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巴菲特致股东的信19971997ChairmansLetterTotheShareholdersofBerkshireHathawayInc.:
1.AllfiguresusedinthisreportapplytoBerkshiresAsharesthesuccessortotheonlystockthatthecompanyhadoutstandingbefore
1996.TheBshareshaveaneconomicinterestequalto1/30ththatoftheA.Givenourgainof
34.1%itistemptingtodeclarevictoryandmoveon.Butlastyearsperformancewasnogreattriumph:Anyinvestorcanchalkuplargereturnswhenstockssoarastheydidin
1997.Inabullmarketonemustavoidtheerrorofthepreeningduckthatquacksboastfullyafteratorrentialrainstormthinkingthatitspaddlingskillshavecausedittoriseintheworld.Aright-thinkingduckwouldinsteadcompareitspositionafterthedownpourtothatoftheotherducksonthepond.Sowhatsourduckratingfor1997ThetableonthefacingpageshowsthatthoughwepaddledfuriouslylastyearpassiveducksthatsimplyinvestedintheSPIndexrosealmostasfastaswedid.Ourappraisalof1997sperformancethen:Quack.WhenthemarketboomswetendtosufferincomparisonwiththeSPIndex.TheIndexbearsnotaxcostsnordomutualfundssincetheypassthroughalltaxliabilitiestotheirowners.LastyearontheotherhandBerkshirepaidoraccrued$
4.2billionforfederalincometaxorabout18%ofourbeginningnetworth.Berkshirewillalwayshavecorporatetaxestopaywhichmeansitneedstoovercometheirdraginordertojustifyitsexistence.ObviouslyCharlieMungerBerkshiresViceChairmanandmypartnerandIwontbeabletolickthathandicapeveryyear.ButweexpectovertimetomaintainamodestSincetrulymajorcatastrophesarerareoccurrencesoursuper-catbusinesscanbeexpectedtoshowlargeprofitsinmostyears-andtorecordahugelossoccasionally.Inotherwordstheattractivenessofoursuper-catbusinesswilltakeagreatmanyyearstomeasure.Whatyoumustunderstandhoweveristhatatrulyterribleyearinthesuper-catbusinessisnotapossibility-itsacertainty.Theonlyquestioniswhenitwillcome.Lastyearwewereveryluckyinoursuper-catoperation.Theworldsufferednocatastrophesthatcausedhugeamountsofinsureddamagesovirtuallyallpremiumsthatwereceiveddroppedtothebottomline.Thispleasantresulthasadarksidehowever.Manyinvestorswhoareinnocents-meaningthattheyrelyonrepresentationsofsalespeopleratherthanonunderwritingknowledgeoftheirown-havecomeintothereinsurancebusinessbymeansofpurchasingpiecesofpaperthatarecalledcatastrophebonds.ThesecondwordinthistermthoughisanOrwellianmisnomer:Atruebondobligestheissuertopay;thesebondsineffectarecontractsthatlayaprovisionalpromisetopayonthepurchaser.Thisconvolutedarrangementcameintobeingbecausethepromotersofthecontractswishedtocircumventlawsthatprohibitthewritingofinsurancebyentitiesthathaventbeenlicensedbythestate.Asidebenefitforthepromotersisthatcallingtheinsurancecontractabondmayalsocauseunsophisticatedbuyerstoassumethattheseinstrumentsinvolvefarlessriskthanisactuallythecase.Trulyoutsizedriskswillexistinthesecontractsiftheyarenotproperlypriced.Aperniciousaspectofcatastropheinsurancehowevermakesitlikelythatmispricingevenofaseverevarietywillnotbediscoveredforaverylongtime.Considerforexampletheoddsofthrowinga12withapairofdice-1outof
36.Nowassumethatthedicew川bethrownonceayear;thatyouthebond-buyeragreetopay$50millionifa12appears;andthatforinsuringthisriskyoutakeinanannualpremiumof$1million.Thatwouldmeanyouhadsignificantlyunderpricedtherisk.Neverthelessyoucouldgoalongforyearsthinkingyouweremakingmoney-indeedeasymoney.Thereisactuallya
75.4%probabilitythatyouwouldgoforadecadewithoutpayingoutadime.Eventuallyhoweveryouwouldgobroke.Inthisdiceexampletheoddsareeasytofigure.CalculationsinvolvingmonsterhurricanesandearthquakesarenecessarilymuchfuzzierandthebestwecandoatBerkshireistoestimatearangeofprobabilitiesforsuchevents.Thelackofprecisedatacoupledwiththerarityofsuchcatastrophesplaysintothehandsofpromoterswhotypicallyemployanexperttoadvisethepotentialbond-buyerabouttheprobabilityoflosses.Theexpertputsnomoneyonthetable.Insteadhereceivesanup-frontpaymentthatisforeverhisnomatterhowinaccuratehispredictions.Surprise:Whenthestakesarehighanexpertcaninvariablybefoundwhowillaffirm-toreturntoourexample-thatthechanceofrollinga12isnot1in36butmorelike1in
100.Infairnessweshouldaddthattheexpertwillprobablybelievethathisoddsarecorrectafactthatmakeshimlessreprehensible-butmoredangerous.Theinfluxofinvestormoneyintocatastrophebonds-whichmaywellliveuptotheirname-hascausedsuper-catpricestodeterioratematerially.Thereforewewillwritelessbusinessin
1998.Wehavesomelargemulti-yearcontractsinforcehoweverthatwillmitigatethedrop.Thelargestofthesearetwopoliciesthatwedescribedinlastyearsreport-onecoveringhurricanesinFloridaandtheothersignedwiththeCaliforniaEarthquakeAuthoritycoveringearthquakesinthatstate.Ourworst-case*lossremainsabout$600millionafter-taxthemaximumwecouldloseundertheCEApolicy.Thoughthislosspotentialmaysoundlargeitisonlyabout1%ofBerkshiresmarketvalue.Indeedifwecouldgetappropriatepriceswewouldbewillingtosignificantlyincreaseourworst-caseexposure.Oursuper-catbusinesswasdevelopedfromscratchbyAjitJainwhohascontributedtoBerkshiressuccessinavarietyofotherwaysaswell.Ajitpossessesboththedisciplinetowalkawayfrombusinessthatisinadequatelypricedandtheimaginationtothenfindotheropportunities.QuitesimplyheisoneofBerkshiresmajorassets.Ajitwouldhavebeenastarinwhatevercareerhechose;fortunatelyforusheenjoysinsurance.Insurance-GEICO1-800-555-2756andOtherPrimaryOperationsLastyearIwroteaboutGEICOsTonyNicelyandhisterrificmanagementskills.IfIhadknownthenwhathehadinstoreforusin1997Iwouldhavesearchedforstillgreatersuperlatives.Tonynow54hasbeenwithGEICOfor36yearsandlastyearwashisbest.AsCEOhehastransmittedvisionenergyandenthusiasmtoallmembersoftheGEICOfamily-raisingtheirsightsfromwhathasbeenachievedtowhatcanbeachieved.WemeasureGEICOsperformancebyfirstthenetincreaseinitsvoluntaryautopoliciesthatisnotincludingpoliciesassignedusbythestateandsecondtheprofitabilityofseasonedautobusinessmeaningpoliciesthathavebeenwithusformorethanayearandarethuspasttheperiodinwhichacquisitioncostscausethemtobemoney-losers.In1996in-forcebusinessgrew10%andItoldyouhowpleasedIwassincethatratewaswellaboveanythingwehadseenintwodecades.Thenin1997growthjumpedto16%.Belowarethenewbusinessandin-forcefiguresforthelastfiveyears:Ofcourseanyinsurercangrowrapidlyifitgetscarelessaboutunderwriting.GEICOsunderwritingprofitfortheyearthoughwas
8.1%ofpremiumsfaraboveitsaverage.Indeedthatpercentagewashigherthanwewishittobe:Ourgoalistopassonmostofthebenefitsofourlow-costoperationtoourcustomersholdingourselvestoabout4%inunderwritingprofit.Withthatinmindwereducedouraverageratesabitduring1997andmaywellcutthemagainthisyear.Ourratechangesvariedofcoursedependingonthepolicyholderandwherehelives;westrivetochargearatethatproperlyreflectsthelossexpectancyofeachdriver.GEICOisnottheonlyautoinsurerobtainingfavorableresultsthesedays.Lastyeartheindustryrecordedprofitsthatwerefarbetterthanitanticipatedorcansustain.Intensifiedcompetitionwillsoonsqueezemarginsverysignificantly.Butthisisadevelopmentwewelcome:Longtermatoughmarkethelpsthelow-costoperatorwhichiswhatweareandintendtoremain.LastyearItoldyouabouttherecord
16.9%profit-sharingcontributionthatGEICOsassociateshadearnedandexplainedthattwosimplevariablessettheamount:policygrowthandprofitabilityofseasonedbusiness.Ifurtherexplainedthat1996*sperformancewassoextraordinarythatwehadtoenlargethechartdelineatingthepossiblepayouts.Thenewconfigurationdidn*tmakeitthrough1997:Weenlargedthechartsboundariesagainandawardedour10500associatesaprofit-sharingcontributionamountingto
26.9%oftheirbasecompensationor$71million.Inadditionthesametwovariables--policygrowthandprofitabilityofseasonedbusiness--determinedthecashbonusesthatwepaidtodozensoftopexecutivesstartingwithTony.AtGEICOwearepayinginawaythatmakessenseforbothourownersandourmanagers.Wedistributemeritbadgesnotlotterytickets:InnoneofBerkshiressubsidiariesdowerelatecompensationtoourstockpricewhichourassociatescannotaffectinanymeaningfulway.Insteadwetiebonusestoeachunitsbusinessperformancewhichisthedirectproductoftheunitspeople.Whenthatperformanceisterrific--asithasbeenatGEICO--thereisnothingCharlieandIenjoymorethanwritingabigcheck.GEICOsunderwritingprofitabilitywillprobablyfallin1998butthecompanysgrowthcouldaccelerate.Wereplanningtosteponthegas:GEICOsmarketingexpendituresthisyearwilltop$100millionup50%from
1997.Ourmarketsharetodayisonly3%alevelofpenetrationthatshouldincreasedramaticallyinthenextdecade.Theautoinsuranceindustryishuge-itdoesabout$115billionofvolumeannually-andtherearetensofmillionsofdriverswhowouldsavesubstantialmoneybyswitchingtous.Inthe1995reportIdescribedtheenormousdebtthatyouandIowetoLorimerDavidson.OnaSaturdayearlyin1951hepatientlyexplainedtheinsandoutsofbothGEICOanditsindustrytome--a20-year-oldstrangerwhodarrivedatGEICOsheadquartersuninvitedandunannounced.DavylaterbecamethecompanysCEOandhasremainedmyfriendandteacherfor47years.ThehugerewardsthatGEICOhasheapedonBerkshirewouldnothavematerializedhaditnotbeenforhisgenerosityandwisdom.IndeedhadInotmetDavyImightneverhavegrowntounderstandthewholefieldofinsurancewhichovertheyearshasplayedsuchakeypartinBerkshiressuccess.Davyturned95lastyearanditsdifficultforhimtotravel.NeverthelessTonyandIhopethatwecanpersuadehimtoattendourannualmeetingsothatourshareholderscanproperlythankhimforhisimportantcontributionstoBerkshire.Wishusluck.ThoughtheyareofcoursefarsmallerthanGEICOourotherprimaryinsuranceoperationsturnedinresultslastyearthatinaggregatewerefullyasstunning.NationalIndemnitystraditionalbusinesshadanunderwritingprofitof
32.9%andasusualdevelopedalargeamountoffloatcomparedtopremiumvolume.OverthelastthreeyearsthissegmentofourbusinessrunbyDonWursterhashadaprofitof
24.3%.OurhomestateoperationmanagedbyRodEldredrecordedanunderwritingprofitof
14.1%eventhoughitcontinuedtoabsorbtheexpensesofgeographicalexpansion.Rodsthree-yearrecordisanamazing
15.1%.Berkshiresworkers*compensationbusinessrunoutofCaliforniabyBradKinstlerhadamodestunderwritinglossinadifficultenvironment;itsthree-yearunderwritingrecordisapositive
1.5%.JohnKizeratCentralStatesIndemnitysetanewvolumerecordwhilegeneratinggoodunderwritingearnings.AtKansasBankersSuretyDonTowlemorethanliveduptothehighexpectationswehadwhenwepurchasedthecompanyin
1996.Inaggregatethesefiveoperationsrecordedanunderwritingprofitof
15.0%ThetwoDonsalongwithRodBradandJohnhavecreatedsignificantvalueforBerkshireandwebelievethereismoretocome.SourcesofReportedEarningsThetablethatfollowsshowsthemainsourcesofBerkshiresreportedearnings.Inthispresentationpurchase-accountingadjustmentsarenotassignedtothespecificbusinessestowhichtheyapplybutareinsteadaggregatedandshownseparately.Thisprocedureletsyouviewtheearningsofourbusinessesastheywouldhavebeenreportedhadwenotpurchasedthem.Forthereasonsdiscussedonpages69and70thisformofpresentationseemstoustobemoreusefultoinvestorsandmanagersthanoneutilizinggenerally-acceptedaccountingprinciplesGAAPwhichrequirepurchase-premiumstobechargedoffbusiness-by-business.ThetotalearningsweshowinthetableareofcourseidenticaltotheGAAPtotalinourauditedfinancialstatements.inmillionsBerkshiresShareofNetEarningsaftertaxesandPre-TaxEarningsminorityinterests1997199619971996OperatingEarnings:InsuranceGroup:Underwriting-Super-Cat$
283.0$
167.0$
182.7$
107.4Underwriting-OtherReinsurance....
155.
2174.
8100.
1112.4Underwriting-GEICO
280.
7171.
4181.
1110.2Underwriting-OtherPrimary
52.
958.
534.
137.6NetInvestmentIncome
882.
3726.
2703.
6593.1BuffaloNews
55.
950.
432.
729.5$
2827.6$
3705.9$
1901.6FromdateofacquisitionDecember
231996.IncludesStarFurniturefromJuly
11997.⑶ExcludesinterestexpenseofFinanceBusinesses.Overallouroperatingbusinessescontinuetoperformexceptionallywellfaroutdoingtheirindustrynorms.WeareparticularlypleasedthatprofitsimprovedatHelzbergsafteradisappointing
1996.JeffCommentHelzbergsCEOtookdecisivestepsearlyin1997thatenabledthecompanytogainrealmomentumbythecrucialChristmasseason.Intheearlypartofthisyearaswellsalesremainedstrong.Casualobserversmaynotappreciatejusthowextraordinarytheperformanceofmanyofourbusinesseshasbeen:IftheearningshistoryofsayBuffaloNewsorScottFetzeriscomparedtotherecordsoftheirpublicly-ownedpeerstheirperformancemightseemtohavebeenunexceptional.Butmostpubliccompaniesretaintwo-thirdsormoreoftheirearningstofundtheircorporategrowth.IncontrastthoseBerkshiresubsidiarieshavepaid100%oftheirearningstoustheirparentcompanytofundourgrowth.Ineffecttherecordsofthepubliccompaniesreflectthecumulativebenefitsoftheearningstheyhaveretainedwhiletherecordsofouroperatingsubsidiariesgetnosuchboost.OvertimehowevertheearningsthesesubsidiarieshavedistributedhavecreatedtrulyhugeamountsofearningpowerelsewhereinBerkshire.TheNewsSeesandScottFetzerhavealonepaidus$
1.8billionwhichwehavegainfullyemployedelsewhere.Weowetheirmanagementsourgratitudeformuchmorethantheearningsthataredetailedinthetable.Additionalinformationaboutourvariousbusinessesisgivenonpages36-50whereyouw川alsofindoursegmentearningsreportedonaGAAPbasis.Inadditiononpages55-61wehaverearrangedBerkshiresfinancialdataintofoursegmentsonanon-GAAPbasisapresentationthatcorrespondstothewayCharlieandIthinkaboutthecompany.Ourintentistosupplyyouwiththefinancialinformationthatwewouldwishyoutogiveusifourpositionswerereversed.Look-ThroughEarningsReportedearningsareapoormeasureofeconomicprogressatBerkshireinpartbecausethenumbersshowninthetablepresentedearlierincludeonlythedividendswereceivefrominvestees--thoughthesedividendstypicallyrepresentonlyasmallfractionoftheearningsattributabletoourownership.Notthatwemindthisdivisionofmoneysinceonbalanceweregardtheundistributedearningsofinvesteesasmorevaluabletousthantheportionpaidout.Thereasonissimple:Ourinvesteesoftenhavetheopportunitytoreinvestearningsathighratesofreturn.SowhyshouldwewantthempaidoutTodepictsomethingclosertoeconomicrealityatBerkshirethanreportedearningsthoughweemploytheconceptoflook-throughearnings.Aswecalculatethesetheyconsistof:1theoperatingearningsreportedintheprevioussectionplus;2ourshareoftheretainedoperatingearningsofmajorinvesteesthatunderGAAPaccountingarenotreflectedinourprofitsless;3anallowanceforthetaxthatwouldbepaidbyBerkshireiftheseretainedearningsofinvesteeshadinsteadbeendistributedtous.Whentabulatingoperatingearningshereweexcludepurchase-accountingadjustmentsaswellascapitalgainsandothermajornon-recurringitems.Thefollowingtablesetsforthour1997look-throughearningsthoughIwarnyouthatthefigurescanbenomorethanapproximatesincetheyarebasedonanumberofjudgmentcalls.Thedividendspaidtousbytheseinvesteeshavebeenincludedintheoperatingearningsitemizedonpage11mostlyunderInsuranceGroup:NetInvestmentIncome.BerkshiresShareofUndistributedBerkshiresApproximateOperatingEarningsBerkshiresMajcxlnvesteesOwnershipatYearend⑴inmillions⑵Berkshiresshareofundistributedearningsofmajorinvestees743Hypotheticaltaxontheseundistributedinvesteeearnings3105ReportedoperatingearningsofBerkshire1292Totallook-throughearningsofBerkshire$1930DoesnotincludesharesallocabletominorityinterestsCalculatedonaverageownershipfortheyearThetaxrateusedis14%whichistherateBerkshirepaysonthedividendsitreceivesAcquisitionsof1997In1997weagreedtoacquireStarFurnitureandInternationalDairyQueenadealthatclosedearlyin
1998.Bothbusinessesfullymeetourcriteria:Theyareunderstandable;possessexcellenteconomics;andarerunbyoutstandingpeople.TheStartransactionhasaninterestinghistory.WheneverwebuyintoanindustrywhoseleadingparticipantsarentknowntomeIalwaysaskournewpartnersHArethereanymoreathomelikeyouUponourpurchaseofNebraskaFurnitureMartin1983thereforetheBlumkinfamilytoldmeaboutthreeoutstandingfurnitureretailersinotherpartsofthecountry.Atthetimehowevernonewasforsale.ManyyearslaterIrvBlumkinlearnedthatB川ChildCEOofR.C.Willey-oneoftherecommendedthree-mightbeinterestedinmergingandwepromptlymadethedealdescribedinthe1995report.Wehavebeendelightedwiththatassociation-Billistheperfectpartner.FurthermorewhenweaskedBillaboutindustrystandoutshecameupwiththeremainingtwonamesgivenmebytheBlumkinsoneofthesebeingStarFurnitureofHouston.Buttimewentbywithouttherebeinganyindicationthateitherofthetwowasavailable.OntheThursdaybeforelastyearsannualmeetinghoweverBobDenhamofSalomontoldmethatMelvynWolffthelong-timecontrollingshareholderandCEOofStarwantedtotalk.AtourinvitationMelvyncametothemeetingandspenthistimeinOmahaconfirminghispositivefeelingsaboutBerkshire.ImeanwhilelookedatStarsfinancialsandlikedwhatIsaw.AfewdayslaterMelvynandImetinNewYorkandmadeadealinasingletwo-hoursession.AswasthecasewiththeBlumkinsandBillChildIhadnoneedtocheckleasesworkoutemploymentcontractsetc.IknewIwasdealingwithamanofintegrityandthatswhatcounted.ThoughtheWolfffamilysassociationwithStardatesbackto1924thebusinessstruggleduntilMelvynandhissisterShirleyToomintookoverin
1962.TodayStaroperates12stores-teninHoustonandoneeachinAustinandBryan-andw川soonmoveintoSanAntonioaswell.WewontbesurprisedifStarismanytimesitspresentsizeadecadefromnow.HeresastoryillustratingwhatMelvynandShirleyarelike:WhentheytoldtheirassociatesofthesaletheyalsoannouncedthatStarwouldmakelargespecialpaymentstothosewhohadhelpedthemsucceed--andthendefinedthatgroupaseveryoneinthebusiness.UnderthetermsofourdealitwasMelvynandShirleysmoneynotoursthatfundedthisdistribution.CharlieandIloveitwhenwebecomepartnerswithpeoplewhobehavelikethat.TheStartransactionclosedonJuly
1.InthemonthssincewevewatchedStarsalready-excellentsalesandearningsgrowthacceleratefurther.MelvynandShirleywillbeattheannualmeetingandIhopeyougetachancetomeetthem.Nextacquisition:InternationalDairyQueen.Thereare5792DairyQueenstoresoperatingin23countries-allbutahandfulrunbyfranchisees-andinadditionIDQfranchises409OrangeJuliusoperationsand43Karmelkornoperations.In190locationstreatcentersprovidesomecombinationofthethreeproducts.FormanyyearsIDQhadabumpyhistory.Thenin1970aMinneapolisgroupledbyJohnMootyandRudyLuthertookcontrol.Thenewmanagersinheritedajumbleofdifferentfranchisingagreementsalongwithsomeunwisefinancingarrangementsthathadleftthecompanyinaprecariouscondition.Intheyearsthatfollowedmanagementrationalizedtheoperationextendedfoodservicetomanymorelocationsandingeneralbuiltastrongorganization.LastsummerMr.Lutherdiedwhichmeanthisestateneededtosellstock.AyearearlierDickKiphartofWilliamBlairCo.hadintroducedmetoJohnMootyandMikeSullivanIDQsCEOandIhadbeenimpressedwithbothmen.SowhenwegotthechancetomergewithIDQweofferedapropositionpatternedonourFlightsafetyacquisitionextendingsellingshareholderstheoptionofchoosingeithercashorBerkshireshareshavingaslightlylowerimmediatevalue.Bytiltingtheconsiderationaswedidweencouragedholderstooptforcashthetypeofpaymentwebyfarprefer.Eventhenonly45%ofIDQshareselectedcash.CharlieandIbringamodicumofproductexpertisetothistransaction:HehasbeenpatronizingtheDairyQueensinCassLakeandBemidjiMinnesotafordecadesandIhavebeenaregularinOmaha.Wehaveputourmoneywhereourmouthis.AConfessionIvementionedthatwestronglyprefertousecashratherthanBerkshirestockinacquisitions.Astudyoftherecordwilltellyouwhy:Ifyouaggregateallofourstock-onlymergersexcludingthosewedidwithtwoaffiliatedcompaniesDiversifiedRetailingandBlueChipStampsyouwillfindthatouradvantageovertheIndexandthatistheyardstickagainstwhichyoushouldmeasureus.WewillnotaskyoutoadoptthephilosophyoftheChicagoCubsfanwhoreactedtoastringoflacklusterseasonsbysayingWhygetupsetEveryonehasabadcenturynowandthen.GainsinbookvalueareofcoursenotthebottomlineatBerkshire.Whattrulycountsaregainsinper-shareintrinsicbusinessvalue.Ordinarilythoughthetwomeasurestendtomoveroughlyintandemandin1997thatwasthecase:Ledbyablow-outperformanceatGEICOBerkshiresintrinsicvaluewhichfarexceedsbookvaluegrewatnearlythesamepaceasbookvalue.FormoreexplanationofthetermintrinsicvalueyoumaywishtorefertoourOwnersManualreprintedonpages62to
71.Thismanualsetsforthourowner-relatedbusinessprinciplesinformationthatisimportanttoallofBerkshiresshareholders.InourlasttwoannualreportswefurnishedyouatablethatCharlieandIbelieveiscentraltoestimatingBerkshiresintrinsicvalue.Intheupdatedversionofthattablewhichfollowswetraceourtwokeycomponentsofvalue.Thefirstcolumnlistsourper-shareownershipofinvestmentsincludingcashandequivalentsandthesecondcolumnshowsourper-shareearningsfromBerkshiresoperatingbusinessesbeforetaxesandpurchase-accountingadjustmentsdiscussedonpages69and70butafterallinterestandcorporateexpenses.Thesecondcolumnexcludesalldividendsinterestandcapitalgainsthatwerealizedfromtheinvestmentspresentedinthefirstcolumn.IneffectthecolumnsshowwhatBerkshirewouldlooklikewereitsplitintotwopartswithoneentityholdingourinvestmentsandtheotheroperatingallofourbusinessesandbearingallcorporatecosts.Pre-taxEarningsPerShareInvestmentsExcludingAllIncomefromYearPerShareInvestmentsPunditswhoignorewhatour38000employeescontributetothecompanyandinsteadsimplyviewBerkshireasadefactoinvestmentcompanyshouldstudythefiguresinthesecondcolumn.Wemadeourfirstbusinessacquisitionin1967andsincethenourpre-taxoperatingearningsshareholdersareslightlyworseoffthantheywouldhavebeenhadInotdonethetransactions.ThoughithurtsmetosayitwhenIveissuedstockIvecostyoumoney.Beclearaboutonething:Thiscosthasnofoccurredbecauseweweremisledinanywaybysellersorbecausetheythereafterfailedtomanagewithdiligenceandskill.Onthecontrarythesellerswerecompletelycandidwhenwewerenegotiatingourdealsandhavebeenenergeticandeffectiveeversince.Insteadourproblemhasbeenthatweownatrulymarvelouscollectionofbusinesseswhichmeansthattradingawayaportionofthemforsomethingnewalmostnevermakessense.Whenweissuesharesinamergerwereduceyourownershipinallofourbusinesses-partly-ownedcompaniessuchasCoca-ColaGilletteandAmericanExpressandallofourterrificoperatingcompaniesaswell.Anexamplefromsportswillillustratethedifficultyweface:Forabaseballteamacquiringaplayerwhocanbeexpectedtobat.350isalmostalwaysawonderfulevent-exceptwhentheteammusttradea.380hittertomakethedeal.Becauseourrosterisfilledwith.380hitterswehavetriedtopaycashforacquisitionsandhereourrecordhasbeenfarbetter.StartingwithNationalIndemnityin1967andcontinuingwithamongothersSeesBuffaloNewsScottFetzerandGEICOwehaveacquired-forcash-anumberoflargebusinessesthathaveperformedincrediblywellsinceweboughtthem.TheseacquisitionshavedeliveredBerkshiretremendousvalue--indeedfarmorethanIanticipatedwhenwemadeourpurchases.Webelievethatitisalmostimpossibleforustotradeupfromourpresentbusinessesandmanagements.OursituationistheoppositeofCamelotsMordredofwhomGueneverecommentedTheonethingIcansayforhimisthatheisboundtomarrywell.Everybodyisabovehim.MarryingwellisextremelydifficultforBerkshire.SoyoucanbesurethatCharlieandIwillbeveryreluctanttoissuesharesinthefuture.Inthosecaseswhenwesimplymustdoso-whencertainshareholdersofadesirableacquireeinsistongettingstock-wewillincludeanattractivecashoptioninordertotemptasmanyofthesellerstotakecashasispossible.Mergingwithpubliccompaniespresentsaspecialproblemforus.Ifwearetoofferanypremiumtotheacquireeoneoftwoconditionsmustbepresent:Eitherourownstockmustbeovervaluedrelativetotheacquireesorthetwocompaniestogethermustbeexpectedtoearnmorethantheywouldifoperatedseparately.HistoricallyBerkshirehasseldombeenovervalued.Inthismarketmoreoverundervaluedacquireesarealmostimpossibletofind.Thatotherpossibility-synergygains-isusuallyunrealisticsinceweexpectacquireestooperateafterweveboughtthemjustastheydidbefore.JoiningwithBerkshiredoesnotnormallyraisetheirrevenuesnorcuttheircosts.IndeedtheirreportedcostsbutnottheirtrueoneswillriseaftertheyareboughtbyBerkshireiftheacquireehasbeengrantingoptionsaspartofitscompensationpackages.Inthesecasesearningsoftheacquireehavebeenoverstatedbecausetheyhavefollowedthestandard-butinourviewdeadwrong--accountingpracticeofignoringthecosttoabusinessofissuingoptions.WhenBerkshireacquiresanoption-issuingcompanywepromptlysubstituteacashcompensationplanhavinganeconomicvalueequivalenttothatofthepreviousoptionplan.Theacquireestruecompensationcostistherebybroughtoutoftheclosetandchargedasitshouldbeagainstearnings.ThereasoningthatBerkshireappliestothemergerofpubliccompaniesshouldbethecalculusforallbuyers.Payingatakeoverpremiumdoesnotmakesenseforanyacquirerunlessaitsstockisovervaluedrelativetotheacquireesorbthetwoenterprisesw川earnmorecombinedthantheywouldseparately.Predictablyacquirersnormallyhewtothesecondargumentbecauseveryfewarewillingtoacknowledgethattheirstockisovervalued.Howevervoraciousbuyers-theonesthatissuesharesasfastastheycanprintthem-aretacitlyconcedingthatpoint.OftenalsotheyarerunningWallStreetsversionofachain-letterscheme.Insomemergerstheretrulyaremajorsynergies-thoughoftentimestheacquirerpaystoomuchtoobtainthem-butatothertimesthecostandrevenuebenefitsthatareprojectedproveillusory.Ofonethinghoweverbecertain:IfaCEOisenthusedaboutaparticularlyfoolishacquisitionbothhisinternalstaffandhisoutsideadvisorswillcomeupwithwhateverprojectionsareneededtojustifyhisstance.Onlyinfairytalesareemperorstoldthattheyarenaked.CommonStockInvestmentsBelowwepresentourcommonstockinvestments.Thosewithamarketvalueofmorethan$750millionareitemized.12/31/97dollarsinmillions*Representstax-basiscostwhichinaggregateis$
1.8billionlessthanGAAPcost.Wemadenetsalesduringtheyearthatamountedtoabout5%ofourbeginningportfolio.Inthesewesignificantlyreducedafewofourholdingsthatarebelowthe$750millionthresholdforitemizationandwealsomodestlytrimmedafewofthelargerpositionsthatwedetail.Someofthesaleswemadeduring1997wereaimedatchangingourbond-stockratiomoderatelyinresponsetotherelativevaluesthatwesawineachmarketarealignmentwehavecontinuedin
1998.OurreportedpositionsweshouldaddsometimesreflecttheinvestmentdecisionsofGEICOsLouSimpson.Louindependentlyrunsanequityportfolioofnearly$2billionthatmayattimesoverlaptheportfoliothatImanageandoccasionallyhemakesmovesthatdifferfrommine.Thoughwedontattempttopredictthemovementsofthestockmarketwedotryinaveryroughwaytovalueit.AttheannualmeetinglastyearwiththeDowat7071andlong-termTreasuryyieldsat
6.89%CharlieandIstatedthatwedidnotconsiderthemarketovervalued//1interestratesremainedwheretheywereorfelland2Americanbusinesscontinuedtoearntheremarkablereturnsonequitythatithadrecentlyrecorded.Sofarinterestrateshavefallen-thatsonerequisitesatisfied-andreturnsonequitystillremainexceptionallyhigh.Iftheystaythere-andifinterestratesholdnearrecentlevels-thereisnoreasontothinkofstocksasgenerallyovervalued.Ontheotherhandreturnsonequityarenotasurethingtoremainatorevenneartheirpresentlevels.Inthesummerof1979whenequitieslookedcheaptomeIwroteaForbesarticleentitledYoupayaveryhighpriceinthestockmarketforacheeryconsensus.Atthattimeskepticismanddisappointmentprevailedandmypointwasthatinvestorsshouldbegladofthefactsincepessimismdrivesdownpricestotrulyattractivelevels.Nowhoweverwehaveaverycheeryconsensus.Thatdoesnotnecessarilymeanthisisthewrongtimetobuystocks:CorporateAmericaisnowearningfarmoremoneythanitwasjustafewyearsagoandinthepresenceoflowerinterestrateseverydollarofearningsbecomesmorevaluable.TodayspricelevelsthoughhavemateriallyerodedthemarginofsafetythatBenGrahamidentifiedasthecornerstoneofintelligentinvesting.InlastyearsannualreportIdiscussedCoca-Colaourlargestholding.Cokecontinuestoincreaseitsmarketdominancethroughouttheworldbuttragicallyithaslosttheleaderresponsibleforitsoutstandingperformance.RobertoGoizuetaCokesCEOsince1981diedinOctober.AfterhisdeathIreadeveryoneofthemorethan100lettersandnoteshehadwrittenmeduringthepastnineyears.Thosemessagescouldwellserveasaguidebookforsuccessinbothbusinessandlife.InthesecommunicationsRobertodisplayedabrilliantandclearstrategicvisionthatwasalwaysaimedatadvancingthewell-beingofCokeshareholders.Robertoknewwherehewasleadingthecompanyhowhewasgoingtogetthereandwhythispathmadethemostsenseforhisowners--andequallyimportanthehadaburningsenseofurgencyaboutreachinghisgoals.Anexcerptfromonehandwrittennotehesenttomeillustrateshismind-set:BythewayIhavetoldOlguitathatwhatshereferstoasanobsessionyoucallfocus.Ilikeyourtermmuchbetter.LikeallwhoknewRobertoIwillmisshimenormously.ConsistentwithhisconcernforthecompanyRobertopreparedforaseamlesssuccessionlongbeforeitseemednecessary.RobertoknewthatDougIvesterwastherightmantotakeoverandworkedwithDougovertheyearstoensurethatnomomentumwouldbelostwhenthetimeforchangearrived.TheCoca-ColaCompanywillbethesamesteamrollerunderDougasitwasunderRoberto.ConvertiblePreferredsTwoyearsagoIgaveyouanupdateonthefiveconvertiblepreferredsthatwepurchasedthroughprivateplacementsinthe1987-1991period.AtthetimeofthatearlierreportwehadrealizedasmallprofitonthesaleofourChampionInternationalholding.ThefourremainingpreferredcommitmentsincludedtwoGilletteandFirstEmpireStatethatwehadconvertedintocommonstockinwhichwehadlargeunrealizedgainsandtwoothersUSAirandSalomonthathadbeentrouble-prone.Attimesthelasttwohadmemouthingalinefromacountrysong:HowcanImissyouifyouwontgoaway1SinceIdeliveredthatreportallfourholdingshavegrownsignificantlyinvalue.ThecommonstocksofbothGilletteandFirstEmpirehaverisensubstantiallyinlinewiththecompaniesexcellentperformance.Atyearendthe$600millionweputintoGillettein1989hadappreciatedto$
4.8billionandthe$40m川ionwecommittedtoFirstEmpirein1991hadrisento$236million.Ourtwolaggardsmeanwhilehavecometolifeinaverymajorway.Inatransactionthatfinallyrewardeditslong-sufferingshareholdersSalomonrecentlymergedintoTravelersGroup.AllofBerkshiresshareholders-includingmeverypersonally-oweahugedebttoDeryckMaughanandBobDenhamforfirstplayingkeyrolesinsavingSalomonfromextinctionfollowingits1991scandalandsecondrestoringthevitalityofthecompanytoalevelthatmadeitanattractiveacquisitionforTravelers.IhaveoftensaidthatIwishtoworkwithexecutivesthatIliketrustandadmire.NotwofitthatdescriptionbetterthanDeryckandBob.BerkshiresfinalresultsfromitsSalomoninvestmentwontbetalliedforsometimebutitissafetosaythattheywillbefarbetterthanIanticipatedtwoyearsago.LookingbackIthinkofmySalomonexperienceashavingbeenbothfascinatingandinstructionalthoughforatimein1991-92Ifeltlikethedramacriticwhowrote:IwouldhaveenjoyedtheplayexceptthatIhadanunfortunateseat.Itfacedthestage.TheresuscitationofUSAirwaysbordersonthemiraculous.ThosewhohavewatchedmymovesinthisinvestmentknowthatIhavecompiledarecordthatisunblemishedbysuccess.IwaswronginoriginallypurchasingthestockandIwaswronglaterinrepeatedlytryingtounloadourholdingsat50centsonthedollar.Twochangesatthecompanycoincidedwithitsremarkablerebound:1CharlieandIlefttheboardofdirectorsand2StephenWolfbecameCEO.Fortunatelyforouregosthesecondeventwasthekey:StephenWolfsaccomplishmentsattheairlinehavebeenphenomenal.TherestillismuchtodoatUSAirwaysbutsurvivalisnolongeranissue.Consequentlythecompanymadeupthedividendarrearagesonourpreferredduring1997addingextrapaymentstocompensateusforthedelaywesuffered.Thecompanyscommonstockfurthermorehasrisenfromalowof$4toarecenthighof$
73.OurpreferredhasbeencalledforredemptiononMarch
15.Buttheriseinthecompanysstockhasgivenourconversionrightswhichwethoughtworthlessnotlongagogreatvalue.ItisnowalmostcertainthatourUSAirwaysshareswillproduceadecentprofit-thatisifmycostforMaaloxisexcluded-andthegaincouldevenproveindecent.NexttimeImakeabigdumbdecisionBerkshireshareholderswillknowwhattodo:PhoneMr.Wolf.Inadditiontotheconvertiblepreferredswepurchasedoneotherprivateplacementin1991$300millionofAmericanExpressPeres.Thissecuritywasessentiallyacommonstockthatfeaturedatradeoffinitsfirstthreeyears:Wereceivedextradividendpaymentsduringthatperiodbutwewerealsocappedinthepriceappreciationwecouldrealize.DespitethecapthisholdinghasprovedextraordinarilyprofitablethankstoamovebyyourChairmanthatcombinedluckandskill-110%luckthebalanceskill.OurPereswereduetoconvertintocommonstockinAugust1994andinthemonthbeforeIwasmullingwhethertoselluponconversion.OnereasontoholdwasAmexsoutstandingCEOHarveyGolubwhoseemedlikelytomaximizewhateverpotentialthecompanyhadasuppositionthathassincebeenproved--inspades.Butthesizeofthatpotentialwasinquestion:Amexfacedrelentlesscompetitionfromamultitudeofcard-issuersledbyVisa.WeighingtheargumentsIleanedtowardsale.HereswhereIgotlucky.DuringthatmonthofdecisionIplayedgolfatProutsNeckMainewithFrankOlsonCEOofHertz.Frankisabrilliantmanagerwithintimateknowledgeofthecardbusiness.SofromthefirstteeonIwasquizzinghimabouttheindustry.BythetimewereachedthesecondgreenFrankhadconvincedmethatAmexscorporatecardwasaterrificfranchiseandIhaddecidednottosell.OnthebacknineIturnedbuyerandinafewmonthsBerkshireowned10%ofthecompany.Wenowhavea$3billiongaininourAmexsharesandInaturallyfeelverygratefultoFrank.ButGeorgeGillespieourmutualfriendsaysthatIamconfusedaboutwheremygratitudeshouldgo.AfterallhepointsoutitwashewhoarrangedthegameandassignedmetoFranksfoursome.QuarterlyReportstoShareholdersThecostofpublishingquarterlieshowevercontinuestoballoonandwehavethereforedecidedtosendprintedversionsonlytoshareholderswhorequestthem.Ifyouwishthequarterliespleasecompletethereplycardthatisboundintothisreport.Inthemeantimebeassuredthata//shareholderswillcontinuetoreceivetheannualreportinprintedform.Thoseofyouwhoenjoythecomputershouldcheckoutourhomepage.ItcontainsalargeamountofcurrentinformationaboutBerkshireandalsoallofourannualletterssince
1977.InadditionourwebsiteincludeslinkstothehomepagesofmanyBerkshiresubsidiaries.Onthesesitesyoucanlearnmoreaboutoursubsidiariesproductsand-yes-evenplaceordersforthem.WearerequiredtofileourquarterlyinformationwiththeSECnolaterthan45daysaftertheendofeachquarter.OneofourgoalsinpostingcommunicationsontheInternetistomakethismaterialinformation-infulldetailandinaformunfilteredbythemedia-simultaneouslyavailabletoallinterestedpartiesatatimewhenmarketsareclosed.Accordinglyweplantosendour1998quarterlyinformationtotheSEConthreeFridaysMay15August14andNovember13andonthosenightstopostthesameinformationontheInternet.Thisprocedurewillputallofourshareholderswhethertheybedirectorstreet-nameonanequalfooting.Similarlywew川postour1998annualreportontheInternetonSaturdayMarch131999andmailitataboutthesametime.Shareholder-DesignatedContributionsAbout
97.7%ofalleligiblesharesparticipatedinBerkshires1997shareholder-designatedcontributionsprogram.Contributionsmadewere$
15.4millionand3830charitieswererecipients.Afulldescriptionoftheprogramappearsonpages52-
53.Cumulativelyoverthe17yearsoftheprogramBerkshirehasmadecontributionsof$
113.1millionpursuanttotheinstructionsofourshareholders.TherestofBerkshiresgivingisdonebyoursubsidiarieswhichsticktothephilanthropicpatternsthatprevailedbeforetheywereacquiredexceptthattheirformerownersthemselvestakeontheresponsibilityfortheirpersonalcharities.Inaggregateoursubsidiariesmadecontributionsof$
8.1millionin1997includingin-kinddonationsof$
4.4million.Everyyearafewshareholdersmissoutonourcontributionsprogrambecausetheydonthavetheirsharesregisteredintheirownnamesontheprescribedrecorddateorbecausetheyfailtogetthedesignationformbacktouswithinthe60-dayperiodallowed.CharlieandIregretthis.Butifrepliesarereceivedlatewehavetorejectthembecausewecantmakeexceptionsforsomeshareholderswhilerefusingtomakethemforothers.ToparticipateinfutureprogramsyoumustownClassAsharesthatareregisteredinthenameoftheactualownernotthenomineenameofabrokerbankordepository.SharesnotsoregisteredonAugust311998willbeineligibleforthe1998program.Whenyougetthecontributionsformfromusreturnitpromptlysothatitdoesnotgetputasideorforgotten.TheAnnualMeetingWoodstockWeekendatBerkshirewillbeMay2-4thisyear.Thefinalewillbetheannualmeetingwhichwillbeginat9:30a.m.onMondayMay
4.LastyearwemetatAksarbenColiseumandbothourstaffandthecrowdweredelightedwiththevenue.Therewasonlyonecrisis:ThenightbeforethemeetingIlostmyvoicetherebyfulfillingCharlieswildestfantasy.HewascrushedwhenIshowedupthenextmorningwithmyspeechrestored.Lastyearabout7500attendedthemeeting.Theyrepresentedall50statesaswellas16countriesincludingAustraliaBrazilIsraelSaudiArabiaSingaporeandGreece.Takingintoaccountseveraloverflowroomswebelievethatwecanhandlemorethan11000peopleandthatshouldputusingoodshapethisyeareventhoughourshareholdercounthasrisensignificantly.ParkingisampleatAksarben;acousticsareexcellent;andseatsarecomfortable.Thedoorswillopenat7a.m.onMondayandat8:30wew川againfeaturetheworldpremiereofamovieepicproducedbyMarcHamburgourCFO.Themeetingw川lastuntil3:30withashortbreakatnoon.ThisintervalwillpermittheexhaustedtoleaveunnoticedandallowtimeforthehardcoretolunchatAksarbensconcessionstands.CharlieandIenjoyquestionsfromownerssobringupwhateverisonyourmind.Berkshireproductswillagainbeforsaleinthehallsoutsidethemeetingroom.Lastyear-notthatIpayattentiontothissortofthing-weagainsetsalesrecordsmoving2500poundsofSeescandy1350pairsofDextershoes$75000ofWorldBooksandrelatedpublicationsand888setsofQuikutknives.WealsotookordersforanewlineofapparelfeaturingourBerkshirelogoandsoldabout1000polosweatandT-shirts.Atthisyearsmeetingwewillunveilour1998collection.GEICOwillagainbeonhandwithaboothstaffedbystarassociatesfromitsregionaloffices.FindoutwhetheryoucansavemoneybyshiftingyourautoinsurancetoGEICO.About40%ofthosewhocheckusoutlearnthatsavingsarepossible.Theproportionisnot100%becauseinsurersdifferintheirunderwritingjudgmentswithsomefavoringdriverswholiveincertaingeographicalareasandworkatcertainoccupationsmorethanwedo.Webelievehoweverthatwemorefrequentlyofferthelowpricethandoesanyothernationalcarriersellinginsurancetoallcomers.IntheGEICOinformationalmaterialthataccompaniesthisreportyouwillseethatin38stateswenowofferaspecialdiscountofasmuchas8%toourshareholders.Wealsohaveapplicationspendingthatwouldextendthisdiscounttodriversinotherstates.Anattachmenttotheproxymaterialthatisenclosedwiththisreportexplainshowyoucanobtainthecardyouwillneedforadmissiontothemeeting.Weexpectalargecrowdsogetplanehotelandcarreservationspromptly.AmericanExpress800-799-6634willbehappytohelpyouwitharrangements.AsusualwewillhavebusesatthelargerhotelsthatwilltakeyoutoandfromthemeetingandalsodeliveryoutoNebraskaFurnitureMartBorsheimsandtheairportafteritsconclusion.Youarelikelyhowevertofindacarhandy.NFMsmainstorelocatedona75-acresiteaboutamilefromAksarbenisopenfrom10a.m.to9p.m.onweekdays10a.m.to6p.m.onSaturdaysandnoonto6p.m.onSundays.DuringtheperiodfromMay1toMay5shareholderswhopresentNFMwiththecouponthatwillaccompanytheirmeetingticketwillbeentitledtoadiscountthatisotherwiserestrictedtoitsemployees.BorsheimsnormallyisclosedonSundaybutwillbeopenforshareholdersfrom10a.m.to6p.m.onMay3rd.Lastyearwasoursecond-bestshareholdersdayexceededonlyby1996s.Iregardthisslippageasananomalyandhopethatyouwillprovemerightthisyear.Charliewillbeavailableforautographs.HesmileshoweveronlyifthepaperhesignsisaBorsheimssalesticket.ShareholderswhowishtovisitonSaturday10a.m.to5:30p.m.oronMonday10a.m.-8p.m.shouldbesuretoidentifythemselvesasBerkshireownerssothatSusanJacquesBorsheimsCEOcanmakeyouespeciallywelcome.SusanIshouldaddhadafabulousyearin
1997.Asamanagersheiseverythingthatanownerhopesfor.OnSundayafternoonwewillalsohaveaspecialtreatforbridgeplayersinthemalloutsideofBorsheims.ThereBobHamman-alegendofthegameformorethanthreedecades-willtakeonallcomers.JoininanddazzleBobwithyourskill.MyfavoritesteakhouseGoratsopensoneSundayayear-forBerkshireshareholdersonthenightbeforetheannualmeeting.Lastyeartherestaurantstartedservingat4p.m.andfinishedabout1:30a.manendurancetrialthatwastheresultoftaking1100reservationsvs.aseatingcapacityof
235.IfyoumakeareservationandthencantattendbesuretoletGoratsknowpromptlysinceitgoestogreatefforttohelpusandwewanttoreciprocate.YoucanmakereservationsbeginningonApril1stbutnotbeforebycalling402-551-
3733.LastyearIhadtoleaveGoratsalittleearlybecauseofmyvoiceproblembutthisyearIplantoleisurelysavoreverybiteofmyrareT-boneanddoubleorderofhashbrowns.AfterthiswarmupCharlieandIwillheadfortheDairyQueenon114thjustsouthofDodge.Thereare12greatDairyQueensinmetropolitanOmahabutthe114thStreetlocationisthebestsuitedtohandlethelargecrowdthatweexpect.Southofthepropertytherearehundredsofparkingspacesonbothsidesofthestreet.AlsothisDairyQueenwillextenditsSundayhoursto11p.m.inordertoaccommodateourshareholders.The114thStreetoperationisnowrunbytwosistersConiBirgeandDebNovotnywhosegrandfatherputupthebuildingin1962atwhatwasthentheouteredgeofthecity.TheirmotherJanNobletookoverin1972andConiandDebcontinueasthirdgenerationowner-managers.JanConiandDebwillallbeonhandSundayeveningandIhopethatyoumeetthem.EnjoyoneoftheirhamburgersifyoucantgetintoGorats.AndthenaroundeightoclockjoinmeinhavingaDustySundaefordessert.Thisitemisapersonalspecialty-theDairyQueenwillfurnishyouacopyofmyrecipe-andwillbeofferedonlyonShareholderSunday.TheOmahaRoyalsandAlbuquerqueDukeswillplaybaseballonSaturdayeveningMay2ndatRosenblattStadium.AsusualyourChairmanshamelesslyexploitinghis25%ownershipoftheteamwilltakethemound.Butthisyearyouwillseesomethingnew.InpastgamesmuchtothebafflementofthecrowdIhaveshakenoffthecatchersfirstcall.HehasconsistentlyaskedformysweepingcurveandIhavejustasregularlyresisted.InsteadIhaveservedupapatheticfastballwhichonmybestdaywasclockedateightmilesperhourwithafollowingwind.Theresastorybehindmyunwillingnesstothrowthecurveball.AssomeofyoumayknowCandyCummingsinventedthecurvein1867andusedittogreateffectintheNationalAssociationwhereheneverwonlessthan28gamesinaseason.ThepitchhoweverdrewimmediatecriticismfromtheveryhighestofauthoritiesnamelyCharlesElliottthenpresidentofHarvardUniversitywhodeclarednlhaveheardthatthisyearweatHarvardwonthebaseballchampionshipbecausewehaveapitcherwhohasafinecurveball.Iamfurtherinstructedthatthepurposeofthecurveballistodeliberatelyhavegrownfrom$1millionto$888million.FurthermoreasnotedinthisexercisewehaveassignedallofBerkshirescorporateexpenses-overheadof$
6.6m川ioninterestof$
66.9millionandshareholdercontributionsof$
15.4million-toourbusinessoperationseventhoughaportionofthesecouldjustaswellhavebeenassignedtotheinvestmentside.Herearethegrowthratesofthetwosegmentsbydecade:Pre-taxEarningsPerShareInvestmentsExcludingAllIncomefromDecadeEndinnPerShareInvestmentsDuring1997bothpartsofourbusinessgrewatasatisfactoryratewithinvestmentsincreasingby$9543pershareor
33.5%andoperatingearningsgrowingby$
296.43pershareor
70.3%Oneimportantcaveat:Becausewewereluckyinoursuper-catinsurancebusinesstobediscussedlaterandbecauseGEICOsunderwritinggainwaswellabovewhatwecanexpectinmostyearsour1997operatingearningsweremuchbetterthanweanticipatedandalsomorethanweexpectfor
1998.Ourrateofprogressinbothinvestmentsandoperationsiscertaintofallinthefuture.Foranyonedeployingcapitalnothingrecedeslikesuccess.Myownhistorymakesthepoint:Backin1951whenIwasattendingBenGrahamsclassatColumbiaanideagivingmea$10000gainimprovedmyinvestmentperformancefortheyearbyafull100percentagepoints.Todayanideaproducinga$500millionpre-taxprofitforBerkshireaddsonepercentagepointtoourperformance.Itsnowonderthatmyannualresultsinthe1950swerebetterbynearlythirtypercentagepointsthanmyannualgainsinanysubsequentdecade.Charliesexperiencewassimilar.Wewerentsmarterthenjustsmaller.Atourpresentsizeanyperformancesuperiorityweachievewillbeminor.Wew川behelpedhoweverbythefactthatthebusinessestowhichwehavealreadyallocatedcapital-bothoperatingsubsidiariesandcompaniesindeceivethebatter.Harvardisnotinthebusinessofteachingdeception.Tmnotmakingthisup.EversinceIlearnedofPresidentElliottsmoralteachingsonthissubjectIhavescrupulouslyrefrainedfromusingmycurvehoweverdevastatingitseffectmighthavebeenonhaplessbatters.NowhoweveritistimeformykarmatorunoverElliottsdogmaandformetoquitholdingback.VisittheparkonSaturdaynightandmarvelatthemajesticarcofmybreakingball.Ourproxystatementincludesinformationaboutobtainingticketstothegame.Wewillalsoprovideaninformationpacketdescribingthelocalhotspotsincludingofcoursethose12DairyQueens.CometoOmaha--thecradleofcapitalism-inMayandenjoyyourself.WarrenE.BuffettChairmanoftheBoardwhichwearepassiveinvestors-havesplendidlong-termprospects.Wearealsoblessedwithamanagerialcorpsthatisunsurpassedinabilityandfocus.MostoftheseexecutivesarewealthyanddonotneedthepaytheyreceivefromBerkshiretomaintaintheirwayoflife.Theyaremotivatedbythejoyofaccomplishmentnotbyfameorfortune.Thoughwearedelightedwithwhatweownwearenotpleasedwithourprospectsforcommittingincomingfunds.Pricesarehighforbothbusinessesandstocks.Thatdoesnotmeanthatthepricesofeitherwillfall-wehaveabsolutelynoviewonthatmatter-butitdoesmeanthatwegetrelativelylittleinprospectiveearningswhenwecommitfreshmoney.UnderthesecircumstanceswetrytoexertaTedWilliamskindofdiscipline.InhisbookTheScienceofHittingTedexplainsthathecarvedthestrikezoneinto77cellseachthesizeofabaseball.Swingingonlyatballsinhisbestcellheknewwouldallowhimtobat.400;reachingforballsinhisworstspotthelowoutsidecornerofthestrikezonewouldreducehimto.
230.InotherwordswaitingforthefatpitchwouldmeanatriptotheHallofFame;swingingindiscriminatelywouldmeanatickettotheminors.Iftheyareinthestrikezoneatallthebusinesspitcheswenowseearejustcatchingtheloweroutsidecorner.Ifweswingwewillbelockedintolowreturns.Butifweletalloftodaysballsgobytherecanbenoassurancethatthenextonesweseewillbemoretoourliking.Perhapstheattractivepricesofthepastweretheaberrationsnotthefullpricesoftoday.UnlikeTedwecantbecalledoutifweresistthreepitchesthatarebarelyinthestrikezone;neverthelessjuststandingtheredayafterdaywithmybatonmyshoulderisnotmyideaoffun.UnconventionalCommitmentsWhenwecan*tfindourfavoritecommitment-awell-runandsensibly-pricedbusinesswithfineeconomics-weusuallyopttoputnewmoneyintoveryshort-terminstrumentsofthehighestquality.Sometimeshoweverweventureelsewhere.Obviouslywebelievethatthealternativecommitmentswemakearemorelikelytoresultinprofitthanloss.Butwealsorealizethattheydonotofferthecertaintyofprofitthatexistsinawonderfulbusinesssecuredatanattractiveprice.Findingthatkindofopportunityweknowthatwearegoingtomakemoney-theonlyquestionbeingwhen.Withalternativeinvestmentswethinkthatwearegoingtomakemoney.Butwealsorecognizethatwewillsometimesrealizelossesoccasionallyofsubstantialsize.Wehadthreenon-traditionalpositionsatyearend.Thefirstwasderivativecontractsfor
14.0millionbarrelsofoilthatbeingwhatwasthenleftofa
45.7millionbarrelpositionweestablishedin1994-
95.Contractsfor
31.7millionbarrelsweresettledin1995-97andthesesupplieduswithapre-taxgainofabout$
61.9million.Ourremainingcontractsexpireduring1998and
1999.Inthesewehadanunrealizedgainof$
11.6millionatyearend.Accountingrulesrequirethatcommoditypositionsbecarriedatmarketvalue.Thereforebothourannualandquarterlyfinancialstatementsreflectanyunrealizedgainorlossinthesecontracts.Whenweestablishedourcontractsoilforfuturedeliveryseemedmodestlyunderpriced.Todaythoughwehavenoopinionastoitsattractiveness.Oursecondnon-traditionalcommitmentisinsilver.Lastyearwepurchased
111.2millionounces.Markedtomarketthatpositionproducedapre-taxgainof$
97.4millionforusin
1997.Inawaythisisareturntothepastforme:ThirtyyearsagoIboughtsilverbecauseIanticipateditsdemonetizationbytheU.S.Government.EversinceIhavefollowedthemetalsfundamentalsbutnotownedit.InrecentyearsbullioninventorieshavefallenmateriallyandlastsummerCharlieandIconcludedthatahigherpricewouldbeneededtoestablishequilibriumbetweensupplyanddemand.Inflationexpectationsitshouldbenotedplaynopartinourcalculationofsilversvalue.Finallyourlargestnon-traditionalpositionatyearendwas$
4.6billionatamortizedcostoflong-termzero-couponobligationsoftheU.S.Treasury.Thesesecuritiespaynointerest.Insteadtheyprovidetheirholdersareturnbywayofthediscountatwhichtheyarepurchasedacharacteristicthatmakestheirmarketpricesmoverapidlywheninterestrateschange.Ifratesriseyouloseheavilywithzerosandifratesfallyoumakeoutsizedgains.Sinceratesfellin1997weendedtheyearwithanunrealizedpre-taxgainof$
598.8millioninourzeros.Becausewecarrythesecuritiesatmarketvaluethatgainisreflectedinyearendbookvalue.Inpurchasingzerosratherthanstayingwithcash-equivalentswerisklookingveryfoolish:Amacro-basedcommitmentsuchasthisneverhasanythingclosetoa100%probabilityofbeingsuccessful.HoweveryoupayCharlieandmetouseourbestjudgment-nottoavoidembarrassment-andwewilloccasionallymakeanunconventionalmovewhenwebelievetheoddsfavorit.Trytothinkkindlyofuswhenweblowone.AlongwithPresidentClintonwew川befeelingyourpain:TheMungerfamilyhasmorethan90%ofitsnetworthinBerkshireandtheBuffettsmorethan99%.HowWeThinkAboutMarketFluctuationsAshortquiz:IfyouplantoeathamburgersthroughoutyourlifeandarenotacattleproducershouldyouwishforhigherorlowerpricesforbeefLikewiseifyouaregoingtobuyacarfromtimetotimebutarenotanautomanufacturershouldyoupreferhigherorlowercarpricesThesequestionsofcourseanswerthemselves.Butnowforthefinalexam:IfyouexpecttobeanetsaverduringthenextfiveyearsshouldyouhopeforahigherorlowerstockmarketduringthatperiodManyinvestorsgetthisonewrong.Eventhoughtheyaregoingtobenetbuyersofstocksformanyyearstocometheyareelatedwhenstockpricesriseanddepressedwhentheyfall.Ineffecttheyrejoicebecausepriceshaverisenforthehamburgerstheyw川soonbebuying.Thisreactionmakesnosense.Onlythosewhowillbesellersofequitiesinthenearfutureshouldbehappyatseeingstocksrise.Prospectivepurchasersshouldmuchprefersinkingprices.ForshareholdersofBerkshirewhodonotexpecttosellthechoiceisevenclearer.Tobeginwithourownersareautomaticallysavingeveniftheyspendeverydimetheypersonallyearn:Berkshiresavesforthembyretainingallearningsthereafterusingthesesavingstopurchasebusinessesandsecurities.Clearlythemorecheaplywemakethesebuysthemoreprofitableourowners*indirectsavingsprogramwillbe.FurthermorethroughBerkshireyouownmajorpositionsincompaniesthatconsistentlyrepurchasetheirshares.Thebenefitsthattheseprogramssupplyusgrowaspricesfall:Whenstockpricesarelowthefundsthataninvesteespendsonrepurchasesincreaseourownershipofthatcompanybyagreateramountthanisthecasewhenpricesarehigher.ForexampletherepurchasesthatCoca-ColaTheWashingtonPostandWellsFargomadeinpastyearsatverylowpricesbenefitedBerkshirefarmorethandotodaysrepurchasesmadeatloftierprices.Attheendofeveryyearabout97%ofBerkshiressharesareheldbythesameinvestorswhoownedthematthestartoftheyear.Thatmakesthemsavers.Theyshouldthereforerejoicewhenmarketsdeclineandallowbothusandourinvesteestodeployfundsmoreadvantageously.SosmilewhenyoureadaheadlinethatsaysInvestorsloseasmarketfalls.EdititinyourmindtoD/sinvestorsloseasmarketfalls-butinvestorsgain.1*Thoughwritersoftenforgetthistruismthereisabuyerforeverysellerandwhathurtsonenecessarilyhelpstheother.Astheysayingolfmatches:Everyputtmakessomeonehappy.*Wegainedenormouslyfromthelowpricesplacedonmanyequitiesandbusinessesinthe1970sand1980s.Marketsthatthenwerehostiletoinvestmenttransientswerefriendlytothosetakinguppermanentresidence.Inrecentyearstheactionswetookinthosedecadeshavebeenvalidatedbutwehavefoundfewnewopportunities.InitsroleasacorporatesaverBerkshirecontinuallylooksforwaystosensiblydeploycapitalbutitmaybesometimebeforewefindopportunitiesthatgetustrulyexcited.InsuranceOperations-OverviewWhatdoesexciteushoweverisourinsurancebusiness.GEICOisflyingandweexpectthatitwillcontinuetodoso.BeforeweexpoundonthatthoughletsdiscussHfloatandhowtomeasureitscost.Unlessyouunderstandthissubjectitw川beimpossibleforyoutomakeaninformedjudgmentaboutBerkshiresintrinsicvalue.Tobeginwithfloatismoneyweholdbutdontown.Inaninsuranceoperationfloatarisesbecausepremiumsarereceivedbeforelossesarepaidanintervalthatsometimesextendsovermanyyears.Duringthattimetheinsurerinveststhemoney.Typicallythispleasantactivitycarrieswithitadownside:Thepremiumsthataninsurertakesinusuallydonotcoverthelossesandexpensesiteventuallymustpay.Thatleavesitrunninganunderwritinglosswhichisthecostoffloat.Aninsurancebusinesshasvalueifitscostoffloatovertimeislessthanthecostthecompanywouldotherwiseincurtoobtainfunds.Butthebusinessisalemonifitscostoffloatishigherthanmarketratesformoney.Acautionisappropriatehere:Becauselosscostsmustbeestimatedinsurershaveenormouslatitudeinfiguringtheirunderwritingresultsandthatmakesitverydifficultforinvestorstocalculateacompanystruecostoffloat.Estimatingerrorsusuallyinnocentbutsometimesnotcanbehuge.Theconsequencesofthesemiscalculationsflowdirectlyintoearnings.Anexperiencedobservercanusuallydetectlarge-scaleerrorsinreservingbutthegeneralpubliccantypicallydonomorethanacceptwhatspresentedandattimesIhavebeenamazedbythenumbersthatbig-nameauditorshaveimplicitlyblessed.AsforBerkshireCharlieandIattempttobeconservativeinpresentingitsunderwritingresultstoyoubecausewehavefoundthatvirtuallyallsurprisesininsuranceareunpleasantones.AsthenumbersinthefollowingtableshowBerkshiresinsurancebusinesshasbeenahugewinner.Forthetablewehavecalculatedourfloat-whichwegenerateinlargeamountsrelativetoourpremiumvolume-byaddingnetlossreserveslossadjustmentreservesfundsheldunderreinsuranceassumedandunearnedpremiumreservesandthensubtractingagentsbalancesprepaidacquisitioncostsprepaidtaxesanddeferredchargesapplicabletoassumedreinsurance.Ourcostoffloatisdeterminedbyourunderwritinglossorprofit.Inthoseyearswhenwehavehadanunderwritingprofitsuchasthelastfiveourcostoffloathasbeennegative.Ineffectwehavebeenpaidforholdingmoney.BondsIn$MillionsRatioof1to2YearendonGovt.Since1967whenweenteredtheinsurancebusinessourfloathasgrownatanannualcompoundedrateof
21.7%.Betteryetithascostusnothingandinfacthasmadeusmoney.Thereinliesanaccountingirony:ThoughourfloatisshownonourbalancesheetasaliabilityithashadavaluetoBerkshiregreaterthananequalamountofnetworthwouldhavehad.Theexpirationofseverallargecontractswillcauseourfloattodeclineduringthefirstquarterof1998butweexpectittogrowsubstantiallyoverthelongterm.Wealsobelievethatourcostoffloatwillcontinuetobehighlyfavorable.Super-CatInsuranceOccasionallyhoweverthecostofourfloatwillspikeseverely.Thatwilloccurbecauseofourheavyinvolvementinthesuper-catbusinesswhichbyitsnatureisthemostvolatileofallinsurancelines.Inthisoperationwesellpoliciesthatinsuranceandreinsurancecompaniespurchaseinordertolimittheirlosseswhenmega-catastrophesstrike.Berkshireisthepreferredmarketforsophisticatedbuyers:Whenthe“bigonehitsthefinancialstrengthofsuper-catwritersw川betestedandBerkshirehasnopeerinthisrespect.YearsNewVoluntaryAutoPoliciesVoluntaryAutoPoliciesinForce1993354882201105519943962172147549199546160823100371996617669254369919979131762949439FinanceBusinesses....
28.
123.
118.
014.9Flightsafety
139.
53.
1184.
41.91HomeFurnishings...
56.
8243.
832.
2224.8Jewelry
31.
627.
818.
316.1ScottFetzerexcludingfinanceoperation.
118.
9121.
777.
381.6SeesCandies.
58.
651.
935.
030.8ShoeGroup.
48.
861.
632.
241.0Purchase-AccountingAdjustments
104975.
797.
070.5InterestExpense3…
106.
694.
367.
156.6Shareholder-DesignatedContributions…
15.
413.
39.
98.5Other
60.
773.
037.
042.2OperatingEarnings..
1715.
71221.
41194.
5883.1CapitalGainsfromInvestments.
1111.
92484.
5707.
11605.5AmericanExpressCompany
10.7%$161TheCoca-ColaCompany
8.1%216TheWaltDisneyCompany
3.2%65FreddieMac
8.6%86TheGilletteCompany
8.6%82TheWashingtonPostCompany
16.5%30WellsFargoCompany
7.8%1031967$41$
1.
09197737212.
4419873910108.
14199738043717.8249456900AmericanExpressCompany$
1392.7$
4414.0200000000TheCoca-ColaCompany
1298.
913337.521563414TheWaltDisneyCompany
381.
22134.863977600FreddieMac
329.
42683.148000000TheGilletteCompany
600.
04821.023733198TravelersGroupInc.
604.
41278.61727765TheWashingtonPostCompany
10.
6840.66690218WellsFargoCompany
412.
62270.9Others
2177.
14467.2TotalCommonStocks$
7206.9$
36247.712YieldUnderwritingApproximateLong-TermLossAverageFloatCostofFunds1967profit
17.3lessthanzero
5.50%1968profit
19.9lessthanzero
5.90%1969profit
23.4lessthanzero
6.79%
19700.
3732.
41.14%
6.25%1971profit
52.5lessthanzero
5.81%1972profit
69.5lessthanzero
5.82%1973profit
73.3lessthanzero
7.27%
19747.
3679.
19.30%
8.13%
197511.
3587.
612.96%
8.03%1976profit
102.6lessthanzero
7.30%1977profit
139.0lessthanzero
7.97%1978profit
190.4lessthanzero
8.93%1979profit
227.3lessthanzero
10.08%1980profit
237.0lessthanzero
11.94%1981profit
228.4lessthanzero
13.61%
198221.
56220.
69.77%
10.64%
198333.
87231.
314.64%
11.84%
198448.
06253.
218.98%
11.58%
198544.
23390.
211.34%
9.34%
198655.
84797.
57.00%
7.60%
198755.
431266.
74.38%
8.95%
198811.
081497.
70.74%
9.00%
198924.
401541.
31.58%
7.97%
199026.
651637.
31.63%
8.24%
1991119.
591895.
06.31%
7.40%
1992108.
962290.
44.76%
7.39%1993profit
2624.7lessthanzero
6.35%1994profit
3056.6lessthanzero
7.88%1995profit
3607.2lessthanzero
5.95%1996profit
6702.0lessthanzero
6.64%1997profit
7093.1lessthanzero
5.92%。