Today, while talking with Jing, I mentioned that managing a company is similar to making investments, as it requires allocating resources to people and projects with higher return on investment. Jing suggested that I read the original versions of Buffett's shareholder letters; the unaltered letters might be more helpful than interpretations or processed versions by others. I started reading them on the plane. Although I don't particularly focus on the investment field myself, I took some reading notes 📒 mainly targeting parts that could inspire company management:

Performance history of the Buffett Fund from 1957-1960

Learning Notes from the 1957 Shareholder Letter

"Work-out" Noun Study

The term "work-out" specifically refers to investments that depend on specific corporate actions (such as sales, mergers and acquisitions, liquidations, tender offers, etc.) for profit, rather than relying on a general increase in stock prices. In other words, a "work-out" is an investment strategy where the profits primarily stem from the successful completion of anticipated corporate actions.

The specific explanation is as follows:

• (Sales): The company sells part or all of its assets.
• (Mergers): The company merges with another company.
• (Liquidations): The company will convert assets into cash and distribute them to shareholders.
• (Tenders): The company repurchases its shares through a tender offer.

In this case, the risk of investment lies in the possibility that the anticipated corporate action may be canceled or not proceed as planned, rather than a general decline in the stock market due to a worsening overall economic situation. The operation of Sanborn mentioned below should fall under work-out.

The performance of Buffett's fund

The market was not good that year, with the Dow Jones Industrial Average starting at 499 points and ending at 435 points, losing 64 points. With a dividend of 22 points added, the overall loss was 42 points, which is an annual loss of 8.470% (why my calculation is 8.417%). However, all three of Buffett's partnerships in 1956 showed growth, with increases of approximately 6.2%, 7.8%, and 25% respectively in their year-end net worths. The strong performance of the third partnership was mainly due to short-term luck, especially regarding the timing of capital availability. The third partnership was established later in 1956 when the market was at a lower level, and several securities were particularly attractive. Due to the availability of funds, significant positions were taken in these securities. Meanwhile, the earlier two partnerships already had substantial investments and therefore could only take relatively smaller positions in these securities.

Background of the three partnerships

In 1956, after returning to Omaha from New York, Warren Buffett established his first investment partnership, Buffett Associates Ltd. This partnership started with $105,000 invested by seven family members and friends, along with $100 of Buffett's own money.

By the end of 1956, Buffett had established two more partnerships, each with its own group of investors. As of January 1, 1957, the combined net worth amounted to $303,726.

These partnerships operated under similar terms, which significantly influenced Buffett's early success. The main terms included:

1. Buffett did not charge a management fee, which was very unusual at the time. The profit distribution method was that for profits below 4%, limited partners received all of it; for profits exceeding 4%, they were distributed with 75% going to the partners and 25% going to Buffett.
2. Limited partners could only withdraw funds on the last day of the year.
3. Buffett focused on value investing, selecting investments based on intrinsic value rather than market trends.

The structure of these partnerships was designed to align Buffett's interests with those of the investors. He invested almost his entire net worth in these partnerships, helping to build trust and encourage prudent investment decisions. Over the years, these partnerships achieved significant returns, far surpassing the Dow Jones Index.

Reasons for outperforming the market

The most essential thing is to have patience and find securities that are significantly undervalued. Maximizing long-term profits: Buffett's primary interest lies in stocks staying still or declining rather than rising. Therefore, a considerable portion of the investment portfolio may be in a dormant phase.

Learning notes from the 1958 shareholder letter

Performance of the Buffett Fund

The Dow Jones Industrial Average rose from 435 points to 583 points, plus about 20 points in dividends, for an overall increase of 38.5%. Buffett's five investment partnerships had year-end growth ranging from 36.7% to 46.2%.

Explain why the fund performs better in bear markets than in bull markets

In the 1957 shareholder letter, Buffett mentioned that he believed their investment strategy would show more advantages in a declining or stable market because they focused on undervalued securities. These securities are more likely to be undervalued when the overall market declines. However, during a rising market, due to the overall rise of the market, they could only strive to keep up with the performance of the index.

Buffett's largest holding accounted for 10% to 20% of the assets of each partnership. When a bear market comes, it is advantageous if this stock falls or remains relatively stable, as it allows for an increased proportion of holdings. However, in a bull market, such securities may drag down comparative performance.

Case Analysis: Commonwealth Trust Co.

10, but because the company does not pay cash dividends, this has caused its stock price to be depressed to about $50 per share.

Commonwealth Trust Co. has approximately $50 million in assets (about half the size of the First National Bank of Omaha), with 25.5% owned by a larger bank that has been hoping for a merger for many years. Due to personal reasons, such a merger has not been realized, but there is evidence suggesting that this situation will not last indefinitely.

Buffett believed that this company had several advantages:

1. Very strong defensive characteristics;
2. Value steadily growing at a satisfactory rate;
3. There are signs that this value will eventually be released, although it may take a year or even ten years. If it's the latter, then this value could increase to a fairly large number, such as $250 per share.

Within about a year, Buffett successfully acquired approximately 12% of Commonwealth Trust Co.'s shares at an average price of around $51 per share. The unchanged stock price was very beneficial for investors. As his stake increased, especially when Buffett became the second-largest shareholder with sufficient voting rights, he would have significant say in potential mergers, thereby further unlocking the company's intrinsic value.

Commonwealth had only about 300 shareholders, with an average of roughly two trades per month. Therefore, overall market activity had almost no impact on the price fluctuations of some of these holdings. The broader market would not affect the stock price of Commonwealth Trust Co. Moreover, Buffett quietly bought shares during the acquisition process. Even so, there was some competition during the buying process, which caused the price to rise to about $65. In illiquid stocks, even very small buy orders can cause such significant price movements, explaining why ensuring that investment portfolio information is not leaked is so important.

Later, Buffett sold his shares in Commonwealth at $80 (at that time, Buffett assessed the intrinsic value of the stock to be $135). Because this transaction, relative to Buffett's purchase at $50 when the intrinsic value was $125, involved less discount, Buffett believed that capital could be better utilized for new investments (which accounted for about 25% of each partnership's assets). Although the degree of undervaluation of this new investment was not higher than many other securities held, Buffett became the largest shareholder, thus bringing significant advantages in correcting the undervaluation (work-outs).

In this particular holding, Buffett was almost certain that its performance would outperform the Dow Jones Index during the holding period. While the newly purchased company was not explicitly mentioned in the report, according to subsequent letters to shareholders, the new company should be Sanborn Map Company. This company engaged in publishing and continuously revising extremely detailed maps of various cities across the United States. These maps were widely used by insurance companies, real estate companies, and local governments, providing detailed layouts of buildings and locations of fire protection facilities, among other things. The company also made substantial investments using its cash flow.

Action Plan

As the market level rises, undervalued securities become scarcer, and Buffett finds it difficult to locate a sufficient number of attractive investments. He wishes to increase the proportion of assets in "work-outs," but suitable conditions are hard to find. Therefore, he attempts to create his own "work-outs" by heavily purchasing several undervalued securities (becoming the largest shareholder). This strategy is expected to achieve the forecast made in 1957, which is to outperform during a bear market.

Learning Notes from the 1959 Shareholder Letter

Reiterating Principles

Buffett reiterates his consistent principle: he would rather suffer the penalty of being overly conservative than face the consequences of permanent capital loss that could result from accepting the "new era" philosophy (i.e., trees can really grow to the sky). This conservative investment strategy has helped him maintain stable returns in uncertain market environments.

The performance of the Buffett Fund

In 1959, the Dow Jones Industrial Average, including dividends, had an overall increase of 19.9%. In contrast, the annual returns of Buffett's six partnerships ranged between 22.3% and 30.0%, averaging approximately 25.9%. The allocation in Sanborn Map Company increased from 25% to 35% of total assets, not only enhancing control over the company but also further securing the potential gains of this undervalued asset.

Learning notes from the 1960 shareholder letter

Investor expectation management

Buffett continuously emphasizes expectation management and long-termism. He believes that if a fund declines by 15% in a given year while the average index drops by 30%, it is far superior to both the fund and the average index rising by 20%. Over the long term, there will be good years and bad years, and it makes no sense to get excited or frustrated about the sequence of these years. What matters is outperforming the benchmark; scoring four on a three-par hole is worse than scoring five on a five-par hole, and assuming one will never encounter either three-par or five-par holes is unrealistic.

The performance of Buffett Fund

The Industrial Average Index dropped from 679 points to 616 points, a decline of 9.3%. Even with the dividends earned from holding these stocks, there was still an overall loss of 6.3%. However, Buffett's seven partnerships achieved an average increase of 22.8%.

Sanborn Map Case

After Buffett sold his shares in Commonwealth Trust Co. in 1958, he purchased Sanborn Map Company. This year's letter provided more details about this.

Sanborn Map Company was engaged in publishing and continuously updating highly detailed maps of cities across the United States. These maps showed information such as the diameter of street drainage pipes, the location of fire hydrants, and the materials used for roofs, primarily for use by fire insurance companies. A large portion of Sanborn’s business was conducted with about thirty insurance companies, but maps were also sold to utility companies, mortgage companies, and tax departments outside the insurance industry.

The business logic of Sanborn Map was very solid in that era. In the first 75 years of the company's existence, it operated in a more or less monopolistic manner, turning a profit every year and being almost completely immune to recessions, requiring no sales effort. In the early days, the insurance industry was concerned that Sanborn's profits might become too high, so they arranged for some well-known insurance executives to join Sanborn's board as supervisory members.

However, in the early 1950s, a competitive underwriting method known as "card records" eroded Sanborn's business, causing the after-tax profits of the map business to decline from an average of over $500,000 per year at the end of the 1930s to less than $100,000 in 1958 and 1959. Considering the upward trend of the economy during this period, this almost entirely eliminated the previously considerable and stable profitability. However, in the early 1930s, Sanborn began accumulating an investment portfolio. Since the business did not require capital, any retained earnings could be used for this investment. Over time, about $2.5 million was invested, with approximately half in bonds and the other half in stocks. Therefore, especially in the past decade, the portfolio flourished while the operating map business gradually declined.

In 1958, just like in 1938, Sanborn possessed a large amount of information of great value to the insurance industry. To replicate the detailed information they had collected over the years would cost tens of millions of dollars. Despite the rise of "card records," more than $500 million in fire premiums were still underwritten by "mapping" companies. However, the way Sanborn sold and packaged its product (information) had not changed over these years, and this "inaction" eventually reflected in its earnings.

Sanborn had annual sales of about $2 million and owned approximately $7 million worth of marketable securities. The income from the portfolio was quite substantial, and the company had no potential financial issues. Insurance companies were satisfied with the price of maps, and shareholders were still receiving dividends (although within the last 8 years, these dividends had been cut five times). There were a total of 105,000 shares, with 1,600 shareholders.

Major Shareholders/Directors after Buffett's Involvement:

Buffett wanted to separate the two businesses (maps and investments) to achieve the fair value of the investment portfolio while striving to rebuild the profitability of the map business. By leveraging Sanborn's rich raw materials and combining electronic means to convert this data into the most suitable form for customer use, the map business appears to have a real opportunity to double its profits.

The final split was as follows:

• Share Repurchase Plan: 72% of the outstanding shares were exchanged at fair value for securities in the investment portfolio, which were distributed to shareholders, involving 50% of the 1,600 shareholders.
• Map Business: More than $1.25 million in government and municipal bonds were retained as a reserve fund, and over $1 million in potential corporate capital gains taxes were eliminated. The remaining shareholders received slightly improved asset values, significantly increased earnings per share, and higher dividend rates.

Re-emphasizing the investment philosophy

Buffett's main business is to buy undervalued securities and sell them when the undervaluation is corrected, while investing in special situations where profits depend on corporate actions rather than market behavior. As the partnership fund continues to grow, opportunities in "control situations" may increase.

Takeaways

• Set up a clear and correct set of rules, and then consistently follow these rules to do those "simple" things.

• Buffett has established strict investment criteria and discipline in his investments, and repeatedly implemented these simple but effective strategies.

• Ensure that you can control the entire situation in order to truly move in the right direction.

• By holding large stakes, Buffett ensures sufficient influence in the company's decision-making process, thereby being able to steer the company toward developments favorable to shareholders.

• Adjust others' expectations.

• Buffett continuously conveys his investment philosophy and strategies through the shareholder letters, helping investors establish reasonable expectations and avoid unnecessary panic or excessive optimism during short-term market fluctuations.

• Adhere to long-termism and be patient.

• Buffett emphasizes the importance of long-term investment, patiently waiting for the market to correct undervalued assets while ignoring short-term market fluctuations.

• Companies need to build their own defensive moats.

• Invest in companies with strong competitive advantages and stable profitability. These companies often have unique business models, brand advantages, or other hard-to-replicate competitive edges.