1977 Shareholder Letter

Date: March 1978 Author: Warren Buffett Company: Berkshire Hathaway

Overview

In 1977, Berkshire delivered operating earnings of $21.9 million ($22.54 per share), slightly better than expected. The year was marked by exceptional insurance underwriting results led by Phil Liesche's team at National Indemnity, while textile operations continued to disappoint. This letter introduced Buffett's argument that return on equity (ROE) is a better measure of managerial performance than earnings per share, which can be misleading as companies grow their equity base.

Key Points

The Case for Return on Equity

Buffett argued that EPS growth is meaningless without context:

"Most companies define 'record' earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding."

Insurance Excellence

The insurance segment, particularly Phil Liesche's National Indemnity, delivered outstanding results. Buffett highlighted the importance of disciplined underwriting and noted that the industry faced a turning point as inflation pushed costs up 1% per month while rate increases were slowing.

Why Stay in Textiles?

Buffett explained his reasoning for remaining in the struggling textile business: (1) the mills are major local employers, (2) management was honest and hardworking, (3) labor had been cooperative, and (4) the business should generate modest cash returns.

The Inflation Warning

This letter contained an early warning about inflation's impact on insurance:

"We estimate that costs involved in the insurance areas in which we operate rise at close to 1% per month. This is due to continuous monetary inflation affecting the cost of repairing humans and property, as well as 'social inflation'..."

Famous Quotes

"We try to buy businesses where we can understand why they are making money... We want to be sure that the businesses we understand are indeed making money and that they will continue to do so."

"In the insurance business... there are no important advantages from trademarks, patents, location, corporate longevity, raw material sources, etc., and very little consumer differentiation to produce insulation from competition."

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