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WARREN BUFFETT

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ValueWalk
2015 - All rights Reserved
Charlie
Munger

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WARREN BUFFETT

PART ONE

(C)
ValueWalk
2015 - All rights Reserved
Charlie
Munger

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WARREN BUFFETT

The First Partnership
Following the my last ten part series on the life and career of Charlie Munger, Vice-Chairman of Berkshire Hathaway
Corporation and Warren Buffett’s right hand man, in this series I’m taking a look at Warren Buffett’s early career.
Before Warren Buffett became well-known, and before he acquired Berkshire Hathaway Inc. (NYSE:BRK.A)
(NYSE:BRK.B), he ran a number of partnerships, investing the money of family, friends and outside investors. It’s
these partnerships that helped build his reputation and provided the funds for him to ultimately acquire Berkshire
Hathaway.
This is the story of Warren Buffett’s early career, the years that laid the foundations for him to become the world’s
greatest investor.

Warren Buffett -- Part one: The First Partnership
In 1952, Warren Buffett went to work with the godfather of value investing, Benjamin Graham at the GrahamNewman partnership. Here, Warren Buffett put his education from the Columbia University to work and learnt his
trade as a value investor.
Unfortunately, Graham-Newman partnership closed its doors during 1956 so Buffett, took his savings (around
$174,000) and started the first Buffett Partnership Ltd in Omaha.
When he first set out to invest money for others, Warren Buffett knew that he wouldn’t be able to stand criticism from
his partners if stocks he selected started to fall. As Buffett was going to be the sole manager of the partnerships run
by Buffett Partnership Ltd., there was nowhere to hide if he failed. With this being the case, Buffett only invited family
and friends to invest in his first partnership -- Buffett Associates, Ltd.
In total, six other partners, plus Warren Buffett invested in Buffett Associates, Ltd. raising $105,100 in capital.
Two more partnerships were set up in the months after Buffett Associates, Ltd. started trading bringing the total
number of partnerships controlled by Buffett to three by the end of 1956.

On September 1st, 1956, he raised $120,000 from Homer Dodge, a physics professor who had attended Har
vard University. With it, Buffett setup Buffett Fund, Ltd.



Then, on October 1, 1956, Warren founded another partnership for a friend of his, John Cleary, who was
his father’s secretary in Congress. (Buffett’s father served in the House of Representatives.) It had $55,000
in capital.

These partnerships immediately made money for investors in their first full year of trading. As Warren Buffett wrote
in his second annual letter to limited partners at the end of 1957:
“In 1957 the three partnerships which we formed in 1956 did substantially better than the
general market. At the beginning of the year, the Dow-Jones Industrials stood at 499 and at
the end of the year it was at 435 for a loss of 64 points. If one had owned the Averages, he
would have received 22 points in dividends reducing the overall loss to 42 points or 8.470%...

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ValueWalk
2015 - All rights Reserved
Charlie
Munger

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WARREN BUFFETT
All three of the 1956 partnerships showed a gain during the year amounting to about
6.2%, 7.8% and 25% on year end 1956 net worth. Naturally a question is created as to
the vastly superior performance of the last partnership, particularly in the mind of the
partners of the first two. This performance emphasizes the importance of luck in the
short run, particularly in regard to when funds are received. The third partnership was
started [in late] 1956 when the market was at a lower level and when several securities
were particularly attractive. Because of the availability of funds, large positions were
taken in these issues. Whereas the two partnerships formed earlier were already substantially invested so that they could only take relatively small positions in these issues.”
-- Warren Buffett annual letter to partners
All three partnerships held the same securities with similar weightings. I’ll cover the stocks Warren was buying later
in the series.

Three types of trade
It’s here that I should introduce Warren Buffett’s early trading strategies.
Buffett had three main strategies: Firstly, Buffett has his “generals”, which were usually undervalued securities where
he had nothing to say about corporate policies. Typical value plays in other words. Generals made up the bulk of Buffett’s portfolio.
Then there were the “work-outs”, undervalued securities where corporate action was required for the market imbalance to correct itself. And finally the “control” situations where Buffett aimed to influence policies of the company
in order to unlock value. In a number of cases, Buffett’s generals and work-outs quickly turned into control situations
when Buffett either ran out of patience or decided that management had to go.
“At the end of 1956, we had a ratio of about 70-30 between general issues and workouts. Now it is about 85-15. During the past year we have taken positions in two situations which have reached a size where we may expect to take some part in corporate
decisions. One of these positions accounts for between 10% and 20% of the portfolio
of the various partnerships and the other accounts for about 5%. Both of these will
probably take in the neighborhood of three to five years of work but they presently
appear to have potential for a high average annual rate of return with a minimum of
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2015 - All rights Reserved
Charlie
Munger

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Warren charged no fee for the management of this partnership. If there were a loss. What’s more. it was unlimited. The compensation structure for Warren Buffett’s partnerships was fairly simple. they have very little dependence on the general action of the stock market. Investors received 6% interest on their money from the partnership and 75% of profits above this threshold.Warren Buffett 1957 annual letter to partners. Should the general market have a substantial rise. That means that even if Buffet broke even. Buffett’s obligation to pay back losses was not limited to his capital. Buffett also had a little partnership with his father.WARREN BUFFETT risk. I would expect this section of our portfolio to lag behind the action of the market. Buffett took 25% of it himself.” -.All rights Reserved Charlie Munger 5 5 . (C) ValueWalk 2015 . of course. called Buffett & Buffett. he lost money. While not in the classification of work-outs.

WARREN BUFFETT PART TWO (C) ValueWalk 2015 .All rights Reserved Charlie Munger 6 .

000 for themselves and their three children.WARREN BUFFETT Expanding Warren Buffett’s first three partnerships. but it will be all we can do to keep pace with a rising market.000. Ltd. with $85. but these are very difficult to find on the right terms.5%.2%. As a result. Dan Monen and his wife. Eddie Davis and his wife Dorothy Davis had Buffett manage $100.5% from the Dow-Jones unit. formed the basis of Warren’s next partnership.7% to 46. which benefit very little from a fast-rising market. Warren Buffett was struggling to find opportunities. 1956 outperformed the market significantly during their early years and attracted plenty of attention.7% to 46. 1958. I will continue to forecast that our results will be above average in a declining or level market. called Mo-Buff. which was called Dacee.” -. The year after. Warren Buffett started his fifth partnership. So. The five partnerships that were in operation during 1958 posted returns of 36. on May 5. They put in $70. Based on market values at the end of both years. the fewer the undervalued securities and I am finding some difficulty in securing an adequate number of attractive investments. to meet demand during June of 1957.000. set up during. Considering the fact that a substantial portion of assets has been and still is invested in securities.All rights Reserved Charlie Munger 7 7 . I believe these results are reasonably good. (C) ValueWalk 2015 . Then. As Buffett wrote in his annual letter to partners at the end of 1958: “The latter sentence describes the type of year we had in 1958 and my forecast worked out. Elizabeth Peters.2%. their gains ranged from 36. 1957. I would prefer to increase the percentage of our assets in work-outs. Warren Buffett However. and it’s at this point that his investing methods started to take on an activist style.Warren Buffett 1958 annual letter to partners. “THE CURRENT SITUATION The higher the level of the market. more potential investors began to approach Warren and ask him to manage their money. on August 5. with the market rising. The five partnerships that operated throughout the entire year obtained results averaging slightly better than this 38. with one of the original partners of Buffett Associates. after adding back dividends of about 20 points. The Dow-Jones Industrial average advanced from 435 to 583 which. gave an overall gain of 38.. Mary Ellen. Buffett started another partnership calledUnderwood.

(This was written to inform several new Buffett partners what they should expect when investing in the partnerships.5% of the combined partnerships due to his performance. Over a period of time there are going to be good and bad years. it will be through better-than-average performance in stable or declining markets and average.085 and owned approximately 9. as covered within the first part of this series. I would consider a year in which we declined 15% and the Average 30% to be much superior to a year when both we and the Average advanced 20%. How was Buffett going to achieve this goal? By not losing money. will more or less parallel the results of leading investment companies.I have pointed out that any superior record which we might accomplish should not be expected to be evidenced by a relatively constant advantage in performance compared to the Average. (C) ValueWalk 2015 . over a period of years.) “.. by 1959. Warren Buffett knew and understood that his focus should be to outperform the leading indexes on a long-term time horizon. I am attempting to create my own work-outs by acquiring large positions in several undervalued securities…” -. of $83. Unless we do achieve this superior performance there is no reason for existence of the partnerships.Warren Buffett 1960 letter to partners. there is nothing to be gained by getting enthused or depressed about the sequence in which they occur. Based on the compensation structure.. Compounding growth From the outset. I believe this Average. and some of my known limitations…” -. a four on a par three hole is not as good as a five on a par five hole and it is unrealistic to assume we are not going to have our share of both par three’s and par five’s.WARREN BUFFETT To the extent possible.than-average performance in rising markets. or perhaps even poorer. had earned fees. who had only contributed $100 to each partnership. The above dose of philosophy is being dispensed since we have a number of new partners this year and I want to make sure they understand my objectives. Here’s an extremely valuable piece of advice from the Sage of Omaha. therefore. Buffett. Rather it is likely that if such an advantage is achieved.Warren Buffett 1960 letter to partners. “My continual objective in managing partnership funds is to achieve a long-term performance record superior to that of the Industrial Average.All rights Reserved Charlie Munger 8 .000 contributed by a local businessman and two sons in one of Omaha’s most prominent families. The seventh Buffett partnership was called Glenoff and consisted of $50. The important thing is to be beating par. counting reinvested earnings.” -.Warren Buffett 1958 annual letter to partners. my measure of attainment of these objectives. It was established in February of 1959. to any investors just starting out.

All rights Reserved Charlie Munger 9 .WARREN BUFFETT (C) ValueWalk 2015 .

WARREN BUFFETT PART THREE (C) ValueWalk 2015 .All rights Reserved Charlie Munger 10 .

During the first half of 1951..All rights Reserved Charlie Munger 11 . By 1960.7% [for the sector average]. Early recommendation At only 20 years of age. In his trademark style. The article was titled “The Security I Like Best” and was published on Thursday. a poor year for the industry. 1951.71 on the smaller amount of business in 1949. with a large portion of partnership assets. GEICO’s valuation did not reflect: “the tremendous growth potential of the company. But he was also recommending investments as early as 1951. GEICO qualifies as a legitimate growth company…” “Probably the biggest attraction of GEICO is the profit margin advantage it enjoys. Buffett was pitching the Government Employees Insurance Company. the then unknown Warren Buffett penned an article that was published in the Commercial and Financial Chronicle.. Buffett had seven partnerships operating and had produced a cumulative return for partners of 141% over three years from 1957 to 1960. it appears that no price is being paid for the tremendous growth potential of the company.Whereas GEICO’s profit margin was cut to slightly above 9%.. Warren Buffett details some of his biggest investments at the time in his letters to partners of the Buffett Partnerships.5% for GEICO as compared to 6. December 6.. but the wave of rate increases during the past summer should evidence themselves in 1952 earnings. his investing prowess really started to show through. Buffett would buy a large percentage of his target company..92 as contrasted to $4.. Earnings in 1951 will be lower than 1950. The ratio of underwriting profit to premiums earned in 1949 was 27. Buffett recognized the fact that.” “Earnings in 1950 amounted to $3. at only eight times earnings. or GEICO that had gone public three years before.” (C) ValueWalk 2015 . These figures include no allowance for the increase in the unearned premium reserve which was substantial in both years. practically all insurers operated in the red on casualty lines.” “The term “growth company” has been applied with abandon during the past few years to companies whose sales increases represented little more than inflation of price and general easing of business competition. isolating his good ideas and reaping the rewards as their valuations returned to normal levels. These returns were generated by using a combination of deep value.WARREN BUFFETT GEICO As more investors flocked to Warren Buffett’s partnerships during the late 50s and early 60s. from 1956 onwards. and activist investing. reflecting the growth of the company’s assets.” “At the present price of about eight times the earnings of 1950. Investment income quadrupled between 1947 and 1950.

he was still able to sniff out a bargain in the market and conduct the rigorous. GEICO’s valuation did not reflect: “the tremendous growth potential of the company. Warren Buffett pumped around 65% of his own personal wealth (around $13. at only eight times earnings. Within a year-and-a-half of Buffett’s initial purchase. until several decades after. but it certainly wasn’t the last. Even though he was only 20 at the time. (C) ValueWalk 2015 . This article gives an invaluable insight into Warren Buffett’s investment process.” This was the first time that Buffett wrote about GEICO.000) into GEICO stock and he later wrote that with GEICO he was able to “develop a depth of conviction which I have felt few times since about any security”. Buffett was pitching the Government Employees Insurance Company. However.WARREN BUFFETT You can find the whole article here.All rights Reserved Charlie Munger 12 . though Buffett owned GEICO in his personal accounts as early as 1951. There’s no mention of GEICO in Buffett’s letters to partners from 1956 to 1970. the then unknown Warren Buffett penned an article that was published in the Commercial and Financial Chronicle. The article was titled “The Security I Like Best” and was published on Thursday. No mention At only 20 years of age. GEICO’s share price doubled as growth continued. December 6. or GEICO that had gone public three years before. 1951. but simplistic analysis that he has become so well known for over his career. Buffett recognized the fact that. he didn’t start buying the stock for his partnerships or Berkshire.

issued $75 million in convertible preferred stock. hiked rates by as much as 40% in some regions and tightened its insurance criteria. It was at this point that Warren Buffett started buying GEICO common at $2 per share. David Byrne was poached from GEICO’s fellow insurer. A combination of overexpansion. federal price controls. Buffett kept buying. The company withdrew from markets with overbearing regulatory regimes. even these drastic actions failed to shore up GEICO’s balance sheet. the company reported its first loss in 36 years. another renowned value investor. GEICO stock hit $15. bad risks and questionable accounting had floored GEICO.000 of GEICO’s 7. 3. Finally. Unfortunately. started buying.1 million. investing an initial sum of $4. and during 1975. specializing in insurance stocks. GEICO undertook a hefty restructuring in the years after 1975.WARREN BUFFETT Buffett makes his move Warren Buffett didn’t make his move on GEICO until it was teetering on the edge of bankruptcy. Travelers Insurance. He persuaded 27 competing insurance companies to contribute capital to help avert a GEICO bankruptcy.000 employees were laid off. inflation. in 1995 Berkshire purchased the rest of GEICO for a total of $70 a share. where he was executive vice president to initiate a turnaround. At was at this time that Shelby Davis. and along with the help of Warren Buffett.All rights Reserved Charlie Munger 13 . (C) ValueWalk 2015 . and David Byrne has to take drastic action. Five years later.

WARREN BUFFETT PART FOUR (C) ValueWalk 2015 .All rights Reserved Charlie Munger 14 .

the shares traded only around two times per month. It is obvious that we could still be sitting with $50 stock patiently buying in dribs and drabs. it’s Warren Buffett’s early investments that are really interesting. Last year I referred to our largest holding which comprised 10% to 20% of the assets of the various partnerships. A deal Buffett was pushed into by Charlie Munger. However. which made Buffett and his partners the bank’s second largest shareholder.WARREN BUFFETT Unlocking Value “So that you may better understand our method of operation. Indeed. so we sold our block of Commonwealth obtaining $80 per share although the quoted market was about 20% lower at the time. This change was inspired by the $25 million purchase of See’s Candies.” Warren Buffett letter to partners 1958 There’s a stark contrast between Warren Buffett’s early investments and those of later years. Buffett acquired around 12% of the bank at a price of $51 per share. during the latter half of 1958. many view Warren Buffett as a passive deep value investor. Buffett computed that the bank’s intrinsic value could rise to $250 per share. this was both a deep value and growth play. Commonwealth was trading at a measly five times earnings and had had an intrinsic value $125 per share computed on a conservative basis. Over time. Still. It was in 1972 that Warren Buffett’s strategy really started to change. from a deep value activist approach to that of long-term quality and value. “Late in the year we were successful in finding a special situation where we could become the largest holder at an attractive price. But that is not the case. which Buffett started buying during 1958. Granted. Buffett would devote most of his partners’ assets to one company. At $50 per share. who’s incredible skill (and possibly some luck) at picking investments helped him to get to where he is today.All rights Reserved Charlie Munger 15 . as the two investors started to become friends and build a strong working relationship. But Buffett wasn’t prepared to wait for the market to correct the valuation gap. approximately ten years. This situation was Commonwealth Bank. Over a period of 12 months. The year when a situation such at Commonwealth results in a realized profit is. Commonwealth Bank One of the first investments Warren Buffett wrote about wasn’t an activist situation. buy a controlling stake and then push for change. The bank only had around 300 shareholders in total. I think it would be well to review a specific activity of 1958. (C) ValueWalk 2015 . Warren Buffett sold his entire commonwealth holding. most of the companies he targeted were trading below their net asset value and were deep value opportunities anyway. to a great extent. and I would be quite happy with such a program although our performance relative to the market last year would have looked poor. So. Many of Buffett’s early successes were driven by activist tactics.

substantially higher earnings per share.in under a year -. and a potential corporate capital gains tax of over $1 million was eliminated. Warren Buffett managed to get his hands on a large chunk of 15. (C) ValueWalk 2015 .25 million in government and municipal bonds as a reserve fund.and started to gobble up the stock of another deep value opportunity. It’s here that it starts to become clear that Buffett’s success has not been wholly down to his stock selection strategies. Buffett hoped the situation would work out within a few years. Buffett was paying close attention to the index at the time.” A great example of Warren Buffett’s early activist activities. involving 50% of the 1.000 shares and pushed for change. to instigate change at the company.600 stockholders. the reason he took his gains in Commonwealth and snapped up another opportunity. Sanborn was a mapping company that had. Sanborn Map The other opportunity was a company called Sanborn Map and at the end of 1959.2%.5%.All rights Reserved Charlie Munger 16 . the trade is well documented so I won’t go into too much detail here. As I said above.70 on the dollar. over the years. I believe that a program of investing in such undervalued well protected securities offers the surest means of long term profits in securities. and during 1960 he was proved right. To avoid a proxy fight. The map business was left with over $l. Warren Buffett had ploughed a total of 35% of partnership assets into Sanborn stock. “About 72% of the Sanborn stock. Through open market purchases. Her son had tried and failed. However.” In other words. Clearly. The company was separated.000 Sanborn shares from the widow of a deceased president of the company. outperforming the Dow-Jones Industrial Average. and an increased dividend rate. management caved. our performance for any single year has serious limitations as a basis for estimating long term results. Thus. was exchanged for portfolio securities at fair value. Sanborn had a sales volume of about $2 million per year and owned about $7 million worth of marketable securities. Buffett increased his holding to 24. The remaining stockholders were left with a slightly improved asset value. Buffett’s involvement in Commonwealth did have some impact on the bank’s stock price. He wanted to outperform.WARREN BUFFETT fortuitous. and value was unlocked. At the time Warren Buffett started buying Sanborn stock. during 1958. The five Buffett partnerships that were operating throughout the year gained between 36. and Buffett got his way. which returned 38. Buffett took his near 60% return -.7% to 46. Warren Buffett’s Sanborn trade (I consider Sanborn to be a short-term trade rather than the long-term investments Buffett has become known for) is well documented. built a sizeable equity and bond portfolio with excess cash. the map business was evaluated at a minus $20 with the stock portfolio trading at only $0.

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coupled with Buffett’s conviction in his ideas that helped turbocharge returns over the years.” -. by his asset allocation strategy. the likes ofCarl Icahn and Bill Ackman. Charlie Munger. In fact. These investments could account for as much as a third (or more) of total partnership assets at any one time. it was this asset allocation strategy. Buffett was. Warren Buffett ploughed most of the assets of his partnerships into several key investments. from (C) ValueWalk 2015 . it’s unlikely that Buffett would have taken these large positions if it were not for the fact that he was trying to gain control of each company. as advocated by his mentor. Indeed. Michael J. who won most regularly after he had learned to assign virtually all playing time to his seven best players. Position sizing Indeed. He writes that: “Position size is extremely important in determining equity portfolio returns.somethingI’ll explore in part six of this series. Sanborn Map. Mauboussin has written an interesting paper on position sizing. using the winning method of the famous basketball coach. As Charlie Munger says. John Wooden. rather than Graham alumni and Superinvestors of Graham-and-Doddsville. in effect. Activist investor If Warren Buffett had used a traditional asset allocation model. in every case where more than a fifth of partnership assets were pumped into one stock. Buffett sought to take control of the company to unlock value -. I don’t really have enough space to explore the topic in full here but if you’re looking for further research on the topic. Great investors don’t stop with finding attractive investment opportunities. in part. Benjamin Graham would he have been able to achieve the same returns over his career? It is unlikely. they know how to take maximum advantage of the opportunities. As the quote from Warren Buffett’s right-hand man. This investing philosophy has more in common with activist investors. at the top of this article indicates.Charlie Munger Warren Buffett adopted the same mentality from an early age.Dempster Mill and Berkshire Hathaway. it could be said that Buffett was.All rights Reserved Charlie Munger 18 . Two portfolio managers with the same list and number of stocks can generate meaningfully different results based on how they allocate the capital among the stocks. throughout the late 50s and 60s.” Warren Buffett’s success over the years has been driven.WARREN BUFFETT A Lollapalooza “Buffett’s decision to limit his activities to a few kinds and to maximize his attention to them. and to keep doing so for 50 years. was a lollapalooza. Commonwealth Bank. That being said. Buffett succeeded for the same reason Roger Federer became good at tennis. It’s here that I’m going to deviate slightly from Warren Buffett’s history and look at the topic of asset allocation and position sizing in general. good investing combines patience and aggressive opportunism. This is extremely apparent in his early partnership letters.

and wrong. it’s mathematical. [farm price] volatility went up. (C) ValueWalk 2015 . an activist investor. Risk comes from not knowing what you’re doing. the size of the position as a percentage of overall assets shouldn’t matter. here’s a quote from Berkshire Hathaway’s 2007 annual meeting: “The measurement of volatility: it’s nice. And to understand Warren Buffett’s position sizing strategy you have to understand his perception of risk. Dexter Shoes was a terrible mistake-I was wrong about the business. but not because shoe prices were volatile.” -. Warren Buffett on risk John Maynard Keynes wrote in 1942 that: “To suppose that safety-first consists in having a small gamble in a large number of different [companies] where I have no information to reach a good judgment. but a farm priced at $600 per acre that was formerly $2.” What about Warren Buffett’s altered perception of risk? Well.WARREN BUFFETT the very start of his career. Those who have written about risk don’t know how to measure risk. If you understand the business you own. if you really know and understand the company you’re taking a position in.Warren Buffett To put it simply. I cannot recall a case where we lost a lot of money due to volatility. When farm prices crashed.000 per acre isn’t riskier because it’s more volatile.All rights Reserved Charlie Munger 19 . That’s nonsense. as compared with a substantial stake in a company where one’s information is adequate. Volatility is not risk. Volatility is useful for people who want a career in teaching. Past volatility does not measure risk. [Measures like] beta let people who teach finance use the math they’ve learned. strikes me as a travesty of investment policy. you’re not taking risk. The whole concept of volatility as a measure of risk has developed in my lifetime and isn’t any use to us.

WARREN BUFFETT PART SIX (C) ValueWalk 2015 .All rights Reserved Charlie Munger 20 .

00.8 billion.” Buffett notes that the generals tended to behave very much in sympathy with the Dow. when we will get how much and what might upset the applecart. liquidations. To celebrate this fact. the generals as a group put in the best performance over the long-term. Method of operation Warren Buffett notes that his method of operation is very different to that of mutual funds and he then goes on to break down the various categories of trades that he undertook for partners -.. within reasonable error limits. Tri -Continental Corporation about $ . “The first section consists of generally undervalued securities (hereinafter called “generals”) where we have nothing to say about corporate policies and no timetable as to when the undervaluation may correct itself. Warren Buffett presented the following chart in his annual 1961 letter to partners.5 billion. the Massachusetts Investors Trust has net assets of about $1.5 billion. etc. Investors Stock Fund about $1 billion.6% for his partners over the space of four years. Nevertheless. We usually have fairly large positions (5% to 10% of our total assets) in each of five or six generals.” These are securities whose financial results depend on corporate action rather than supply and demand factors created by buyers and sellers of securities.500. they are securities with a timetable where we can predict. this has been our largest category of investment.WARREN BUFFETT Method Of Operation By 1961. Warren Buffett had achieved a compounded gain of 181. lead to work-outs. and point out how rare such outperformance was. with smaller positions in another ten or fifteen. spin-offs. reorganizations. and more money has been made here than in either of the other categories. the two largest common stock open-end investment companies at the time and the two largest closed-end investment companies.All rights Reserved Charlie Munger 21 . At the beginning of 1962 net assets belonging to the Buffett partnership group amounted to $7. and Lehman Corporation about $350 million. Corporate events such as mergers. This chart shows the performance of Buffett’s limited partnerships compared to the Dow. Buffett also uses this section of the letter to lay out his position sizing strategy.178. “Our second category consists of “work-outs. In other words. When Warren Buffett presented this data. An important (C) ValueWalk 2015 .I touched on this briefly in part four. Over the years. or a total of over $3.

consolidated working capital about $50 per share.” (C) ValueWalk 2015 .All rights Reserved Charlie Munger 22 22 .” And Warren Buffett’s final category of investments at the time was “control” situations.WARREN BUFFETT source in recent years has been sell-outs by oil producers to major integrated oil companies. we may be in ten to fifteen of these. I feel this is a fair valuation to both new and old partners. In a year where the Dow falls by a large percentage. As Buffett explains in his 1962 letter to partners: “Dempster is a manufacturer of farm implements and water systems with sales in 1961 of about $9 million. Further. Our controlling interest was acquired at an average price of about $28.My self-imposed limit regarding borrowing is 25% of partnership net worth. and this holding currently represents 21% of partnership net assets based on the $35 value. Buffett goes on to note. These situations saw Buffett take a large. and even if it cannot. if even moderate earning power can be restored. tend to move irrespective of the Dow. While I claim no oracular vision in a matter such as this. These positions tended to be the biggest single positions in Buffett’s portfolio. Dempster should work out at a higher figure. a higher valuation will be justified. consolidated net worth (book value) is about $4. Buffett’s general’s turned into control situations and Dempster Mill Manufacturing Company was one such investment. controlling stake in the target company and attempt to influence corporate policies. Dempster Mill is an interesting case study of Buffett’s style. At any given time. work-outs have provided our second largest category.” Work-outs.5 million. the work-outs tended to help improve Buffett outperform. it is only as an offset against work-outs. The position was first purchased in the mid-50s. and Buffett brought his way onto the board in late 1961. This reflected a poor management situation. or $75 per share. His activist approach to control situations allowed Buffett to take huge bets on these opportunities as the chances of the trade turning against him were almost non-existent. Buffett notes that these work-outs were the one situation where it was permissible to use borrowed money to improve results: “Over the years. Operations have produced only nominal profits in relation to invested capital during recent years. some just beginning and others in the late stage of their development. Dempster Mill In some cases. Presently.. I believe in using borrowed money to offset a portion of our work-out portfolio since there is a high degree of safety in this category in terms of both eventual results and intermediate market behavior.. along with a fairly tough industry situation. Certainly. and at yearend we valued our interest at $35 per share. Oftentimes we owe no money and when we do borrow.

Harry Bottle got straight to work. Warren Buffett grew tired of management’s lack of action. sold Dempster’s unproductive assets and freed up capital. Buffett met with turnaround guru Harry Bottle. The change in Dempster’s asset value in just 12 months is highly impressive. 1962. Dempster Mill balance sheet 1962 (pre-Harry) (C) ValueWalk 2015 . and by April 23rd Harry was sitting in Dempster’s president’s chair. on April 17. as the two tables below show.WARREN BUFFETT After several months of pushing for change at Dempster.All rights Reserved Charlie Munger 23 . So.

All rights Reserved Charlie Munger 24 .WARREN BUFFETT PART SEVEN (C) ValueWalk 2015 .

sell-outs by oil producers to major integrated oil companies. And at the time. Partnership assets stood at $9. These three categories were: generals. Buffett was finding deals in the oil sector. this reduced risk. In his 1962 letter to investors. Buffett’s partnerships borrowed a total of $1. the predictability coupled with a short holding period produces quite decent annual rates of return.WARREN BUFFETT Work-Outs As covered in the last part of this series. 3. A friend refers to this as getting the last nickel after the other fellow has made the first ninety-five cents. However. In addition to using leverage. Buffett purchases 64. Warren Buffett notes. Buffett purchased $264. This delayed the deal but did not (C) ValueWalk 2015 . a workout that arose from Buffett’s number one source of workouts. and to some extent. spin-offs. During 1962. over a specified period of time. (Buffett makes it quite clear that he never acts on rumors). This category produces more steady absolute profits from year to year than generals do.000 3.000 warrants to purchase common stock at $3. 2. TNP had three types of securities: 1.500. Some just beginning and others in the late stage of their development. or special situations (corporate events such as mergers. workouts and control situations.035 650. this cost him a “substantial” amount of money.that he often borrowed money to increase returns. Warren Buffett had three different types of investments when he was managing his partnerships. Buffett was involved in five to ten workouts. 6 ½% debentures.All rights Reserved Charlie Munger 25 . “The gross profits in many workouts appear quite small. Buffett also made use of short selling during 1962 to hedge against market volatility while he was waiting for a workout to play out: One run-of-the-mill workout opportunity that Warren Buffett took was Texas National Petroleum. Buffett purchased 13% of this issue.Warren Buffett used the term “high degree of safety” -. Workouts. Warren Buffett gave a detailed explanation of his workout plays undertaken during the year. although he failed to act on the opportunity.000 to fund workout situations. Warren Buffett: Borrowing to increase returns At any one time. Specifically.7 million shares of common.5 million of these outstanding. Due to their nature.) are by far the most interesting of this group. liquidations.50 per share.4 million at the end of 1963. Nonetheless in early April 1962 a deal was announced. The deal was negotiated by the controlling stockholders. The risk of stockholder disapproval was nil. 40% of which were owned by directors. reorganizations. Early in 1962. Unfortunately. Of the $6. Buffett was able to predict what kind of a return he would generate from each workout. there were rumors that TNP was discussing a deal with Union Oil of California.” Warren Buffett considered some of his workouts to be so low risk -. Buffett’s self-imposed borrowing limit was 25% of partnership funds. The only problem was the obtaining of the necessary tax ruling. sellouts of oil and gas producing companies. There were no antitrust problems.

The following are excerpts from some of the telephone conversations we had with company officials in ensuing months: On June 18th the secretary stated “Union has been told a favorable IRS ruling has been formulated but must be passed on by additional IRS people. (2) On the stock and warrants we have realized a capital gain of $89.946.42 per share. Based on the time the money was employed. and USC people were all in Washington attempting to thrash out a ruling. From an investment or $146. Still hoping for ruling in July.” On August 13th the treasurer informed us that the TNP. On September 18th the treasurer informed us “No news. the estimate was $7. our holdings ran to $731. and the sale closed October 31st… The financial results of TNP were as follows: (1) On the bonds we invested $260. The proxy material was mailed May 9th and stated the sale “will be consummated during the summer of 1962 and that within a few months thereafter the greater part of the proceeds will be distributed to stockholders in liquidation. Warren Buffett describes the whole deal in his letter to partners: “When we talked with the company on April 23rd and 24th. This works out to an overall rate of return of approximately 20% per annum.773 and had an average holding period of slightly under five months. Union Oil. their estimate was that the closing would take place in August or September.000 in October.000 in April.All rights Reserved Charlie Munger 26 .WARREN BUFFETT threaten it. although the IRS says the ruling could be ready by next week.” As mentioned earlier.” The ruling was received in late September. We received 6 ½% interest on our money and realized a capital gain of $14.304. Bill Scott attended the stockholders meeting in Houston on May 29th where it was stated they still expected to close on September 1st.” (C) ValueWalk 2015 . and we have stubs presently valued at $2.” On July 24th the president said that he expected the IRS ruling “early next week.446. the rate or return was about 22% per annum.

WARREN BUFFETT (C) ValueWalk 2015 .All rights Reserved Charlie Munger 27 .

All rights Reserved Charlie Munger 28 .WARREN BUFFETT PART EIGHT (C) ValueWalk 2015 .

In relation to our beginning acquisition cost of $7. following.All rights Reserved Charlie Munger 29 . Warren Buffett gave a full run-down of the Berkshire situation within his January1966 letter to partners: “Our purchases of Berkshire started at a price of $7. In the postwar period the company had slid downhill a considerable distance..86 per share. “a policy disagreement with certain outside interests who have purchased sufficient stock to control the company. 1965. and we have not had to bring a single man from the outside into the operation. Berkshire Hathaway Policy Row Spurs Resignations. was $14.WARREN BUFFETT Shaking Up Berkshire Hathaway On May 11. At the time we acquired control in spring of 1965. had net working capital alone (before placing any value on the plants and equipment) of about $19 per share.. This reflected output from 11 mills. The article in the New York Times continues: “Although he did not state who had bought control of the company. chairman. an Omaha investment company. vice president. Chace Jr. Buffett had become bored of Berkshire Hathaway’s management. “The partnership owns a controlling interest in Berkshire Hathaway Inc. having hit a peak in 1948 when about $29 1/2 million was earned before tax and about 11. Berkshire is a delight to own.” (C) ValueWalk 2015 . This price partially reflected large losses incurred by the prior management in closing some of the mills made obsolete by changing conditions within the textile business (which the old management had been quite slow to recognize). Berkshire was down to two mills and about 2.” Seabury Stanton. Warren Buffett himself did not mention Berkshire Hathaway by name in his letters to partners until November 1. It was a very pleasant surprise to find that the remaining units had excellent management personnel. the company on December 31. the Buffett Partnerships had owned the stock.asset values and earning power are the dominant factors affecting the valuation of a controlling interest in a business…” Stealth position Buffett first mentioned Berkshire by name to his partners at the end of 1965..60 per share in 1962. a director and chairman of the executive committee. John K. a publicly-traded security. buying up a controlling stake in the company to help enforce change. treasurer and director were the officers handing in their notices. along with his son. president. Two top officers of the company had tendered their resignations. said yesterday that a large interest had been purchased by Buffett Partnership Ltd.. However.300 employees. In true early-Buffett style. reflecting very heavy purchases in early 1965).” Although this article was published the first half of 1965. however. 1965..000 workers were employed. Stanton. as one of Buffett’s “generals” since 1962. 1965 an article appeared in the The New York Times Company (NYSE:NYT) titled: TEXTILE CONCERN CHANGES CONTROL.60 per share (the average cost. The article cited a curious case at a small. Malcolm G. 76-year old textile company called Berkshire Hathaway.

ended Sept.” Of course. Therefore. The New York Times article. from Wall Street sources that Seabury Stanton and the Buffett group might have been at odds over the speed with which unprofitable mills should be closed. Mr. it’s possible that his son might have hoped to succeed him.WARREN BUFFETT But this wasn’t the whole story. certain-to-fail business. Cowin were said to be anxious to have younger men at the company to take over a bigger role in its management. Mr. if Warren Buffett had been working with Charlie Munger at the time. have slipped in each year but one since fiscal 1959. a major northern mill. turned a profit in the latest fiscal year.’” “It was learned.All rights Reserved Charlie Munger 30 . 1964 for the first time in four years. But by July 1967 performance had deteriorated once again.” -. Buffett said that Seabury Stanton ‘was planning to resign at the end of the year. I similarly see no prospect of a good return on the assets employed in the textile business. 30. Berkshire Hathaway. In addition. Berkshire experienced two good years. 1965 and 1966. Buffett and Mr. “[The] textile business in New England… was totally doomed because textiles are congealed electricity and the power rates were way higher in New England than they were down in TVA country in Georgia... this segment of our portfolio will be a substantial drag on our relative performance (as it has been during the first half). The company’s sales however. however. while I don’t presently foresee any loss in underlying values.” Trouble ahead After Seabury Stanton left.Source (C) ValueWalk 2015 . mentioned above sheds some more light on the situation: “In discussing the resignations of the two Stantons. (Charlie Munger didn’t join forces with Buffett on a full-time basis until 1978 when he closed his own investment partnerships) he would have been able to see the dire situation that Berkshire was in. Buffett wrote in his July 1967 letter to partners: “B-H is experiencing and faces real difficulties in the textile business. A totally doomed.

All rights Reserved Charlie Munger 31 .WARREN BUFFETT PART NINE (C) ValueWalk 2015 .

National Fire & Marine. Meanwhile. In extreme cases. Investing had become a popular past time. Therefore. National Indemnity The National Indemnity acquisitions turned out to be two of Buffett’s greatest acquisitions ever. which Buffett and his partners owned 80% of. During March 1967. the number of analysts on Wall Street was exploding. insurers get to invest this float for their benefit. The number of low-risk. There was also Hochschild Kohn as mentioned earlier in this series. pay-later model leaves P/C companies holding large sums – money we call “float” – that will eventually go to others. Though individual policies and claims come and go. within his July 1967 letter to partners Buffett wrote that: “B-H is experiencing and faces real difficulties in the textile business while I don’t presently foresee any loss in underlying values.Warren BuffettBerkshire 2014 letter. and more money was flowing into the market.. the amount of float an insurer holds usually remains fairly stable in relation to premium volume. (C) ValueWalk 2015 . such as those arising from certain workers’ compensation accidents.. payments can stretch over many decades. chasing a shrinking number of opportunities. as Buffett made a note of in Berkshire’s 50th-anniversary letter to shareholders National Indemnity provided Buffett with more than just an insurance business: “One reason we were attracted to the property-casualty business was its financial characteristics: P/C insurers receive premiums upfront and pay claims later..All rights Reserved Charlie Munger 32 .6 million. Today.”-. Buffett controlled around 70% of Berkshire. Buffett purchased Associated Cotton Shops. This collect-now. At the time. so his partnerships effectively owned the business. these businesses are worth $111 billion. by mid-1967.WARREN BUFFETT Berkshire Hathaway Starts To Grow After shaking up Berkshire Hathaway in the mid 60’s. Changing strategy At the end of 1967.” But by this point Berkshire Hathaway was evolving. Further. for $8. Warren Buffett wrote to his partners informing them that the market was changing. As covered in part eight of this series. this segment of our portfolio will be a substantial drag on our relative performance (as it has been during the first half). Berkshire acquired National Indemnity and its sister company.. a value which exceeds that of any other insurer in the world. Diversified Retailing. to meet the rising demand for brokerages services. based on GAAP principles. I similarly see no prospect of a good return on the assets employed in the textile business. So Buffett started to invest differently. high-return deep value opportunities available was shrinking. Through another entity. What’s more. after two years of good performance the textile business was beginning to deteriorate once again.

a subsidiary of B-H run by Jack Ringwalt. Among Fortune’s “500” (the largest manufacturing entities in the country. Both companies achieved high returns on capital and generated plenty of excess cash for Buffett to grow his expanding Berkshire with. Control Data. value is what you get”).. the company had three main operating businesses: “.. It also owns Sun Newspapers Inc. (NYSE:IBM). Berkshire was down three last week?” Market price is irrelevant to us in the valuation of our controlling interests. By the end of the year. Berkshire Hathaway really started to grow. the insurance operation (conducted by National Indemnity Company and National Fire & Marine Insurance Company. We will prosper or suffer in controlled investments in relation to the operating performances of our businesses .we will not attempt to profit by playing various games in the securities markets. Procter & Gamble.” If anything. Both of these companies earned about 20% on capital employed in their businesses. and National Indemnity Company. starting with General Motors Company (NYSE:GM)).the textile operation.WARREN BUFFETT National Indemnity and Diversified Retailing were acquired as part of this changing strategy. Hewlett-Packard.All rights Reserved Charlie Munger 33 33 . this confirms Buffett’s switch from activist hedge fund manager to businessman. General Motors. (“Price is what you pay. Buffett had commenced the wind-down of his partnerships and the Berkshire Hathaway we know today was starting to take shape.. Illinois. a subsidiary of DRC run by Ben Rosner. and our boys outshone such mildly better-known (but not better appreciated) companies as International Business Machines Corp. which will be collectively called the insurance company) and the Illinois National Bank and Trust Company of Rockford. DuPont. In Buffett’s Jan 1969 letter to partners he wrote: “Particularly outstanding performances were turned in by Associated Cotton Shops. etc…” “I still sometimes get comments from partners like: “Say. General Electric Company (NYSE:GE).stay tuned for the final part of this series. We valued B-H at 25 at yearend 1967 when the market was about 20 and 31 at yearend 1968 when the market was about 37. And during 1969. Berkshire is up four points . only 37 companies achieved this figure in 1967.that’s great!” or “What’s happening to us.. We would have done the same thing if the markets had been 15 and 50 respectively. (C) ValueWalk 2015 . Blacker Printing Company and 70% of Gateway Underwriters…” Winding down By the end of 1969.

All rights Reserved Charlie Munger 34 34 .WARREN BUFFETT PART TEN (C) ValueWalk 2015 .

WARREN BUFFETT Warren Buffett Abandons Deep Value On October 9 1967. My own personal interests dictate a less compulsive approach to superior investment results than when I was younger and leaner. as the investing public has taken the bit in its teeth the time span of expectations has been consistently reduced to the point where investment performance. Up to this date. The numbers deep value opportunities in the market had dwindled by 1969. monthly. Secondly. Buffett identified two key reasons for this decline in bargain issues..has created a hyper-reactive pattern of market behavior against which my analytical techniques have limited value.I do believe certain conditions that now exist are likely to make activity in markets more difficult for us [in] the intermediate future.. 3.. eliminating the need to do the legwork themselves. At the end of 1968. “the exploding ranks of security analysts” that have helped investors identify opportunities with ease.” “In my opinion what is resulting is speculation on an increasing scale.is being measured yearly.. He wrote: “I have always cautioned partners that I considered three years a minimum in determining whether we were “performing”. quarterly.” “. Buffett had sought out deep-value plays. low-risk bets with a high percentage of partners’ capital. it was becoming increasingly difficult for Buffett to make calculated. A hyper-reactive pattern of market behavior was another driving force behind Buffett’s decision to move away from the deep-value side of investing. Mushrooming interest in investment performance. Buffett wrote that he was unable to find any potential ideas for his 1969 watch list.. the number of takeovers was increasing -..problems… 4. and perhaps sometimes even more frequently.” (C) ValueWalk 2015 . Naturally. Firstly.. Warren Buffett wrote to the partners of his Buffett Partnership group announcing that he was changing his strategy. The market environment has changed progressively over the past decade. 2.” The first point was Buffett’s main concern.All rights Reserved Charlie Munger 35 35 .takeovers often focused on bargain issues. with a self-imposed performance hurdle of 10% above the Dow’s annual return. The enlargement of our capital base to about $65 million when applied against a diminishing trickle of good investment ideas has continued to present.. resulting in a sharp diminution in the number of obvious quantitatively based investment bargains available. as laid out in Buffett’s letter: “The following conditions now make a change in yardstick appropriate: 1. This was becoming increasingly difficult to achieve for the following reasons.

.out longer term goal will be to achieve the lesser of 9% per annum or a five percentage point advantage over the Dow. Buffett reduced his yardstick performance water mark. Buffett revealed to his partners that he intended to announce formally his resignation before the end of 1969. safe..have virtually disappeared....” “.. and he was struggling to devote 100% of his time to the running of the Partnership interests. Buffett followed up his first letter.The long-term downside risk will not be less.. This was the end of the Buffett Partnerships and the beginning of Berkshire Hathaway as we know today. an increasing number of investors chasing a dwindling number of securities. (C) ValueWalk 2015 ... after rather steadily drying up over the past twenty years. since commitments of less than about $3 million cannot have a real impact on our overall performance. Buffett noted that the situation in the markets had deteriorated further: “. “. Thus..opportunities for investment. Buffett noted once again that the markets were becoming increasingly short-term focused.our $100 million of assets further eliminates a large portion of this seemingly barren investment world. the upside potential will merely be less. a rising value of asset under management and request for more personal time were the key reasons behind Buffett’s decision to retreat from the deep-value game.. this virtually rules out companies with less than about $100 million common stock at market value…” Along with these factors. At the same time. if the Dow averages -2% over the next five years.WARREN BUFFETT A retreat So. coupled with increasing shorttermism.I am likely to limit myself to things which are reasonably easy. issued at the beginning of October 1967. With these problems laid out. I will hope of achieve an average of only +9%..All rights Reserved Charlie Munger 36 . I would hope to average +3% but if the Dow averages +12%..” Deteriorating On May 29 1969. profitable and pleasant..

All rights Reserved Charlie Munger 37 .WARREN BUFFETT PART ELEVEN (C) ValueWalk 2015 .

before yearend. At the time he announced his retirement..WARREN BUFFETT The End Of An Era “About eighteen months ago I wrote to you regarding changed environmental and personal factors causing me to modify our future performance objectives. I will never be able to put sustained effort into any non-BPL activity. 1969 letter to partners. He made this decision for several reasons. Buffett offered a replacement.Warren Buffett May 29th. Bill Ruane. as mentioned above. the size of the partnership was becoming a problem. Over ten years. I intend to give all limited partners the required formal notice of my intention to retire.6% during the period. And thirdly. During November of 1969. his investment process and returns for partners.” -. Secondly. Buffett turned less than $1 million into more than $100 million. achieving a compound annual return of 31. although it’s the returns that he achieved during his years running the partnerships that are really impressive. If you want to find out more about Bill Ruane. (C) ValueWalk 2015 .publishing a regular record and assuming responsibility for management of what amounts to virtually 100% of the net worth of many partners.” “Therefore. become too much for Buffett.All rights Reserved Charlie Munger 38 . Outsized returns There has always been plenty of talk about Warren Buffett’s ability to compound shareholder equity at Berkshire. Bill Ruane’s managed his own set of partnerships and in the years to the handover achieved returns of 40% on average per annum for shareholders.. Warren Buffett formally announced his intention to wind up his investment partnerships. managing Berkshire alone with its subsidiaries as well as partnership assets.. head over the ValueWalk Bill Ruane resource page. 1967 letter stated that personal considerations were the most important factor among those causing me to modify our objectives.. undervalued securities were becoming harder to find. The investing environment I discussed at that time (and on which I have commented in various other letters has generally become more negative and frustrating as time has passed…” “The October 9th. the partnerships were managing over $100 million in assets. Firstly. But for those that wanted to keep their money in the market. with gains of over $40 million during 1968 alone.

and the General Partner putting his money where his mouth was by investing $100.200 hours. 1956 with seven limited partners (four family. or roughly the same as the full year gain in 1957. the initial predecessor partnership. doesn’t it).726.All rights Reserved Charlie Munger 39 .. On January 1. leading to the 10. we had a gain of $31. 1957 combined net assets were $303.97. contributing $105. giving us a gain of about $33. Buffett summed up the performance of the Buffett Partnerships in one of his final letters to partners.4% figure shown on page one.000. “Buffett Associates. During 1968 I would guess that the New York Stock Exchange 127 was open around 1. Ltd.WARREN BUFFETT This record eclipses Berkshire’s growth. was formed May 5. so that on January 1.615. 5 day week. Two additional single-family limited partnerships were formed during 1956.000 per hour (sort of makes you wish they had stayed with the 5-1/2 hour. 1962 we consolidated the predecessor limited partnerships moved out of the bedroom and hired our first (C) ValueWalk 2015 . three close friends). During 1957.

he was immediately able to achieve an outsized return at Berkshire. By Rupert Hargreaves for (C) ValueWalk 2015 .178.603. 1971 • To the Stockholders of Berkshire Hathaway Inc. Considerably above the average of American industry.431 we have added one person to the payroll. Even though Buffett had wound down his partnerships citing the lack of opportunities and scope for return in the market. Net assets at that time were $7.All rights Reserved Charlie Munger 40 . Buffett Chairman of the Board. If one of Parkinson’s Laws is operating.405. Berkshire’s 1971 operating earnings. Stay tuned for the next exclusive ValueWalk famous investor series.400) rent has gone from $3.947 to $5.1972 • To the Stockholders of Berkshire Hathaway Inc. Below are Warren Buffett’s first three letters to Berkshire stocks holders as the company’s Chairman. All materials in this PDF are protected by United States and international copyright and other applicable laws. and dues and subscriptions from $900 to $994. President. it wasn’t until the partnerships were dissolved that Buffett began to manage Berkshire himself.com.823 (Ben Rosner would never have forgiven me if I had signed a percentage lease) travel from $3. Chace. All other uses requires the prior explicit written permission by ValueWalk. excluding capital gains amounted to more than 14% of shareholders equity. (C) ValueWalk 2015 .429. From that point to our present net assets of $104.WARREN BUFFETT full-time employees. • To the Stockholders of Berkshire Hathaway Inc.” Buffett takes the helm at Berkshire As the Buffett Partnerships controlled the majority of Berkshire Hathaway. Berkshire’s 1971 letter to investors was signed by Warren E.206 to $3. Since 1963 (Assets $9. You may print the PDF website for personal or nonprofit educational purposes only.All rights reserved.500. at least the situation hasn’t gotten completely out of control.1973 That’s the end of this series on Warren Buffett’s early years. Berkshire’s 1970 letter to shareholders was written and signed by Kenneth V. All copies must include any copyright notice originally included with the material and a link to ValueWalk.