now appears, however, that the new accounting rule will 
require us to establish the entire liability at 34% in 1990, 
taking the charge against our earnings.  Assuming no change in 
tax rates by 1990, this step will reduce our earnings in that 
year (and thereby our reported net worth) by $71 million.  The 
proposed rule will also affect other items on our balance sheet, 
but these changes will have only a minor impact on earnings and 
net worth.

     We have no strong views about the desirability of this 
change in calculation of deferred taxes.  We should point out, 
however, that neither a 28% nor a 34% tax liability precisely 
depicts economic reality at Berkshire since we have no plans to 
sell the stocks in which we have the great bulk of our gains.

     To those of you who are uninterested in accounting, I 
apologize for this dissertation.  I realize that many of you do 
not pore over our figures, but instead hold Berkshire primarily 
because you know that: (1) Charlie and I have the bulk of our 
money in Berkshire; (2) we intend to run things so that your 
gains or losses are in direct proportion to ours; and (3) the 
record has so far been satisfactory.  There is nothing 
necessarily wrong with this kind of “faith” approach to 
investing.  Other shareholders, however, prefer an “analysis” 
approach and we want to supply the information they need.  In our 
own investing, we search for situations in which both approaches 
give us the same answer.

Sources of Reported Earnings

     In addition to supplying you with our new four-sector 
accounting material, we will continue to list the major sources 
of Berkshire’s reported earnings just as we have in the past.

     In the following table, amortization of Goodwill and other 
major purchase-price accounting adjustments are not charged 
against the specific businesses to which they apply but are 
instead aggregated and shown separately.  This procedure lets you 
view the earnings of our businesses as they would have been 
reported had we not purchased them.  I’ve explained in past 
reports why this form of presentation seems to us to be more 
useful to investors and managers than the standard GAAP 
presentation, which makes purchase-price adjustments on a 
business-by-business basis.  The total net earnings we show in 
the table are, of course, identical to the GAAP total in our 
audited financial statements.

     Further information about these businesses is given in the 
Business Segment section on pages 32-34, and in the Management’s 
Discussion section on pages 36-40.  In these sections you also 
will find our segment earnings reported on a GAAP basis.  For 
information on Wesco’s businesses, I urge you to read Charlie 
Munger’s letter, which starts on page 52.  It contains the best 
description I have seen of the events that produced the present 
savings-and-loan crisis.  Also, take special note of Dave 
Hillstrom’s performance at Precision Steel Warehouse, a Wesco 
subsidiary.  Precision operates in an extremely competitive 
industry, yet Dave consistently achieves good returns on invested 
capital.  Though data is lacking to prove the point, I think it 
is likely that his performance, both in 1988 and years past, 
would rank him number one among his peers.

                                               (000s omitted) 
                                                         Berkshire's Share 
                                                          of Net Earnings 
                                                         (after taxes and 
                                   Pre-Tax Earnings     minority interests)
                                 -------------------    -------------------
                                   1988       1987        1988       1987 
                                 --------   --------    --------   --------
Operating Earnings:
  Insurance Group:
    Underwriting ............... $(11,081)  $(55,429)   $ (1,045)  $(20,696)
    Net Investment Income ......  231,250    152,483     197,779    136,658
  Buffalo News .................   42,429     39,410      25,462     21,304
  Fechheimer ...................   14,152     13,332       7,720      6,580
  Kirby ........................   26,891     22,408      17,842     12,891
  Nebraska Furniture Mart ......   18,439     16,837       9,099      7,554
  Scott Fetzer 
     Manufacturing Group .......   28,542     30,591      17,640     17,555
  See’s Candies ................   32,473     31,693      19,671     17,363
  Wesco - other than Insurance     16,133      6,209      10,650      4,978
  World Book ...................   27,890     25,745      18,021     15,136
  Amortization of Goodwill .....   (2,806)    (2,862)     (2,806)    (2,862)
  Other Purchase-Price 
     Accounting Charges ........   (6,342)    (5,546)     (7,340)    (6,544)
  Interest on Debt* ............  (35,613)   (11,474)    (23,212)    (5,905)
     Contributions .............   (4,966)    (4,938)     (3,217)    (2,963)
  Other ........................   41,059     23,217      27,177     13,697
                                 --------   --------    --------   --------
Operating Earnings .............  418,450    281,676     313,441    214,746
Sales of Securities ............  131,671     28,838      85,829     19,806
                                 --------   --------    --------   --------
Total Earnings - All Entities .. $550,121   $310,514    $399,270   $234,552

*Excludes interest expense of Scott Fetzer Financial Group.

     The earnings achieved by our operating businesses are 
superb, whether measured on an absolute basis or against those of 
their competitors.  For that we thank our operating managers: You 
and I are fortunate to be associated with them.

     At Berkshire, associations like these last a long time.  We 
do not remove superstars from our lineup merely because they have 
attained a specified age - whether the traditional 65, or the 95 
reached by Mrs. B on the eve of Hanukkah in 1988.  Superb 
managers are too scarce a resource to be discarded simply because 
a cake gets crowded with candles.  Moreover, our experience with 
newly-minted MBAs has not been that great.  Their academic 
records always look terrific and the candidates always know just 
what to say; but too often they are short on personal commitment 
to the company and general business savvy.  It’s difficult to 
teach a new dog old tricks.

     Here’s an update on our major non-insurance operations:

   o At Nebraska Furniture Mart, Mrs. B (Rose Blumkin) and her 
cart roll on and on.  She’s been the boss for 51 years, having 
started the business at 44 with $500. (Think what she would have 
done with $1,000!) With Mrs. B, old age will always be ten years 

     The Mart, long the largest home furnishings store in the 
country, continues to grow.  In the fall, the store opened a 
detached 20,000 square foot Clearance Center, which expands our 
ability to offer bargains in all price ranges.

     Recently Dillard’s, one of the most successful department 
store operations in the country, entered the Omaha market.  In 
many of its stores, Dillard’s runs a full furniture department, 
undoubtedly doing well in this line.  Shortly before opening in 
Omaha, however, William Dillard, chairman of the company, 
announced that his new store would not sell furniture.  Said he, 
referring to NFM: “We don’t want to compete with them.  We think 
they are about the best there is.”

     At the Buffalo News we extol the value of advertising, and 
our policies at NFM prove that we practice what we preach.  Over 
the past three years NFM has been the largest ROP advertiser in 
the Omaha World-Herald. (ROP advertising is the kind printed in 
the paper, as contrasted to the preprinted-insert kind.) In no 
other major market, to my knowledge, is a home furnishings 
operation the leading customer of the newspaper.  At times, we 
also run large ads in papers as far away as Des Moines, Sioux 
City and Kansas City - always with good results.  It truly does 
pay to advertise, as long as you have something worthwhile to 

     Mrs. B’s son, Louie, and his boys, Ron and Irv, complete the 
winning Blumkin team.  It’s a joy to work with this family.  All 
its members have character that matches their extraordinary 

   o Last year I stated unequivocally that pre-tax margins at 
The Buffalo News would fall in 1988.  That forecast would have 
proved correct at almost any other newspaper our size or larger.  
But Stan Lipsey - bless him - has managed to make me look 

     Though we increased our prices a bit less than the industry 
average last year, and though our newsprint costs and wage rates 
rose in line with industry norms, Stan actually improved margins 
a tad.  No one in the newspaper business has a better managerial 
record.  He has achieved it, furthermore, while running a paper 
that gives readers an extraordinary amount of news.  We believe 
that our “newshole” percentage - the portion of the paper devoted 
to news - is bigger than that of any other dominant paper of our 
size or larger.  The percentage was 49.5% in 1988 versus 49.8% in 
1987.  We are committed to keeping it around 50%, whatever the 
level or trend of profit margins.

     Charlie and I have loved the newspaper business since we 
were youngsters, and we have had great fun with the News in the 
12 years since we purchased it.  We were fortunate to find Murray 
Light, a top-flight editor, on the scene when we arrived and he 
has made us proud of the paper ever since.

   o See’s Candies sold a record 25.1 million pounds in 1988.  
Prospects did not look good at the end of October, but excellent 
Christmas volume, considerably better than the record set in 
1987, turned the tide.

     As we’ve told you before, See’s business continues to become 
more Christmas-concentrated.  In 1988, the Company earned a 
record 90% of its full-year profits in December: $29 million out 
of $32.5 million before tax. (It’s enough to make you believe in 
Santa Claus.) December’s deluge of business produces a modest 
seasonal bulge in Berkshire’s corporate earnings.  Another small 
bulge occurs in the first quarter, when most World Book annuals 
are sold.

     Charlie and I put Chuck Huggins in charge of See’s about 
five minutes after we bought the company.  Upon reviewing his 
record, you may wonder what took us so long.

   o At Fechheimer, the Heldmans - Bob, George, Gary, Roger and 
Fred - are the Cincinnati counterparts of the Blumkins.  Neither 
furniture retailing nor uniform manufacturing has inherently 
attractive economics.  In these businesses, only exceptional 
managements can deliver high returns on invested capital.  And 
that’s exactly what the five Heldmans do. (As Mets announcer 
Ralph Kiner once said when comparing pitcher Steve Trout to his 
father, Dizzy Trout, the famous Detroit Tigers pitcher: “There’s 
a lot of heredity in that family.”)

     Fechheimer made a fairly good-sized acquisition in 1988.  
Charlie and I have such confidence in the business savvy of the 
Heldman family that we okayed the deal without even looking at 
it.  There are very few managements anywhere - including those 
running the top tier companies of the Fortune 500 - in which we 
would exhibit similar confidence.

     Because of both this acquisition and some internal growth, 
sales at Fechheimer should be up significantly in 1989.

   o All of the operations managed by Ralph Schey - World Book, 
Kirby, and The Scott Fetzer Manufacturing Group - performed 
splendidly in 1988.  Returns on the capital entrusted to Ralph 
continue to be exceptional.

     Within the Scott Fetzer Manufacturing Group, particularly 
fine progress was recorded at its largest unit, Campbell 
Hausfeld.  This company, the country’s leading producer of small 
and medium-sized air compressors, has more than doubled earnings 
since 1986.

     Unit sales at both Kirby and World Book were up 
significantly in 1988, with export business particularly strong.  
World Book became available in the Soviet Union in September, 
when that country’s largest American book store opened in Moscow.  
Ours is the only general encyclopedia offered at the store.

     Ralph’s personal productivity is amazing: In addition to 
running 19 businesses in superb fashion, he is active at The 
Cleveland Clinic, Ohio University, Case Western Reserve, and a 
venture capital operation that has spawned sixteen Ohio-based 
companies and resurrected many others.  Both Ohio and Berkshire 
are fortunate to have Ralph on their side.


     It was in 1983 that Berkshire purchased an 80% interest in 
The Nebraska Furniture Mart.  Your Chairman blundered then by 
neglecting to ask Mrs. B a question any schoolboy would have 
thought of: “Are there any more at home like you?” Last month I 
corrected the error: We are now 80% partners with another branch 
of the family.

     After Mrs. B came over from Russia in 1917, her parents and 
five siblings followed. (Her two other siblings had preceded 
her.) Among the sisters was Rebecca Friedman who, with her 
husband, Louis, escaped in 1922 to the west through Latvia in a 
journey as perilous as Mrs. B’s earlier odyssey to the east 
through Manchuria.  When the family members reunited in Omaha 
they had no tangible assets.  However, they came equipped with an 
extraordinary combination of brains, integrity, and enthusiasm 
for work - and that’s all they needed.  They have since proved 
themselves invincible.

     In 1948 Mr. Friedman purchased Borsheim’s, a small Omaha 
jewelry store.  He was joined in the business by his son, Ike, in 
1950 and, as the years went by, Ike’s son, Alan, and his sons-in-
law, Marvin Cohn and Donald Yale, came in also.

     You won’t be surprised to learn that this family brings to 
the jewelry business precisely the same approach that the 
Blumkins bring to the furniture business.  The cornerstone for 
both enterprises is Mrs. B’s creed: “Sell cheap and tell the 
truth.” Other fundamentals at both businesses are: (1) single 
store operations featuring huge inventories that provide 
customers with an enormous selection across all price ranges, (2) 
daily attention to detail by top management, (3) rapid turnover, 
(4) shrewd buying, and (5) incredibly low expenses.  The 
combination of the last three factors lets both stores offer 
everyday prices that no one in the country comes close to 

     Most people, no matter how sophisticated they are in other 
matters, feel like babes in the woods when purchasing jewelry.  
They can judge neither quality nor price.  For them only one rule 
makes sense: If you don’t know jewelry, know the jeweler.

     I can assure you that those who put their trust in Ike 
Friedman and his family will never be disappointed.  The way in 
which we purchased our interest in their business is the ultimate 
testimonial.  Borsheim’s had no audited financial statements; 
nevertheless, we didn’t take inventory, verify receivables or 
audit the operation in any way.  Ike simply told us what was so -
- and on that basis we drew up a one-page contract and wrote a 
large check.

     Business at Borsheim’s has mushroomed in recent years as the 
reputation of the Friedman family has spread.  Customers now come 
to the store from all over the country.  Among them have been 
some friends of mine from both coasts who thanked me later for 
getting them there.

     Borsheim’s new links to Berkshire will change nothing in the 
way this business is run.  All members of the Friedman family 
will continue to operate just as they have before; Charlie and I 
will stay on the sidelines where we belong.  And when we say “all 
members,” the words have real meaning.  Mr. and Mrs. Friedman, at 
88 and 87, respectively, are in the store daily.  The wives of 
Ike, Alan, Marvin and Donald all pitch in at busy times, and a 
fourth generation is beginning to learn the ropes.

     It is great fun to be in business with people you have long 
admired.  The Friedmans, like the Blumkins, have achieved success 
because they have deserved success.  Both families focus on 
what’s right for the customer and that, inevitably, works out 
well for them, also.  We couldn’t have better partners.

Insurance Operations

     Shown below is an updated version of our usual table 
presenting key figures for the insurance industry:

          Yearly Change    Combined Ratio    Yearly Change   Inflation Rate 
           in Premiums   After Policyholder   in Incurred     Measured by 
           Written (%)        Dividends        Losses (%)   GNP Deflator (%)
          -------------  ------------------  -------------  ----------------
1981 .....     3.8              106.0             6.5              9.6
1982 .....     3.7              109.6             8.4              6.4
1983 .....     5.0              112.0             6.8              3.8
1984 .....     8.5              118.0            16.9              3.7
1985 .....    22.1              116.3            16.1              3.2
1986 .....    22.2              108.0            13.5              2.7
1987 .....     9.4              104.6             7.8              3.3
1988 (Est.)    3.9              105.4             4.2              3.6

Source: A.M. Best Co.

     The combined ratio represents total insurance costs (losses 
incurred plus expenses) compared to revenue from premiums: A 
ratio below 100 indicates an underwriting profit, and one above 
100 indicates a loss.  When the investment income that an insurer 
earns from holding on to policyholders’ funds (“the float”) is 
taken into account, a combined ratio in the 107-111 range 
typically produces an overall break-even result, exclusive of 
earnings on the funds provided by shareholders.

     For the reasons laid out in previous reports, we expect the 
industry’s incurred losses to grow by about 10% annually, even in 
years when general inflation runs considerably lower.  If premium 
growth meanwhile materially lags that 10% rate, underwriting 
losses will mount, though the industry’s tendency to underreserve 
when business turns bad may obscure their size for a time.  As 
the table shows, the industry’s underwriting loss grew in 1988.  
This trend is almost certain to continue - and probably will 
accelerate - for at least two more years.

     The property-casualty insurance industry is not only 
subnormally profitable, it is subnormally popular. (As Sam 
Goldwyn philosophized: “In life, one must learn to take the 
bitter with the sour.”) One of the ironies of business is that 
many relatively-unprofitable industries that are plagued by 
inadequate prices habitually find themselves beat upon by irate 
customers even while other, hugely profitable industries are 
spared complaints, no matter how high their prices.  

     Take the breakfast cereal industry, whose return on invested 
capital is more than double that of the auto insurance industry 
(which is why companies like Kellogg and General Mills sell at 
five times book value and most large insurers sell close to 
book).  The cereal companies regularly impose price increases, 
few of them related to a significant jump in their costs.  Yet 
not a peep is heard from consumers.  But when auto insurers raise 
prices by amounts that do not even match cost increases, 
customers are outraged.  If you want to be loved, it’s clearly 
better to sell high-priced corn flakes than low-priced auto 

     The antagonism that the public feels toward the industry can 
have serious consequences: Proposition 103, a California 
initiative passed last fall, threatens to push auto insurance 
prices down sharply, even though costs have been soaring.  The 
price cut has been suspended while the courts review the 
initiative, but the resentment that brought on the vote has not 
been suspended: Even if the initiative is overturned, insurers 
are likely to find it tough to operate profitably in California. 
(Thank heavens the citizenry isn’t mad at bonbons: If Proposition 
103 applied to candy as well as insurance, See’s would be forced 
to sell its product for $5.76 per pound. rather than the $7.60 we 
charge - and would be losing money by the bucketful.)

     The immediate direct effects on Berkshire from the 
initiative are minor, since we saw few opportunities for profit 
in the rate structure that existed in California prior to the 
vote.  However, the forcing down of prices would seriously affect 
GEICO, our 44%-owned investee, which gets about 10% of its 
premium volume from California.  Even more threatening to GEICO 
is the possibility that similar pricing actions will be taken in 
other states, through either initiatives or legislation.

     If voters insist that auto insurance be priced below cost, 
it eventually must be sold by government.  Stockholders can 
subsidize policyholders for a short period, but only taxpayers 
can subsidize them over the long term.  At most property-casualty 
companies, socialized auto insurance would be no disaster for 
shareholders.  Because of the commodity characteristics of the 
industry, most insurers earn mediocre returns and therefore have 
little or no economic goodwill to lose if they are forced by 
government to leave the auto insurance business.  But GEICO, 
because it is a low-cost producer able to earn high returns on 
equity, has a huge amount of economic goodwill at risk.  In turn, 
so do we.

     At Berkshire, in 1988, our premium volume continued to fall, 
and in 1989 we will experience a large decrease for a special 
reason: The contract through which we receive 7% of the business 
of Fireman’s Fund expires on August 31.  At that time, we will 
return to Fireman’s Fund the unearned premiums we hold that 
relate to the contract.  This transfer of funds will show up in 
our “premiums written” account as a negative $85 million or so 
and will make our third-quarter figures look rather peculiar.  
However, the termination of this contract will not have a 
significant effect on profits.

     Berkshire’s underwriting results continued to be excellent 
in 1988.  Our combined ratio (on a statutory basis and excluding 
structured settlements and financial reinsurance) was 104.  
Reserve development was favorable for the second year in a row, 
after a string of years in which it was very unsatisfactory.  
Details on both underwriting and reserve development appear on 
pages 36-38.

     Our insurance volume over the next few years is likely to 
run very low, since business with a reasonable potential for 
profit will almost certainly be scarce.  So be it.  At Berkshire, 
we simply will not write policies at rates that carry the 
expectation of economic loss.  We encounter enough troubles when 
we expect a gain.

     Despite - or perhaps because of - low volume, our profit 
picture during the next few years is apt to be considerably 
brighter than the industry’s.  We are sure to have an exceptional 
amount of float compared to premium volume, and that augurs well 
for profits.  In 1989 and 1990 we expect our float/premiums 
ratio to be at least three times that of the typical 
property/casualty company.  Mike Goldberg, with special help from 
Ajit Jain, Dinos Iordanou, and the National Indemnity managerial 
team, has positioned us well in that respect.

     At some point - we don’t know when - we will be deluged with 
insurance business.  The cause will probably be some major 
physical or financial catastrophe.  But we could also experience 
an explosion in business, as we did in 1985, because large and 
increasing underwriting losses at other companies coincide with 
their recognition that they are far underreserved. in the 
meantime, we will retain our talented professionals, protect our 
capital, and try not to make major mistakes.

Marketable Securities

     In selecting marketable securities for our insurance 
companies, we can choose among five major categories: (1) long-
term common stock investments, (2) medium-term fixed-income 
securities, (3) long-term fixed-income securities, (4) short-term 
cash equivalents, and (5) short-term arbitrage commitments.

     We have no particular bias when it comes to choosing from 
these categories. We just continuously search among them for the 
highest after-tax returns as measured by “mathematical 
expectation,” limiting ourselves always to investment 
alternatives we think we understand.  Our criteria have nothing 
to do with maximizing immediately reportable earnings; our goal, 
rather, is to maximize eventual net worth.

   o Below we list our common stock holdings having a value over 
$100 million, not including arbitrage commitments, which will be 
discussed later.  A small portion of these investments belongs to 
subsidiaries of which Berkshire owns less than 100%.

   Shares   Company                                    Cost       Market
   ------   -------                                 ----------  ----------
                                                        (000s omitted) 
 3,000,000  Capital Cities/ABC, Inc. ..............  $517,500   $1,086,750
14,172,500  The Coca-Cola Company .................   592,540      632,448
 2,400,000  Federal Home Loan Mortgage 
               Corporation Preferred* .............    71,729      121,200
 6,850,000  GEICO Corporation .....................    45,713      849,400
 1,727,765  The Washington Post Company ...........     9,731      364,126

*Although  nominally a preferred stock, this security is 
 financially equivalent to a common stock.

     Our permanent holdings - Capital Cities/ABC, Inc., GEICO 
Corporation, and The Washington Post Company - remain unchanged.  
Also unchanged is our unqualified admiration of their 
managements: Tom Murphy and Dan Burke at Cap Cities, Bill Snyder 
and Lou Simpson at GEICO, and Kay Graham and Dick Simmons at The 
Washington Post.  Charlie and I appreciate enormously the talent 
and integrity these managers bring to their businesses.

     Their performance, which we have observed at close range, 
contrasts vividly with that of many CEOs, which we have 
fortunately observed from a safe distance.  Sometimes these CEOs 
clearly do not belong in their jobs; their positions, 
nevertheless, are usually secure.  The supreme irony of business 
management is that it is far easier for an inadequate CEO to keep 
his job than it is for an inadequate subordinate.

     If a secretary, say, is hired for a job that requires typing 
ability of at least 80 words a minute and turns out to be capable 
of only 50 words a minute, she will lose her job in no time.  
There is a logical standard for this job; performance is easily 
measured; and if you can’t make the grade, you’re out.  
Similarly, if new sales people fail to generate sufficient 
business quickly enough, they will be let go.  Excuses will not 
be accepted as a substitute for orders.

     However, a CEO who doesn’t perform is frequently carried 
indefinitely.  One reason is that performance standards for his 
job seldom exist.  When they do, they are often fuzzy or they may 
be waived or explained away, even when the performance shortfalls 
are major and repeated.  At too many companies, the boss shoots 
the arrow of managerial performance and then hastily paints the 
bullseye around the spot where it lands.

     Another important, but seldom recognized, distinction 
between the boss and the foot soldier is that the CEO has no 
immediate superior whose performance is itself getting measured.  
The sales manager who retains a bunch of lemons in his sales 
force will soon be in hot water himself.  It is in his immediate 
self-interest to promptly weed out his hiring mistakes.  
Otherwise, he himself may be weeded out.  An office manager who 
has hired inept secretaries faces the same imperative.

     But the CEO’s boss is a Board of Directors that seldom 
measures itself and is infrequently held to account for 
substandard corporate performance.  If the Board makes a mistake 
in hiring, and perpetuates that mistake, so what?  Even if the 
company is taken over because of the mistake, the deal will 
probably bestow substantial benefits on the outgoing Board 
members. (The bigger they are, the softer they fall.)

     Finally, relations between the Board and the CEO are 
expected to be congenial.  At board meetings, criticism of the 
CEO’s performance is often viewed as the social equivalent of 
belching.  No such inhibitions restrain the office manager from 
critically evaluating the substandard typist.

     These points should not be interpreted as a blanket 
condemnation of CEOs or Boards of Directors: Most are able and 
hard-working, and a number are truly outstanding.  But the 
management failings that Charlie and I have seen make us thankful 
that we are linked with the managers of our three permanent 
holdings.  They love their businesses, they think like owners, 
and they exude integrity and ability.

   o In 1988 we made major purchases of Federal Home Loan 
Mortgage Pfd. (“Freddie Mac”) and Coca Cola.  We expect to hold 
these securities for a long time.  In fact, when we own portions 
of outstanding businesses with outstanding managements, our 
favorite holding period is forever.  We are just the opposite of 
those who hurry to sell and book profits when companies perform 
well but who tenaciously hang on to businesses that disappoint.  
Peter Lynch aptly likens such behavior to cutting the flowers and 
watering the weeds.  Our holdings of Freddie Mac are the maximum 
allowed by law, and are extensively described by Charlie in his 
letter.  In our consolidated balance sheet these shares are 
carried at cost rather than market, since they are owned by 
Mutual Savings and Loan, a non-insurance subsidiary.

     We continue to concentrate our investments in a very few 
companies that we try to understand well.  There are only a 
handful of businesses about which we have strong long-term 
convictions.  Therefore, when we find such a business, we want to 
participate in a meaningful way.  We agree with Mae West: “Too 
much of a good thing can be wonderful.”

   o We reduced our holdings of medium-term tax-exempt bonds by 
about $100 million last year.  All of the bonds sold were 
acquired after August 7, 1986. When such bonds are held by 
property-casualty insurance companies, 15% of the “tax-exempt” 
interest earned is subject to tax.

     The $800 million position we still hold consists almost 
entirely of bonds “grandfathered” under the Tax Reform Act of 
1986, which means they are entirely tax-exempt.  Our sales 
produced a small profit and our remaining bonds, which have an 
average maturity of about six years, are worth modestly more than 
carrying value.

     Last year we described our holdings of short-term and 
intermediate-term bonds of Texaco, which was then in bankruptcy.  
During 1988, we sold practically all of these bonds at a pre-tax 
profit of about $22 million.  This sale explains close to $100 
million of the reduction in fixed-income securities on our 
balance sheet.

     We also told you last year about our holdings of another 
security whose predominant characteristics are those of an 
intermediate fixed-income issue: our $700 million position in 
Salomon Inc 9% convertible preferred.  This preferred has a 
sinking fund that will retire it in equal annual installments 
from 1995 to 1999.  Berkshire carries this holding at cost.  For 
reasons discussed by Charlie on page 69, the estimated market 
value of our holding has improved from moderately under cost at 
the end of last year to moderately over cost at 1988 year end.

     The close association we have had with John Gutfreund, CEO 
of Salomon, during the past year has reinforced our admiration 
for him.  But we continue to have no great insights about the 
near, intermediate or long-term economics of the investment 
banking business: This is not an industry in which it is easy to 
forecast future levels of profitability.  We continue to believe 
that our conversion privilege could well have important value 
over the life of our preferred.  However, the overwhelming 
portion of the preferred’s value resides in its fixed-income 
characteristics, not its equity characteristics.

   o We have not lost our aversion to long-term bonds.  We will 
become enthused about such securities only when we become 
enthused about prospects for long-term stability in the 
purchasing power of money.  And that kind of stability isn’t in 
the cards: Both society and elected officials simply have too 
many higher-ranking priorities that conflict with purchasing-
power stability.  The only long-term bonds we hold are those of 
Washington Public Power Supply Systems (WPPSS).  A few of our 
WPPSS bonds have short maturities and many others, because of 
their high coupons, are likely to be refunded and paid off in a 
few years.  Overall, our WPPSS holdings are carried on our 
balance sheet at $247 million and have a market value of about 
$352 million.

     We explained the reasons for our WPPSS purchases in the 1983 
annual report, and are pleased to tell you that this commitment 
has worked out about as expected.  At the time of purchase, most 
of our bonds were yielding around 17% after taxes and carried no 
ratings, which had been suspended.  Recently, the bonds were 
rated AA- by Standard & Poor’s.  They now sell at levels only 
slightly below those enjoyed by top-grade credits.

     In the 1983 report, we compared the economics of our WPPSS 
purchase to those involved in buying a business.  As it turned 
out, this purchase actually worked out better than did the 
general run of business acquisitions made in 1983, assuming both 
are measured on the basis of unleveraged, after tax returns 
achieved through 1988.  

     Our WPPSS experience, though pleasant, does nothing to alter 
our negative opinion about long-term bonds.  It only makes us 
hope that we run into some other large stigmatized issue, whose 
troubles have caused it to be significantly misappraised by the 


     In past reports we have told you that our insurance 
subsidiaries sometimes engage in arbitrage as an alternative to 
holding short-term cash equivalents. We prefer, of course, to 
make major long-term commitments, but we often have more cash 
than good ideas.  At such times, arbitrage sometimes promises 
much greater returns than Treasury Bills and, equally important, 
cools any temptation we may have to relax our standards for long-
term investments.  (Charlie’s sign off after we’ve talked about 
an arbitrage commitment is usually: “Okay, at least it will keep 
you out of bars.”)

     During 1988 we made unusually large profits from arbitrage, 
measured both by absolute dollars and rate of return.  Our pre-
tax gain was about $78 million on average invested funds of about 
$147 million.

     This level of activity makes some detailed discussion of 
arbitrage and our approach to it appropriate.  Once, the word 
applied only to the simultaneous purchase and sale of securities 
or foreign exchange in two different markets.  The goal was to 
exploit tiny price differentials that might exist between, say, 
Royal Dutch stock trading in guilders in Amsterdam, pounds in 
London, and dollars in New York.  Some people might call this 
scalping; it won’t surprise you that practitioners opted for the 
French term, arbitrage.

     Since World War I the definition of arbitrage - or “risk 
arbitrage,” as it is now sometimes called - has expanded to 
include the pursuit of profits from an announced corporate event 
such as sale of the company, merger, recapitalization, 
reorganization, liquidation, self-tender, etc.  In most cases the 
arbitrageur expects to profit regardless of the behavior of the 
stock market.  The major risk he usually faces instead is that 
the announced event won’t happen.  

     Some offbeat opportunities occasionally arise in the 
arbitrage field.  I participated in one of these when I was 24 
and working in New York for Graham-Newman Corp. Rockwood & Co., 
a Brooklyn based chocolate products company of limited 
profitability, had adopted LIFO inventory valuation in 1941 
when cocoa was selling for 5¢ per pound.  In 1954 a 
temporary shortage of cocoa caused the price to soar to over 
60¢.  Consequently Rockwood wished to unload its valuable 
inventory - quickly, before the price dropped.  But if the cocoa 
had simply been sold off, the company would have owed close to 
a 50% tax on the proceeds.

     The 1954 Tax Code came to the rescue.  It contained an 
arcane provision that eliminated the tax otherwise due on LIFO 
profits if inventory was distributed to shareholders as part of a 
plan reducing the scope of a corporation’s business.  Rockwood 
decided to terminate one of its businesses, the sale of cocoa 
butter, and said 13 million pounds of its cocoa bean inventory 
was attributable to that activity.  Accordingly, the company 
offered to repurchase its stock in exchange for the cocoa beans 
it no longer needed, paying 80 pounds of beans for each share.  

     For several weeks I busily bought shares, sold beans, and 
made periodic stops at Schroeder Trust to exchange stock 
certificates for warehouse receipts.  The profits were good and 
my only expense was subway tokens.

     The architect of Rockwood’s restructuring was an unknown, 
but brilliant Chicagoan, Jay Pritzker, then 32.  If you’re 
familiar with Jay’s subsequent record, you won’t be surprised to 
hear the action worked out rather well for Rockwood’s continuing 
shareholders also.  From shortly before the tender until shortly 
after it, Rockwood stock appreciated from 15 to 100, even though 
the company was experiencing large operating losses.  Sometimes 
there is more to stock valuation than price-earnings ratios.

     In recent years, most arbitrage operations have involved 
takeovers, friendly and unfriendly.  With acquisition fever 
rampant, with anti-trust challenges almost non-existent, and with 
bids often ratcheting upward, arbitrageurs have prospered 
mightily.  They have not needed special talents to do well; the 
trick, a la Peter Sellers in the movie, has simply been “Being 
There.” In Wall Street the old proverb has been reworded: “Give a 
man a fish and you feed him for a day.  Teach him how to 
arbitrage and you feed him forever.” (If, however, he studied at 
the Ivan Boesky School of Arbitrage, it may be a state 
institution that supplies his meals.)

     To evaluate arbitrage situations you must answer four 
questions: (1) How likely is it that the promised event will 
indeed occur? (2) How long will your money be tied up? (3) What 
chance is there that something still better will transpire - a 
competing takeover bid, for example? and (4) What will happen if 
the event does not take place because of anti-trust action, 
financing glitches, etc.?

     Arcata Corp., one of our more serendipitous arbitrage 
experiences, illustrates the twists and turns of the business.  
On September 28, 1981 the directors of Arcata agreed in principle 
to sell the company to Kohlberg, Kravis, Roberts & Co. (KKR), 
then and now a major leveraged-buy out firm.  Arcata was in the 
printing and forest products businesses and had one other thing 
going for it: In 1978 the U.S. Government had taken title to 
10,700 acres of Arcata timber, primarily old-growth redwood, to 
expand Redwood National Park.  The government had paid $97.9 
million, in several installments, for this acreage, a sum Arcata 
was contesting as grossly inadequate.  The parties also disputed 
the interest rate that should apply to the period between the 
taking of the property and final payment for it.  The enabling 
legislation stipulated 6% simple interest; Arcata argued for a 
much higher and compounded rate.

     Buying a company with a highly-speculative, large-sized 
claim in litigation creates a negotiating problem, whether the 
claim is on behalf of or against the company.  To solve this 
problem, KKR offered $37.00 per Arcata share plus two-thirds of 
any additional amounts paid by the government for the redwood 

     Appraising this arbitrage opportunity, we had to ask 
ourselves whether KKR would consummate the transaction since, 
among other things, its offer was contingent upon its obtaining 
“satisfactory financing.” A clause of this kind is always 
dangerous for the seller: It offers an easy exit for a suitor 
whose ardor fades between proposal and marriage.  However, we 
were not particularly worried about this possibility because 
KKR’s past record for closing had been good.

     We also had to ask ourselves what would happen if the KKR 
deal did fall through, and here we also felt reasonably 
comfortable: Arcata’s management and directors had been shopping 
the company for some time and were clearly determined to sell.  
If KKR went away, Arcata would likely find another buyer, though 
of course, the price might be lower.

     Finally, we had to ask ourselves what the redwood claim 
might be worth.  Your Chairman, who can’t tell an elm from an 
oak, had no trouble with that one: He coolly evaluated the claim 
at somewhere between zero and a whole lot.

     We started buying Arcata stock, then around $33.50, on 
September 30 and in eight weeks purchased about 400,000 shares, 
or 5% of the company.  The initial announcement said that the 
$37.00 would be paid in January, 1982.  Therefore, if everything 
had gone perfectly, we would have achieved an annual rate of 
return of about 40% - not counting the redwood claim, which would 
have been frosting.

     All did not go perfectly.  In December it was announced that 
the closing would be delayed a bit.  Nevertheless, a definitive 
agreement was signed on January 4. Encouraged, we raised our 
stake, buying at around $38.00 per share and increasing our 
holdings to 655,000 shares, or over 7% of the company.  Our 
willingness to pay up - even though the closing had been 
postponed - reflected our leaning toward “a whole lot” rather 
than “zero” for the redwoods.

     Then, on February 25 the lenders said they were taking a 
“second look” at financing terms “ in view of the severely 
depressed housing industry and its impact on Arcata’s outlook.” 
The stockholders’ meeting was postponed again, to April.  An 
Arcata spokesman said he “did not think the fate of the 
acquisition itself was imperiled.” When arbitrageurs hear such 
reassurances, their minds flash to the old saying: “He lied like 
a finance minister on the eve of devaluation.”

     On March 12 KKR said its earlier deal wouldn’t work, first 
cutting its offer to $33.50, then two days later raising it to 
$35.00. On March 15, however, the directors turned this bid down 
and accepted another group’s offer of $37.50 plus one-half of any 
redwood recovery.  The shareholders okayed the deal, and the 
$37.50 was paid on June 4.

     We received $24.6 million versus our cost of $22.9 million; 
our average holding period was close to six months.  Considering 
the trouble this transaction encountered, our 15% annual rate of 
return excluding any value for the redwood claim - was more than 

     But the best was yet to come.  The trial judge appointed two 
commissions, one to look at the timber’s value, the other to 
consider the interest rate questions.  In January 1987, the first 
commission said the redwoods were worth $275.7 million and the 
second commission recommended a compounded, blended rate of 
return working out to about 14%.

     In August 1987 the judge upheld these conclusions, which 
meant a net amount of about $600 million would be due Arcata.  
The government then appealed.  In 1988, though, before this 
appeal was heard, the claim was settled for $519 million.  
Consequently, we received an additional $29.48 per share, or 
about $19.3 million.  We will get another $800,000 or so in 1989.

     Berkshire’s arbitrage activities differ from those of many 
arbitrageurs.  First, we participate in only a few, and usually 
very large, transactions each year.  Most practitioners buy into 
a great many deals perhaps 50 or more per year.  With that many 
irons in the fire, they must spend most of their time monitoring 
both the progress of deals and the market movements of the 
related stocks.  This is not how Charlie nor I wish to spend our 
lives. (What’s the sense in getting rich just to stare at a 
ticker tape all day?)

     Because we diversify so little, one particularly profitable 
or unprofitable transaction will affect our yearly result from 
arbitrage far more than it will the typical arbitrage operation.  
So far, Berkshire has not had a really bad experience.  But we 
will - and when it happens we’ll report the gory details to you.

     The other way we differ from some arbitrage operations is 
that we participate only in transactions that have been publicly 
announced.  We do not trade on rumors or try to guess takeover 
candidates.  We just read the newspapers, think about a few of 
the big propositions, and go by our own sense of probabilities.

     At yearend, our only major arbitrage position was 3,342,000 
shares of RJR Nabisco with a cost of $281.8 million and a market 
value of $304.5 million.  In January we increased our holdings to 
roughly four million shares and in February we eliminated our 
position.  About three million shares were accepted when we 
tendered our holdings to KKR, which acquired RJR, and the 
returned shares were promptly sold in the market.  Our pre-tax 
profit was a better-than-expected $64 million.

     Earlier, another familiar face turned up in the RJR bidding 
contest: Jay Pritzker, who was part of a First Boston group that 
made a tax-oriented offer.  To quote Yogi Berra; “It was deja vu 
all over again.”

     During most of the time when we normally would have been 
purchasers of RJR, our activities in the stock were restricted 
because of Salomon’s participation in a bidding group.  
Customarily, Charlie and I, though we are directors of Salomon, 
are walled off from information about its merger and acquisition 
work.  We have asked that it be that way: The information would 
do us no good and could, in fact, occasionally inhibit 
Berkshire’s arbitrage operations.

     However, the unusually large commitment that Salomon 
proposed to make in the RJR deal required that all directors be 
fully informed and involved.  Therefore, Berkshire’s purchases of 
RJR were made at only two times: first, in the few days 
immediately following management’s announcement of buyout plans, 
before Salomon became involved; and considerably later, after the 
RJR board made its decision in favor of KKR.  Because we could 
not buy at other times, our directorships cost Berkshire 
significant money.

     Considering Berkshire’s good results in 1988, you might 
expect us to pile into arbitrage during 1989.  Instead, we expect 
to be on the sidelines.

     One pleasant reason is that our cash holdings are down - 
because our position in equities that we expect to hold for a 
very long time is substantially up.  As regular readers of this 
report know, our new commitments are not based on a judgment 
about short-term prospects for the stock market.  Rather, they 
reflect an opinion about long-term business prospects for 
specific companies.  We do not have, never have had, and never 
will have an opinion about where the stock market, interest 
rates, or business activity will be a year from now.

     Even if we had a lot of cash we probably would do little in 
arbitrage in 1989.  Some extraordinary excesses have developed in 
the takeover field.  As Dorothy says: “Toto, I have a feeling 
we’re not in Kansas any more.”

     We have no idea how long the excesses will last, nor do we 
know what will change the attitudes of government, lender and 
buyer that fuel them.  But we do know that the less the prudence 
with which others conduct their affairs, the greater the prudence 
with which we should conduct our own affairs.  We have no desire 
to arbitrage transactions that reflect the unbridled - and, in 
our view, often unwarranted - optimism of both buyers and 
lenders.  In our activities, we will heed the wisdom of Herb 
Stein: “If something can’t go on forever, it will end.”

Efficient Market Theory

     The preceding discussion about arbitrage makes a small 
discussion of “efficient market theory” (EMT) also seem relevant.  
This doctrine became highly fashionable - indeed, almost holy 
scripture in academic circles during the 1970s.  Essentially, it 
said that analyzing stocks was useless because all public 
information about them was appropriately reflected in their 
prices.  In other words, the market always knew everything.  As a 
corollary, the professors who taught EMT said that someone 
throwing darts at the stock tables could select a stock portfolio 
having prospects just as good as one selected by the brightest, 
most hard-working security analyst.  Amazingly, EMT was embraced 
not only by academics, but by many investment professionals and 
corporate managers as well.  Observing correctly that the market 
was frequently efficient, they went on to conclude incorrectly 
that it was always efficient.  The difference between these 
propositions is night and day.

     In my opinion, the continuous 63-year arbitrage experience 
of Graham-Newman Corp. Buffett Partnership, and Berkshire 
illustrates just how foolish EMT is. (There’s plenty of other 
evidence, also.) While at Graham-Newman, I made a study of its 
earnings from arbitrage during the entire 1926-1956 lifespan of 
the company.  Unleveraged returns averaged 20% per year.  
Starting in 1956, I applied Ben Graham’s arbitrage principles, 
first at Buffett Partnership and then Berkshire.  Though I’ve not 
made an exact calculation, I have done enough work to know that 
the 1956-1988 returns averaged well over 20%. (Of course, I 
operated in an environment far more favorable than Ben’s; he had 
1929-1932 to contend with.)

     All of the conditions are present that are required for a 
fair test of portfolio performance: (1) the three organizations 
traded hundreds of different securities while building this 63-
year record; (2) the results are not skewed by a few fortunate 
experiences; (3) we did not have to dig for obscure facts or 
develop keen insights about products or managements - we simply 
acted on highly-publicized events; and (4) our arbitrage 
positions were a clearly identified universe - they have not been 
selected by hindsight.

     Over the 63 years, the general market delivered just under a 
10% annual return, including dividends.  That means $1,000 would 
have grown to $405,000 if all income had been reinvested.  A 20% 
rate of return, however, would have produced $97 million.  That 
strikes us as a statistically-significant differential that 
might, conceivably, arouse one’s curiosity.

     Yet proponents of the theory have never seemed interested in 
discordant evidence of this type.  True, they don’t talk quite as 
much about their theory today as they used to.  But no one, to my 
knowledge, has ever said he was wrong, no matter how many 
thousands of students he has sent forth misinstructed.  EMT, 
moreover, continues to be an integral part of the investment 
curriculum at major business schools.  Apparently, a reluctance 
to recant, and thereby to demystify the priesthood, is not 
limited to theologians.

     Naturally the disservice done students and gullible 
investment professionals who have swallowed EMT has been an 
extraordinary service to us and other followers of Graham.  In 
any sort of a contest - financial, mental, or physical - it’s an 
enormous advantage to have opponents who have been taught that 
it’s useless to even try.  From a selfish point of view, 
Grahamites should probably endow chairs to ensure the perpetual 
teaching of EMT.

     All this said, a warning is appropriate.  Arbitrage has 
looked easy recently.  But this is not a form of investing that 
guarantees profits of 20% a year or, for that matter, profits of 
any kind.  As noted, the market is reasonably efficient much of 
the time: For every arbitrage opportunity we seized in that 63-
year period, many more were foregone because they seemed 

     An investor cannot obtain superior profits from stocks by 
simply committing to a specific investment category or style.  He 
can earn them only by carefully evaluating facts and continuously 
exercising discipline.  Investing in arbitrage situations, per 
se, is no better a strategy than selecting a portfolio by 
throwing darts.

New York Stock Exchange Listing

     Berkshire’s shares were listed on the New York Stock 
Exchange on November 29, 1988.  On pages 50-51 we reproduce the 
letter we sent to shareholders concerning the listing.

     Let me clarify one point not dealt with in the letter: 
Though our round lot for trading on the NYSE is ten shares, any 
number of shares from one on up can be bought or sold.

     As the letter explains, our primary goal in listing was to 
reduce transaction costs, and we believe this goal is being 
achieved.  Generally, the spread between the bid and asked price 
on the NYSE has been well below the spread that prevailed in the 
over-the-counter market.

     Henderson Brothers, Inc., the specialist in our shares, is 
the oldest continuing specialist firm on the Exchange; its 
progenitor, William Thomas Henderson, bought his seat for $500 on 
September 8, 1861. (Recently, seats were selling for about 
$625,000.) Among the 54 firms acting as specialists, HBI ranks 
second in number of stocks assigned, with 83.  We were pleased 
when Berkshire was allocated to HBI, and have been delighted with 
the firm’s performance.  Jim Maguire, Chairman of HBI, personally 
manages the trading in Berkshire, and we could not be in better 

     In two respects our goals probably differ somewhat from 
those of most listed companies.  First, we do not want to 
maximize the price at which Berkshire shares trade.  We wish 
instead for them to trade in a narrow range centered at intrinsic 
business value (which we hope increases at a reasonable - or, 
better yet, unreasonable - rate).  Charlie and I are bothered as 
much by significant overvaluation as significant undervaluation.  
Both extremes will inevitably produce results for many 
shareholders that will differ sharply from Berkshire’s business 
results.  If our stock price instead consistently mirrors 
business value, each of our shareholders will receive an 
investment result that roughly parallels the business results of 
Berkshire during his holding period.

     Second, we wish for very little trading activity.  If we ran 
a private business with a few passive partners, we would be 
disappointed if those partners, and their replacements, 
frequently wanted to leave the partnership.  Running a public 
company, we feel the same way.

     Our goal is to attract long-term owners who, at the time of 
purchase, have no timetable or price target for sale but plan 
instead to stay with us indefinitely.  We don’t understand the 
CEO who wants lots of stock activity, for that can be achieved 
only if many of his owners are constantly exiting.  At what other 
organization - school, club, church, etc. - do leaders cheer when 
members leave? (However, if there were a broker whose livelihood 
depended upon the membership turnover in such organizations, you 
could be sure that there would be at least one proponent of 
activity, as in: “There hasn’t been much going on in Christianity 
for a while; maybe we should switch to Buddhism next week.“)

     Of course, some Berkshire owners will need or want to sell 
from time to time, and we wish for good replacements who will pay 
them a fair price.  Therefore we try, through our policies, 
performance, and communications, to attract new shareholders who 
understand our operations, share our time horizons, and measure 
us as we measure ourselves.  If we can continue to attract this 
sort of shareholder - and, just as important, can continue to be 
uninteresting to those with short-term or unrealistic 
expectations - Berkshire shares should consistently sell at 
prices reasonably related to business value.

David L. Dodd

     Dave Dodd, my friend and teacher for 38 years, died last 
year at age 93.  Most of you don’t know of him.  Yet any long-
time shareholder of Berkshire is appreciably wealthier because of 
the indirect influence he had upon our company.

     Dave spent a lifetime teaching at Columbia University, and 
he co-authored Security Analysis with Ben Graham.  From the 
moment I arrived at Columbia, Dave personally encouraged and 
educated me; one influence was as important as the other.  
Everything he taught me, directly or through his book, made 
sense.  Later, through dozens of letters, he continued my 
education right up until his death.

     I have known many professors of finance and investments but 
I have never seen any, except for Ben Graham, who was the match 
of Dave.  The proof of his talent is the record of his students: 
No other teacher of investments has sent forth so many who have 
achieved unusual success.

     When students left Dave’s classroom, they were equipped to 
invest intelligently for a lifetime because the principles he 
taught were simple, sound, useful, and enduring.  Though these 
may appear to be unremarkable virtues, the teaching of principles 
embodying them has been rare.

     It’s particularly impressive that Dave could practice as 
well as preach. just as Keynes became wealthy by applying his 
academic ideas to a very small purse, so, too, did Dave.  Indeed, 
his financial performance far outshone that of Keynes, who began 
as a market-timer (leaning on business and credit-cycle theory) 
and converted, after much thought, to value investing.  Dave was 
right from the start.

     In Berkshire’s investments, Charlie and I have employed the 
principles taught by Dave and Ben Graham.  Our prosperity is the 
fruit of their intellectual tree.


     We hope to buy more businesses that are similar to the ones 
we have, and we can use some help.  If you have a business that 
fits the following criteria, call me or, preferably, write.

     Here’s what we’re looking for:

     (1) large purchases (at least $10 million of after-tax 

     (2) demonstrated consistent earning power (future projections 
         are of little interest to us, nor are “turnaround” 

     (3) businesses earning good returns on equity while employing 
         little or no debt,

     (4) management in place (we can’t supply it),

     (5) simple businesses (if there’s lots of technology, we won’t 
         understand it),

     (6) an offering price (we don’t want to waste our time or that 
         of the seller by talking, even preliminarily, about a 
         transaction when price is unknown).

     We will not engage in unfriendly takeovers.  We can promise 
complete confidentiality and a very fast answer - customarily 
within five minutes - as to whether we’re interested.  We prefer 
to buy for cash, but will consider issuing stock when we receive 
as much in intrinsic business value as we give.

     Our favorite form of purchase is one fitting the Blumkin-
Friedman-Heldman mold.  In cases like these, the company’s owner-
managers wish to generate significant amounts of cash, sometimes 
for themselves, but often for their families or inactive 
shareholders.  However, these managers also wish to remain 
significant owners who continue to run their companies just as 
they have in the past.  We think we offer a particularly good fit 
for owners with these objectives and invite potential sellers to 
check us out by contacting people with whom we have done business 
in the past.

     Charlie and I frequently get approached about acquisitions 
that don’t come close to meeting our tests: We’ve found that if 
you advertise an interest in buying collies, a lot of people will 
call hoping to sell you their cocker spaniels.  Our interest in 
new ventures, turnarounds, or auction-like sales can best be 
expressed by another Goldwynism: “Please include me out.”

     Besides being interested in the purchase of businesses as 
described above, we are also interested in the negotiated 
purchase of large, but not controlling, blocks of stock 
comparable to those we hold in Cap Cities and Salomon.  We have a 
special interest in purchasing convertible preferreds as a long-
term investment, as we did at Salomon.

                             *  *  *

     We received some good news a few weeks ago: Standard & 
Poor’s raised our credit rating to AAA, which is the highest 
rating it bestows.  Only 15 other U.S. industrial or property-
casualty companies are rated AAA, down from 28 in 1980.

     Corporate bondholders have taken their lumps in the past few 
years from “event risk.” This term refers to the overnight 
degradation of credit that accompanies a heavily-leveraged 
purchase or recapitalization of a business whose financial 
policies, up to then, had been conservative.  In a world of 
takeovers inhabited by few owner-managers, most corporations 
present such a risk.  Berkshire does not.  Charlie and I promise 
bondholders the same respect we afford shareholders.

                             *  *  *

     About 97.4% of all eligible shares participated in 
Berkshire’s 1988 shareholder-designated contributions program.  
Contributions made through the program were $5 million, and 2,319 
charities were recipients.  If we achieve reasonable business 
results, we plan to increase the per-share contributions in 1989.

     We urge new shareholders to read the description of our 
shareholder-designated contributions program that appears on 
pages 48-49.  If you wish to participate in future programs, we 
strongly urge that you immediately make sure your shares are 
registered in the name of the actual owner, not in the nominee 
name of a broker, bank or depository.  Shares not so registered 
on September 30, 1989 will be ineligible for the 1989 program.

                             *  *  *

     Berkshire’s annual meeting will be held in Omaha on Monday, 
April 24, 1989, and I hope you will come.  The meeting provides 
the forum for you to ask any owner-related questions you may 
have, and we will keep answering until all (except those dealing 
with portfolio activities or other proprietary information) have 
been dealt with.

     After the meeting we will have several buses available to 
take you to visit Mrs. B at The Nebraska Furniture Mart and Ike 
Friedman at Borsheim’s.  Be prepared for bargains.

     Out-of-towners may prefer to arrive early and visit Mrs. B 
during the Sunday store hours of noon to five. (These Sunday 
hours seem ridiculously short to Mrs. B, who feels they scarcely 
allow her time to warm up; she much prefers the days on which the 
store remains open from 10 a.m. to 9 p.m.) Borsheims, however, is 
not open on Sunday.

     Ask Mrs. B the secret of her astonishingly low carpet 
prices.  She will confide to you - as she does to everyone - how 
she does it: “I can sell so cheap ‘cause I work for this dummy 
who doesn’t know anything about carpet.”

                                         Warren E. Buffett
February 28, 1989                        Chairman of the Board