1985年巴菲特给股东的信(英文原版)

PAGEPAGE11985年巴菲特给股东的信(英文原版)第一篇：1985年巴菲特给股东的信(英文原版)1985年巴菲特给股东的信(英文原版)BERKSHIREHATHAWAYINC.TotheShareholdersofBerkshireHathawayInc.:Youmayrememberthewildlyupbeatmessageoflastyear’sreport:nothingmuchwasintheworksbutourexperiencehadbeenthatsomethingbigpoppedupoccasionally.Thiscarefully-craftedcorporatestrategypaidoffin1985.Latersectionsofthisreportdiscuss(a)ourpurchaseofamajorpositioninCapitalCities/ABC,(b)ouracquisitionofScott&Fetzer,(c)ourentryintoalarge,extendedtermparticipationintheinsurancebusinessofFireman’sFund,and(d)oursaleofourstockinGeneralFoods.Ourgaininnetworthduringtheyearwas$613.6million,or48.2%.ItisfittingthatthevisitofHalley’sCometcoincidedwiththispercentagegain:neitherwillbeseenagaininmylifetime.Ourgaininper-sharebookvalueoverthelasttwenty-oneyears(thatis,sincepresentmanagementtookover)hasbeenfrom$19.46to$1643.71,or23.2%compoundedannually,anotherpercentagethatwillnotberepeated.Twofactorsmakeanythingapproachingthisrateofgainunachievableinthefuture.Onefactorprobablytransitoryasitmustmathematicallyourscopeisnotcircumscribedbyhistory,structure,orconcept;and(3)weloveourwork.Allofthesehelp.Evenso,wewillalsoneedafullmeasureofgoodfortunetoaverageourhoped-for15%allentities...$613,356$20XX549$435,815$148,895================================Our1985resultsincludeunusuallylargeearningsfromthesaleofsecurities.Thisfact,initself,doesnotmeanthatwehadaparticularlygoodyear(though,ofcourse,wedid).Securityprofitsinagivenyearbearsimilaritiestoacollegegraduationceremonyinwhichtheknowledgegainedoverfouryearsisrecognizedonadaywhennothingfurtherislearned.Wemayholdastockforadecadeormore,andduringthatperioditmaygrowquiteconsistentlyinbothbusinessandmarketvalue.Intheyearinwhichwefinallysellittheremaybenoincreaseinvalue,ortheremayevenbeadecrease.Butallgrowthinvaluesincepurchasewillbereflectedintheaccountingearningsoftheyearofsale.(Ifthestockownedisinourinsurancesubsidiaries,however,anygainorlossinmarketvaluewillbereflectedinnetworthannually.)Thus,reportedcapitalgainsorlossesinanygivenyeararemeaninglessasameasureofhowwellwehavedoneinthecurrentyear.Alargeportionoftherealizedgainin1985($338millionpre-taxoutofatotalof$488million)cameaboutthroughthesaleofourGeneralFoodsshares.Weheldmostofthesesharessince1980,whenwehadpurchasedthematapricefarbelowwhatwefeltwastheirper/sharebusinessvalue.Yearbyyear,themanagerialeffortsofJimFergusonandPhilSmithsubstantiallyincreasedGeneralFoods’businessvalueand,lastfall,PhilipMorrismadeanofferforthecompanythatreflectedtheincrease.Wethusbenefitedfromfourfactors:abargainpurchaseprice,abusinesswithfineunderlyingeconomics,anablemanagementconcentratingontheinterestsofshareholders,andabuyerwillingtopayfullbusinessvalue.Whilethatlastfactoristheonlyonethatproducesreportedearnings,weconsideridentificationofthefirstthreetobethekeytobuildingvalueforBerkshireshareholders.Inselectingcommonstocks,wedevoteourattentiontoattractivepurchases,nottothepossibilityofattractivesales.Wehaveagainreportedsubstantialincomefromspecialdistributions,thisyearfromWashingtonPostandGeneralFoods.(TheGeneralFoodstransactionsobviouslytookplacewellbeforethePhilipMorrisoffer.)Distributionsofthiskindoccurwhenwesellaportionofoursharesinacompanybacktoitsimultaneouslywithitspurchaseofsharesfromothershareholders.Thenumberofsharesweselliscontractuallysetsoastoleaveourpercentageownershipinthecompanypreciselythesameafterthesaleasbefore.SuchatransactionisquiteproperlyregardedbytheIRSassubstantiallyequivalenttoadividendsincewe,asashareholder,receivecashwhilemaintaininganunchangedownershipinterest.Thistaxtreatmentbenefitsusbecausecorporatetaxpayers,unlikeindividualtaxpayers,incurmuchlowertaxesondividendincomethanonincomefromlong-termcapitalgains.(ThisdifferencewillbewidenedfurtheriftheHouse-passedtaxbillbecomeslaw:underitsprovisions,capitalgainsrealizedbycorporationswillbetaxedatthesamerateasordinaryincome.)However,accountingrulesareunclearastopropertreatmentforshareholderreporting.Toconformwithlastyear’streatment,wehaveshownthesetransactionsascapitalgains.Thoughwehavenotsoughtoutsuchtransactions,wehaveagreedtothemonseveraloccasionswhenmanagementsinitiatedtheidea.Ineachcasewehavefeltthatnon-sellingshareholders(allofwhomhadanopportunitytosellatthesamepricewereceived)benefitedbecausethecompaniesmadetheirrepurchasesatpricesbelowintrinsicbusinessvalue.Thetaxadvantageswereceiveandourwishtocooperatewithmanagementsthatareincreasingvaluesforallshareholdershavesometimesledustoselllargelynon-unionandweexpectthattheywill“theintellectshouldbetheservantoftheheart,butnotitsslave”notaremarkablemathematician.”Likewise,atextilecompanythatallocatescapitalbrilliantlywithinitsindustryisaremarkabletextilecompanyorasingleSee’scandystorebraceyourselfandusuallyiswithnooneexaminingwhetherthisgainwasattributablesimplytomanyyearsofretainedearningsandtheworkingsofcompoundinterest.Ifthewidgetcompanyconsistentlyearnedasuperiorreturnoncapitalthroughouttheperiod,orifcapitalemployedonlydoubledduringtheCEO’sreign,thepraiseforhimmaybewelldeserved.Butifreturnoncapitalwaslacklusterandcapitalemployedincreasedinpacewithearnings,applauseshouldbewithheld.Asavingsaccountinwhichinterestwasreinvestedwouldachievethesameyear-by-yearincreaseinearningsi.e.,earningswithheldfromowners.Forexample,ten-year,fixed-pricestockoptionsaregrantedroutinely,oftenbycompanieswhosedividendsareonlyasmallpercentageofearnings.Anexamplewillillustratetheinequitiespossibleundersuchcircumstances.Let’ssupposethatyouhada$100,000savingsaccountearning8%interestand“managed”byatrusteewhocoulddecideeachyearwhatportionoftheinterestyouweretobepaidincash.Interestnotpaidoutwouldbe“retainedearnings”addedtothesavingsaccounttocompound.Andlet’ssupposethatyourtrustee,inhissuperiorwisdom,setthe“pay-outratio”atone-quarteroftheannualearnings.Undertheseassumptions,youraccountwouldbeworth$179,084attheendoftenyears.Additionally,yourannualearningswouldhaveincreasedabout70%from$8,000to$13,515underthisinspiredmanagement.And,finally,your“dividends”wouldhaveincreasedcommensurately,risingregularlyfrom$2,000inthefirstyearto$3,378inthetenthyear.Eachyear,whenyourmanager’spublicrelationsfirmpreparedhisannualreporttoyou,allofthechartswouldhavehadlinesmarchingskyward.Now,justforfun,let’spushourscenarioonenotchfurtherandgiveyourtrustee-manageraten-yearfixed-priceoptiononpartofyour“business”(i.e.,yoursavingsaccount)basedonitsfairvalueinthefirstyear.Withsuchanoption,yourmanagerwouldreapasubstantialprofitatyourexpenseanywherebutI’llneverbuyone.)Individendpolicyalso,theoptionholders’interestsarebestservedbyapolicythatmayillservetheowner.Thinkbacktothesavingsaccountexample.Thetrustee,holdinghisoption,wouldbenefitfromano-dividendpolicy.Conversely,theowneroftheaccountshouldleantoatotalpayoutsothathecanpreventtheoption-holdingmanagerfromsharingintheaccount’sretainedearnings.Despitetheirshortcomings,optionscanbeappropriateundersomecircumstances.Mycriticismrelatestotheirindiscriminateuseand,inthatconnection,Iwouldliketoemphasizethreepoints:First,stockoptionsareinevitablytiedtotheoverallperformanceofacorporation.Logically,therefore,theyshouldbeawardedonlytothosemanagerswithoverallresponsibility.Managerswithlimitedareasofresponsibilityshouldhaveincentivesthatpayoffinrelationtoresultsundertheircontrol.The.350hitterexpects,andalsodeserves,abigpayoffforhisperformanceevenifheplaysforapennantwinner.Onlythosewithoverallresponsibilityfortheteamshouldhavetheirrewardstiedtoitsresults.Second,optionsshouldbestructuredcarefully.Absentspecialfactors,theyshouldhavebuiltintothemaretained-earningsorcarrying-costfactor.Equallyimportant,theyshouldbepricedrealistically.Whenmanagersarefacedwithoffersfortheircompanies,theyunfailinglypointouthowunrealisticmarketpricescanbeasanindexofrealvalue.Butwhy,then,shouldthesesamedepressedpricesbethevaluationsatwhichmanagerssellportionsoftheirbusinessestothemselves?(Theymaygofurther:officersanddirectorssometimesconsulttheTaxCodetodeterminethelowestpricesatwhichtheycan,ineffect,sellpartofthebusinesstoinsiders.Whilethey’reatit,theyoftenelectplansthatproducetheworsttaxresultforthecompany.)Exceptinhighlyunusualcases,ownersarenotwellservedbythesaleofpartoftheirbusinessatabargainpriceandwhoseoperatingrecordsarefarbetterthanminedespiteinefficienciesandinequitiesthatmayinfesttheoptionprogram.“Ifitain’tbroke,don’tfixit”ispreferableto“purityatanyprice”.AtBerkshire,however,weuseanincentive@compensationsystemthatrewardskeymanagersformeetingtargetsintheirownbailiwicks.IfSee’sdoeswell,thatdoesnotproduceincentivecompensationattheNewsandsomenowhavelargeholdings.Byacceptingboththerisksandthecarryingcoststhatgowithoutrightpurchases,thesemanagerstrulywalkintheshoesofowners.Nowlet’sgetbacktoourthreebusinesses:AtNebraskaFurnitureMartourbasicstrengthisanexceptionallylow-costoperationthatallowsthebusinesstoregularlyoffercustomersthebestvaluesavailableinhomefurnishings.NFMisthelargeststoreofitskindinthecountry.Althoughthealready-depressedfarmeconomyworsenedconsiderablyin1985,thestoreeasilysetanewsalesrecord.IalsoamhappytoreportthatNFM’sChairman,RoseBlumkin(thelegendary“Mrs.B”),continuesatage92tosetapaceatthestorethatnoneofuscankeepupwith.She’stherewheelinganddealingsevendaysaweek,andIhopethatanyofyouwhovisitOmahawillgoouttotheMartandseeherinaction.Itwillinspireyou,asitdoesme.AtSee’swecontinuetogetstorevolumesthatarefarbeyondthoseachievedbyanycompetitorweknowof.Despitetheunmatchedconsumeracceptanceweenjoy,industrytrendsarenotgood,andwecontinuetoexperienceslippageinpoundagesalesonasame-storebasis.Thisputspressureonper-poundcosts.Wenowarewillingtoincreasepricesonlymodestlyand,unlesswecanstabilizeper-shoppoundage,profitmarginswillnarrow.AttheNewsvolumegainsarealsodifficulttoachieve.Thoughlinageincreasedduring1985,thegainwasmorethanaccountedforbypreprints.ROPlinage(advertisingprintedonourownpages)declined.PreprintsarefarlessprofitablethanROPads,andalsomorevulnerabletocompetition.In1985,theNewsagaincontrolledcostswellandourhouseholdpenetrationcontinuestobeexceptional.Oneproblemthesethreeoperationsdonothaveismanagement.AtSee’swehaveChuckHuggins,themanweputinchargethedayweboughtthebusiness.Selectinghimremainsoneofourbestbusinessdecisions.AttheNewswehaveStanLipsey,amanagerofequalcaliber.Stanhasbeenwithus17years,andhisunusualbusinesstalentshavebecomemoreevidentwitheveryadditionallevelofresponsibilityhehastackled.And,attheMart,wehavetheamazingBlumkinsathree-generationmiracleofmanagement.Iconsidermyselfextraordinarilyluckytobeabletoworkwithmanagerssuchasthese.IlikethempersonallyasmuchasIadmirethemprofessionally.InsuranceOperationsShownbelowisanupdatedversionofourusualtable,listingtwokeyfiguresfortheinsuranceindustry:YearlyChangeCombinedRatioinPremiumsafterPolicyholderWritten(%)Dividends197210.296.219738.099.219746.2105.4197511.0107.9197621.9102.4197719.897.2197812.897.5197910.3100.619806.0103.119813.9106.019824.4109.719834.5111.91984(Revised)9.2117.91985(Estimated)...20XX118.0Source:Best’sAggregatesandAveragesThecombinedratiorepresentstotalinsurancecosts(lossesincurredplusexpenses)comparedtorevenuefrompremiums:aratiobelow100indicatesanunderwritingprofit,andoneabove100indicatesaloss.Theindustry’s1985resultswerehighlyunusual.Therevenuegainwasexceptional,andhadinsuredlossesgrownattheirnormalrateofmostrecentyearsasignificantdropinthecombinedratiowouldhaveoccurred.Butlossesin1985didn’tcooperate,astheydidnotin1984.Thoughinflationslowedconsiderablyintheseyears,insuredlossesperverselyaccelerated,growingby16%in1984andbyanevenmorestartling17%in1985.Theyear’sgrowthinlossesthereforeexceedstheinflationratebyover13percentagepoints,amodernrecord.Catastropheswerenottheculpritinthisexplosionoflosscost.True,therewereanunusualnumberofhurricanesin1985,buttheaggregatedamagecausedbyallcatastrophesin1984and1985wasabout2%ofpremiumvolume,anotunusualproportion.Norwasthereanyburstinthenumberofinsuredautos,houses,employers,orotherkindsof“exposureunits”.Apartialexplanationforthesurgeinthelossfiguresisalltheadditionstoreservesthattheindustrymadein1985.Asresultsfortheyearwerereported,thesceneresembledarevivalmeeting:shouting“I’vesinned,I’vesinned”,insurancemanagersrushedforwardtoconfesstheyhadunderreservedinearlieryears.Theircorrectionssignificantlyaffected1985lossnumbers.Amoredisturbingingredientinthelosssurgeistheaccelerationin“social”or“judicial”inflation.Theinsurer’sabilitytopayhasassumedoverwhelmingimportancewithjuriesandjudgesintheassessmentofbothliabilityanddamages.Moreandmore,“thedeeppocket”isbeingsoughtandfound,nomatterwhatthepolicywording,thefacts,ortheprecedents.Thisjudicialinflationrepresentsawildcardintheindustry’sfuture,andmakesforecastingdifficult.Nevertheless,theshort-termoutlookisgood.Premiumgrowthimprovedas1985wentalong(quarterlygainswereanestimated15%,19%,24%,and22%)and,barringasupercatastrophe,theindustry’scombinedratioshouldfallsharplyin1986.Theprofitimprovement,however,islikelytobeofshortduration.Twoeconomicprincipleswillseetothat.First,commoditybusinessesachievegoodlevelsofprofitabilityonlywhenpricesarefixedinsomemannerorwhencapacityisshort.Second,managersquicklyaddtocapacitywhenprospectsstarttoimproveandcapitalisavailable.Inmy1982reporttoyou,Idiscussedthecommoditynatureoftheinsuranceindustryextensively.Thetypicalpolicyholderdoesnotdifferentiatebetweenproductsbutconcentratesinsteadonprice.Formanydecadesacartel-likeprocedurekeptpricesup,butthisarrangementhasdisappearedforgood.Theinsuranceproductnowispricedasanyothercommodityforwhichafreemarketexists:whencapacityistight,priceswillbesetremuneratively;otherwise,theywillnotbe.Capacitycurrentlyistightinmanylinesofinsurancethebestintheindustryandwho,in1985,couldnotcollectonmanyoftheirIOUs.ThesebuyerstodayareattractedtoBerkshirebecauseofitsstrongcapitalposition.But,inadevelopmentwedidnotforesee,wealsoarefindingbuyersdrawntousbecauseourabilitytoinsuresubstantialriskssetsusapartfromthecrowd.Tounderstandthispoint,youneedafewbackgroundfactsaboutlargerisks.Traditionally,manyinsurershavewantedtowritethiskindofbusiness.However,theirwillingnesstodosohasbeenalmostalwaysbaseduponreinsurancearrangementsthatallowtheinsurertokeepjustasmallportionoftheriskitselfwhilepassingon(“layingoff”)mostoftherisktoitsreinsurers.Imagine,forexample,adirectorsandofficers(“D&O”)liabilitypolicyproviding$25millionofcoverage.Byvarious“excess-of-loss”reinsurancecontracts,thecompanyissuingthatpolicymightkeeptheliabilityforonlythefirst$1millionofanylossthatoccurs.Theliabilityforanylossabovethatamountupto$24millionwouldbebornebythereinsurersoftheissuinginsurer.Intradeparlance,acompanythatissueslargepoliciesbutretainsrelativelylittleoftheriskforitsownaccountwritesalargegrosslinebutasmallnetline.Inanyreinsurancearrangement,akeyquestionishowthepremiumspaidforthepolicyshouldbedividedamongthevarious“layers”ofrisk.InourD&Opolicy,forexample.whatpartofthepremiumreceivedshouldbekeptbytheissuingcompanytocompensateitfairlyfortakingthefirst$1millionofriskandhowmuchshouldbepassedontothereinsurerstocompensatethemfairlyfortakingtheriskbetween$1millionand$25million?OnewaytosolvethisproblemmightbedeemedthePatrickHenryapproach:“Ihavebutonelampbywhichmyfeetareguided,andthatisthelampofexperience.”Inotherwords，howmuchofthetotalpremiumwouldreinsurershaveneededinthepasttocompensatethemfairlyforthelossestheyactuallyhadtobear?Unfortunately,thelampofexperiencehasalwaysprovidedimperfectilluminationforreinsurersbecausesomuchoftheirbusinessis“long-tail”,meaningittakesmanyyearsbeforetheyknowwhattheirlossesare.Lately,however,thelighthasnotonlybeendimbutalsogrosslymisleadingintheimagesithasrevealed.Thatis,thecourts’tendencytograntawardsthatarebothhugeandlackinginprecedentmakesreinsurers’usualextrapolationsorinferencesfrompastdataaformulafordisaster.OutwithPatrickHenryandinwithPogo:“Thefutureain’twhatitusedtobe.”Theburgeoninguncertaintiesofthebusiness,coupledwiththeentryintoreinsuranceofmanyunsophisticatedparticipants,workedinrecentyearsinfavorofissuingcompanieswritingasmallnetline:theywereabletokeepafargreaterpercentageofthepremiumsthantherisk.Bydoingso,theissuingcompaniessometimesmademoneyonbusinessthatwasdistinctlyunprofitablefortheissuingandreinsuringcompaniescombined.(Thisresultwasnotnecessarilybyintent:issuingcompaniesgenerallyknewnomorethanreinsurersdidabouttheultimatecoststhatwouldbeexperiencedathigherlayersofrisk.)Inequitiesofthissorthavebeenparticularlypronouncedinlinesofinsuranceinwhichmuchchangewasoccurringandlossesweresoaring;e.g.,professionalmalpractice,D&0,productsliability,etc.Giventhesecircumstances,itisnotsurprisingthatissuingcompaniesremainedenthusiasticaboutwritingbusinesslongafterpremiumsbecamewoefullyinadequateonagrossbasis.Anexampleofjusthowdisparateresultshavebeenforissuingcompaniesversustheirreinsurersisprovidedbythe1984financialsofoneoftheleadersinlargeandunusualrisks.Inthatyearthecompanywroteabout$6billionofbusinessandkeptaround$21/2billionofthepremiums,orabout40%.Itgavetheremaining$31/2billiontoreinsurers.Onthepartofthebusinesskept,thecompany’sunderwritinglosswaslessthan$20XXmillionbutitneveragainsatonacoldstove,either.Reinsurershavehadsomanyunpleasantsurprisesinlong-tailcasualtylinesthatmanyhavedecided(probablycorrectly)togiveupthegameentirely,regardlessofpriceinducements.Consequently,therehasbeenadramaticpull-backofreinsurancecapacityincertainimportantlines.Thisdevelopmenthasleftmanyissuingcompaniesunderpressure.Theycannolongercommittheirreinsurers,timeaftertime,fortensofmillionsperpolicyastheysoeasilycoulddoonlyayearortwoago,andtheydonothavethecapitaland/orappetitetotakeonlargerisksfortheirownaccount.Formanyissuingcompanies,grosscapacityhasshrunkmuchclosertonetcapacityalthough,justashortwhileago,manywerewillingtolosefiveortentimesthatamountaslongasvirtuallyallofthelosswasfortheaccountoftheirreinsurers.Inmid-1985ourlargestinsurancecompany,NationalIndemnityCompany,broadcastitswillingnesstounderwritelargerisksbyrunninganadinthreeissuesofaninsuranceweekly.Theadsolicitedpoliciesofonlylargesize:thosewithaminimumpremiumof$1million.Thisaddrewaremarkable600repliesandultimatelyproducedpremiumstotalingabout$50million.(Holdtheapplause:it’salllong-tailbusinessanditwillbeatleastfiveyearsbeforeweknowwhetherthismarketingsuccesswasalsoanunderwritingsuccess.)Today,ourinsurancesubsidiariescontinuetobesoughtoutbybrokerssearchingforlargenetcapacity.AsIhavesaid,thisperiodoftightnesswillpass;insurersandreinsurerswillreturntounderpricing.Butforayearortwoweshoulddowellinseveralsegmentsofourinsurancebusiness.MikeGoldberghasmademanyimportantimprovementsintheoperation(priormismanagementbyyourChairmanhavingprovidedhimampleopportunitytodoso).Hehasbeenparticularlysuccessfulrecentlyinhiringyoungmanagerswithexcellentpotential.Theywillhaveachancetoshowtheirstuffin1986.Ourcombinedratiohasimprovedbutcontinuestoreflectpastmisdeeds.LastyearItoldyouofthemajormistakesIhadmadeinloss-reserving，andpromisedIwouldupdateyouannuallyonloss-developmentfigures.Naturally,Imadethispromisethinkingmyfuturerecordwouldbemuchimproved.Sofarthishasnotbeenthecase.Detailsonlastyear’slossdevelopmentareonpages50-52.Theyrevealsignificantunderreservingattheendof1984,astheydidintheseveralyearspreceding.Theonlybrightspotinthispictureisthatvirtuallyalloftheunderreservingrevealedin1984occurredinthereinsuranceareatheExcept-ForInsuranceCompanynamely,thattherealmistakeisnottheact,buttheactor.Inevitably,ofcourse,businesserrorswilloccurandthewisemanagerwilltrytofindtheproperlessonsinthem.Butthetrickistolearnmostlessonsfromtheexperiencesofothers.Managerswhohavelearnedmuchfrompersonalexperienceinthepastusuallyaredestinedtolearnmuchfrompersonalexperienceinthefuture.GEICO,38%-ownedbyBerkshire,reportedanexcellentyearin1985inpremiumgrowthandinvestmentresults,butapooryearinunderwriting.Privatepassengerautoandhomeownersinsuranceweretheonlyimportantlinesintheindustrywhoseresultsdeterioratedsignificantlyduringtheyear.GEICOdidnotescapethetrend,althoughitsrecordwasfarbetterthanthatofvirtuallyallitsmajorcompetitors.JackByrneleftGEICOatmid-yeartoheadFireman’sFund,leavingbehindBillSnyderasChairmanandLouSimpsonasViceChairman.Jack’sperformanceinrevivingGEICOfromnear-bankruptcywastrulyextraordinary,andhisworkresultedinenormousgainsforBerkshire.Weowehimagreatdealforthat.WeareequallyindebtedtoJackforanachievementthateludesmostoutstandingleaders:hefoundmanagerstosucceedhimwhohavetalentsasvaluableashisown.Byhisskillinidentifying,attractinganddevelopingBillandLou,Jackextendedthebenefitsofhismanagerialstewardshipwellbeyondhistenure.Fireman’sFundQuota-ShareContractNeveronetoletgoofamealticket,wehavefollowedJackByrnetoFireman’sFund(“FFIC”)whereheisChairmanandCEOoftheholdingcompany.OnSeptember1,1985webecamea7%participantinallofthebusinessinforceoftheFFICgroup,withtheexceptionofreinsurancetheywriteforunaffiliatedcompanies.Ourcontractrunsforfouryears,andprovidesthatourlossesandcostswillbeproportionatetotheirsthroughoutthecontractperiod.Ifthereisnoextension,wewillthereafterhavenoparticipationinanyongoingbusiness.However,foragreatmanyyearsinthefuture,wewillbereimbursingFFICforour7%ofthelossesthatoccurredintheSeptember1,1985andeventhought,itselfwhetheritbebridge,chess,orstockselectionthantohaveopponentswhohavebeentaughtthatthinkingisawasteofenergy?)Through1973and1974,WPCcontinuedtodofineasabusiness,andintrinsicvaluegrew.Nevertheless,byyearend1974ourWPCholdingshowedalossofabout25%,withmarketvalueat$8millionagainstourcostof$10.6million.Whatwehadthoughtridiculouslycheapayearearlierhadbecomeagoodbitcheaperasthemarket,initsinfinitewisdom,markedWPCstockdowntowellbelow20XXentsonthedollarofintrinsicvalue.Youknowthehappyoutcome.KayGraham,CEOofWPC,hadthebrainsandcouragetorepurchaselargequantitiesofstockforthecompanyatthosebargainprices,aswellasthemanagerialskillsnecessarytodramaticallyincreasebusinessvalues.Meanwhile,investorsbegantorecognizetheexceptionaleconomicsofthebusinessandthestockpricemovedclosertounderlyingvalue.Thus,weexperiencedatripledip:thecompany’sbusinessvaluesoaredupward,per-sharebusinessvalueincreasedconsiderablyfasterbecauseofstockrepurchasesand,withanarrowingofthediscount,thestockpriceoutpacedthegaininper-sharebusinessvalue.WeholdalloftheWPCsharesweboughtin1973,exceptforthosesoldbacktothecompanyin1985’sproportionateredemption.Proceedsfromtheredemptionplusyearendmarketvalueofourholdingstotal$221million.Ifwehadinvestedour$10.6millioninanyofahalf-dozenmediacompaniesthatwereinvestmentfavoritesinmid-1973,thevalueofourholdingsatyearendwouldhavebeenintheareaof$40ineffect,aparkingplaceformoney(thoughnotatotallysafeone,sincedealssometimesfallthroughandcreatesubstantiallosses).Wesometimesenterthearbitragefieldwhenwehavemoremoneythanideas,butonlytoparticipateinannouncedmergersandsales.Wewouldbealothappierifthefundscurrentlyemployedonthisshort-termbasisfoundalong-termhome.Atthemoment,however,prospectsarebleak.Atyearendourinsurancesubsidiarieshadabout$400millionintax-exemptbonds,ofwhich$194millionatamortizedcostwereissuesofWashingtonPublicPowerSupplySystem(“WPPSS”)Projects1,2,and3.1discussedthispositionfullylastyear,andexplainedwhywewouldnotdisclosefurtherpurchasesorsalesuntilwellafterthefact(adheringtothepolicywefollowonstocks).OurunrealizedgainontheWPPSSbondsatyearendwas$62million,perhapsone-thirdarisingfromtheupwardmovementofbondsgenerally,andtheremainderfromamorepositiveinvestorviewtowardWPPSS1,2,and3s.Annualtax-exemptincomefromourWPPSSissuesisabout$30million.CapitalCities/ABC,Inc.Rightafteryearend,Berkshirepurchased3millionsharesofCapitalCities/ABC,Inc.(“CapCities”)at$172.50pershare,themarketpriceofsuchsharesatthetimethecommitmentwasmadeearlyinMarch,1985.I’vebeenonrecordformanyyearsaboutthemanagementofCapCities:Ithinkitisthebestofanypublicly-ownedcompanyinthecountry.AndTomMurphyandDanBurkearenotonlygreatmanagers,theyarepreciselythesortoffellowsthatyouwouldwantyourdaughtertomarry.Itisaprivilegetobeassociatedwiththemand,thus,forourselvesasownersbut,inmakinginvestments,wetrytosteerclearofthistype.)Today,corporateinstabilityisaninevitableconsequenceofwidely-diffusedownershipofvotingstock.Atanytimeamajorholdercansurface,usuallymouthingreassuringrhetoricbutfrequentlyharboringuncivilintentions.Bycircumscribingourblocksofstockasweoftendo,weintendtopromotestabilitywhereitotherwisemightbelacking.Thatkindofcertainty,combinedwithagoodmanagerandagoodbusiness,providesexcellentsoilforarichfinancialharvest.That’stheeconomiccaseforourarrangements.Thehumansideisjustasimportant.Wedon’twantmanagerswelikeandadmiretoeverloseanysleepwonderingwhethersurprisesmightoccurbecauseofourlargeownership.Ihavetoldthemtherewillbenosurprises,andtheseagreementsputBerkshire’ssignaturewheremymouthis.ThatsignaturealsomeansthemanagershaveacorporatecommitmentandthereforeneednotworryifmypersonalparticipationinBerkshire’saffairsendsprematurely(atermIdefineasanyageshortofthreedigits).OurCapCitiespurchasewasmadeatafullprice,reflectingtheveryconsiderableenthusiasmforbothmediastocksandmediapropertiesthathasdevelopedinrecentyears(andthat,inthecaseofsomepropertypurchases,hasapproachedamania).it’snofieldforbargains.However,ourCapCitiesinvestmentalliesuswithanexceptionalcombinationofpropertiesandpeopleunderstandable,large,well-managed,agoodearner.Thecompanyhassalesofabout$700millionderivedfrom17businesses,manyleadersintheirfields.Returnoninvestedcapitalisgoodtoexcellentformostofthesebusinesses.Somewell-knownproductsareKirbyhome-caresystems,CampbellHausfeldaircompressors,andWayneburnersandwaterpumps.WorldBook,Inc.isbyfarthecompany’slargestoperation.Italsoisbyfartheleaderinitsindustry,sellingmorethantwiceasmanyencyclopediasetsannuallyasitsnearestcompetitor.Infact,itsellsmoresetsintheU.S.thanitsfourbiggestcompetitorscombined.CharlieandIhaveaparticularinterestintheWorldBookoperationbecauseweregarditsencyclopediaassomethingspecial.I’vebeenafan(anduser)for25years,andnowhavegrandchildrenconsultingthesetsjustasmychildrendid.WorldBookisregularlyratedthemostusefulencyclopediabyteachers,librariansandconsumerbuyingguides.Yetitsellsforlessthananyofitsmajorcompetitors.Childcraft,anotherWorldBook,Iduct,offerssimilarvalue.ThiscombinationofexceptionalproductsandmodestpricesatWorldBook,Inc.helpedmakeuswillingtopaythepricedemandedforScottFetzer,despitedecliningresultsformanycompaniesinthedirect-sellingindustry.AnequalattractionatScottFetzerisRalphSchey,itsCEOfornineyears.WhenRalphtookcharge,thecompanyhad31businesses,theresultofanacquisitionspreeinthe1960s.Hedisposedofmanythatdidnotfitorhadlimitedprofitpotential,buthisfocusonrationalizingtheoriginalpotpourriwasnotsointensethathepassedbyWorldBookwhenitbecameavailableforpurchasein1978.Ralph’soperatingandcapital-allocationrecordissuperb,andwearedelightedtobeassociatedwithhim.ThehistoryoftheScottFetzeracquisitionisinteresting,markedbysomezigsandzagsbeforewebecameinvolved.Thecompanyhadbeenanannouncedcandidateforpurchasesinceearly1984.Amajorinvestmentbankingfirmspentmanymonthscanvassingscoresofprospects,evokinginterestfromseveral.Finally,inmid-1985aplanofsale,featuringheavyparticipationbyanESOP(EmployeeStockOwnershipPlan),wasapprovedbyshareholders.However,asdifficultyinclosingfollowed,theplanwasscuttled.Ihadfollowedthiscorporateodysseythroughthenewspapers.OnOctober10,wellaftertheESOPdealhadfallenthrough,IwroteashortlettertoRalph,whomIdidnotknow.Isaidweadmiredthecompany’srecord