Lessons from Berkshire Hathaway’s 1970 Letter
In 1970, Berkshire Hathaway achieved a 10% return on shareholder investment, thanks to its strategic diversification away from the struggling textile business.
Now is the time to review the 1970 letter, which was published on March 15, 1971. In the letter, Warren Buffett provides a detailed overview of the company's performance across its various business segments during a year of significant challenges and strategic shifts.
In this post, we review the key lessons from the letter, highlighting Berkshire's foray into banking, the continued strong performance of its insurance operations, and the struggles within its textile business.
TL; DR
Diversification Strategy: Berkshire Hathaway's diversification away from the textile business significantly improved financial performance, achieving a 10% return on shareholder investment.
Textile Business Struggles: Despite declining sales and market difficulties, the textile operations broke even, which was considered an achievement given the harsh industry environment.
Strong Insurance Performance: The insurance sector saw significant growth, although there were some underwriting challenges; increased investment income resulted in excellent overall returns.
Banking Success: The Illinois National Bank & Trust reported record earnings, maintaining high earnings relative to deposits and excelling under new management.
Regulatory Impact: New bank holding company legislation required Berkshire to divest its bank shares within ten years, potentially through a spin-off to shareholders.
Overview
The letter starts by noting that Berkshire Hathaway's return on average shareholder investment was about 10%, which, while average for American industry, was significantly better than what would have been achieved if the company had continued focusing solely on the textile business.
The past year witnessed dramatically diverse earnings results among our various operating units. The Illinois National Bank & Trust reported record earnings and continued to rank right at the top, nationally, among banks in terms of earnings as a percentage of average resources. Our insurance operations had some deterioration in underwriting results, but increased investment income produced a continued excellent return. The textile business became progressively more difficult throughout the year and the final break-even result is understandable, considering the industry environment.
— WARREN BUFFETT
Buffett reiterates the company's strategy initiated five years prior, to diversify away from the textile business, which has contributed positively to the company's financial performance.
The combination of these factors produced a return of approximately 10% on average shareholder’s investment. While this figure is only about average for American industry, it is considerably in excess of what would have been achieved had resources continued to be devoted exclusively to the textile business, as was the pattern until five years ago.
— WARREN BUFFETT
Textile Operations
The textile sector faced declining sales and continued market difficulties, forcing frequent adjustments in production to prevent inventory buildup. Despite efforts, the textile operations broke even, which was considered an achievement given the harsh industry environment.
Prices continue at poor levels and demand has not strengthened. Inventory levels, while reduced from a year ago through great effort, continue high in relation to current sales levels. We continue to work at making the changes required in manufacturing and marketing areas that will result in profitable operations with more stable employment.
— WARREN BUFFETT
Despite the adverse conditions, The Oracle of Omaha praises the management and labor at the textile operations for their effort and enterprise, which he equates to those in the more profitable divisions of Berkshire.
Insurance Operations
The insurance sector experienced significant growth, particularly due to increased volume in traditional operations as conventional auto insurance markets became more restricted. However, there were some deteriorations in underwriting results, with the combined loss and expense ratio reaching approximately 100%.
We enjoyed an outstanding year for growth in our insurance business, accompanied by a somewhat poorer underwriting picture. Our traditional operation experienced a surge in volume as conventional auto insurance markets became more restricted.
Although our combined loss and expense ratio on the traditional business rose to approximately 100% during the year, our management, led by Jack Ringwalt and Phil Liesche, has the ability and determination to return it to an underwriting profit.
— WARREN BUFFETT
Reinsurance and surety business
The newly established reinsurance division showed promising early signs and is expected to handle larger volumes in the future. In contrast, the surety business faced significant underwriting losses, particularly in contractor's bonds, prompting a strategic shift to focus on miscellaneous bonds.
We are producing significant volume in diverse areas of reinsurance and developing a more complete staff in order to handle a much larger volume of business in the future.
The surety business, referred to in last year’s report, operated at a significant underwriting loss during 1970. The contractor’s bond field was a disappointment and we are restricting our writing to the miscellaneous bond area. This will mean much less volume but, hopefully, underwriting profits.
— WARREN BUFFETT
Home-State Insurance Operations
The Cornhusker Casualty Company, a new venture in Nebraska, had a strong start, effectively combining large-company capabilities with small-company accessibility. Plans were in place to extend this successful model to other states.
The combination of big-company capability and small-company accessibility is providing to be a strong marketing tool with first class agents. John Ringwalt deserves credit for translating the concept into reality.
— WARREN BUFFETT
Banking Operations
The Illinois National Bank & Trust continued to excel, maintaining high earnings relative to its deposits. The CEO successfully led the bank to surpass its prior year's performance despite stable deposit levels. Bob Kline, who took over as President in 1971, was commended for his efforts in deposit generation.
While maintaining a position of above average liquidity, net operating earnings before security gains came to well over 2% of average deposits. This record reflects an exceptionally well-managed banking business.
With generally lower interest rates prevailing on loans throughout the country, it will be a challenge to management to maintain earnings while utilizing a higher cost deposit mix.
— WARREN BUFFETT
Regulatory Changes
New bank holding company legislation passed at the end of 1970 impacted Berkshire due to its controlling interest in the Illinois National Bank. This legislation required Berkshire to divest its bank shares within ten years, possibly through a spin-off to shareholders.
In effect, we have about ten years to dispose of stock in the bank (which could involve a spin-off of bank stock to our shareholders) and it will probably be some time before we decide on a course of action. In the meantime, certain activities of all entities in the Berkshire Hathaway group—including acquisitions—are subject to the provisions of the Act and Regulations of the Federal Reserve Board.
— WARREN BUFFETT
Summary
In 1970, Berkshire Hathaway achieved a 10% return on shareholder investment, thanks to its strategic diversification away from the struggling textile business. The textile operations managed to break even despite challenging conditions. The insurance sector saw significant growth, driven by increased volume and strong management, while the newly established reinsurance division showed promise. The Illinois National Bank & Trust reported record earnings, maintaining high profitability. New banking regulations required Berkshire to divest its bank shares within ten years, potentially through a spin-off to shareholders.
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