1985 Shareholder Letter

Date: March 4, 1986 Author: Warren Buffett Company: Berkshire Hathaway

Overview

1985 delivered a gain in net worth of $613.6 million, or 48.2% — a performance Buffett noted would be seen only as often as Halley's Comet (which coincided with this year). Over 21 years under present management, per-share book value grew from $19.46 to $1,643.71, or 23.2% compounded annually — returns Buffett explicitly stated would not be repeated.

This letter explained two factors making such returns impossible going forward: (1) current stock market offers very little opportunity compared to 1964-1984, and (2) Berkshire's size (20x larger than 10 years prior) makes high returns mathematically harder.

Key Points

Why 23% Returns Cannot Continue

"An iron law of business is that growth eventually dampens exceptional economics. Just look at the records of high-return companies once they have amassed even $1 billion of equity capital. None that I know of has managed subsequently, over a ten-year period, to keep on earning 20% or more on equity while reinvesting all or substantially all of its earnings."

The Math Problem of Size

To earn just 15% annually going forward, Buffett calculated Berkshire would need to profit $5.7 billion over the next ten years:

"Leaving aside oil companies, only about 15 U.S. businesses have managed to earn over $5.7 billion during the past ten years."

Market Rationality and Shareholders

Buffett praised Berkshire's shareholder base and explained why institutional ownership often leads to irrational pricing:

"You might think that institutions, with their large staffs of highly-paid and experienced investment professionals, would be a force for stability and reason in financial markets. They are not: stocks heavily owned and constantly monitored by institutions have often been among the most inappropriately valued."

The Oil Prospector Story

Buffett retold Ben Graham's parable about professionals following the crowd:

An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. The compound for oil men was packed. The prospector asked to say four words to the occupants: "Oil discovered in hell." Immediately all the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in. The prospector paused: "No, I think I'll go along with the rest of the boys. There might be some truth to that rumor after all."

Key Transactions

• Capital Cities/ABC: Major position purchased
• Scott & Fetzer: Acquisition completed
• Fireman's Fund: Entry into large, extended-term insurance participation
• General Foods: Position sold

Famous Quotes

"Over the long term there has been a more consistent relationship between Berkshire's market value and business value than has existed for any other publicly-traded equity with which I am familiar. This is a tribute to you."

"Wild swings in market prices far above and below business value do not change the final gains for owners in aggregate; in the end, investor gains must equal business gains."

"We love our work."

Related

• letter-1980 — Earlier discussion of retained earnings and compounding
• letter-1984 — Preceding year
• letter-1986 — Following year
• warren-buffett
• capital-allocation
• compounding