1957 Annual Letter to Partners
Buffett's second annual letter explaining the distinction between General Issues and Work-outs, and the partnership's outperformance during a declining market.
1957 Annual Letter to Partners
Warren E. Buffett | February 1958 | Omaha, Nebraska
The General Stock Market Picture in 1957
In last year's letter to partners, I said the following:
"My view of the general market level is that it is priced above intrinsic value. This view relates to blue-chip securities. This view, if accurate, carries with it the possibility of a substantial decline in all stock prices, both undervalued and otherwise. In any event I think the probability is very slight that current market levels will be thought of as cheap five years from now."
Buffett emphasized he does not attempt to forecast the market. Primary attention is always given to finding substantially undervalued securities.
The past year witnessed a moderate decline in stock prices. The decline in stock prices has been considerably less than the decline in corporate earning power under present business conditions. The public remains very bullish on blue chip stocks and the general economic picture. The general market is still priced on the high side based on long term investment value.
Our Activities in 1957
The Distinction: General Issues vs. Work-outs
An explanation of the term "work-out" is essential to understanding our method:
"A work-out is an investment which is dependent on a specific corporate action for its profit rather than a general advance in the price of the stock as in the case of undervalued situations. Work-outs come about through: sales, mergers, liquidations, tenders, etc. In each case, the risk is that something will upset the applecart and cause the abandonment of the planned action, not that the economic picture will deteriorate and stocks decline generally."
General Issues (Undervalued Situations): Profit comes from the general advance in the price of the stock as it converges to intrinsic value.
Work-outs: Profit depends on a specific corporate action — merger, acquisition, liquidation, tender offer, or reorganization.
At the end of 1956, the ratio of General Issues to Work-outs was approximately 70-30. By 1957, it shifted to approximately 85-15 due to increased opportunities from the market decline.
Partnership Positions
During 1957, two positions reached a size where the partnership could participate in corporate decisions:
- One position: 10-20% of partnership assets
- Another position: approximately 5% of partnership assets
Both situations appeared to have potential for a high average annual rate of return with minimum of risk, requiring approximately three to five years to realize profits. While not classified as work-outs, they had very little dependence on the general action of the stock market.
Results for 1957
The three partnerships formed in 1956 substantially outperformed the general market:
| Metric | Value |
|---|---|
| Dow-Jones Industrials (Start of 1957) | 499 |
| Dow-Jones Industrials (End of 1957) | 435 |
| Dow-Jones Loss | 64 points |
| Dow-Jones with Dividends | -8.47% |
| Partnership #1 Performance | +6.2% |
| Partnership #2 Performance | +7.8% |
| Partnership #3 Performance | +25.0% |
The vastly superior performance of the third partnership was due to luck in timing — it was started latest in 1956 when the market was at a lower level and several securities were particularly attractive.
Two partnerships started mid-1957 had results roughly equivalent to the general market averages, which were down approximately 12% for their inception period.
Investment Philosophy
"I can definitely say that our portfolio represents better value at the end of 1957 than it did at the end of 2006. This is due to both generally lower prices and the fact that we have had more time to acquire the more substantially undervalued securities which can only be acquired with patience."
Key principles emphasized:
- We want stocks to do nothing or decline rather than advance during accumulation
- A fair proportion of the portfolio may be in the "sterile stage"
- This policy, while requiring patience, should maximize long term profits
- Goal: 10% per year better than the Averages over the long term
Related
- partnership-letter-1958 — The 1958 letter discussing the Commonwealth Trust Co. case study
- partnership-letter-1962 — The classic letter on the three categories: Generals, Work-outs, Controls
- warren-buffett — The author
- margin-of-safety — Core discipline applied in partnership investing