I love reading investors’ partnership letters. I prefer to read old partnership letters of investors who have lasted a long time in the game – at least 30 years – to watch how their thought process and styles have developed. I think its also a neat history lesson – for example, by reading the partnership letters of Berkshire Hathaway in the years leading up to the tech bubble in 2000 or the recession in 2008. Here are my thoughts on Warren Buffett’s letter to his partners in 1957.
First, some context. In 1957, the average car sold for $2,500, the Soviet Union launched the first space satellite in history, Sputnik 1, and the most popular toy was the hula hoop (this is also the year the frisbee was invented!). Problems in Vietnam were starting to form and obviously the Soviets were an adversary of the U.S.
In financial news, inflation was 3.3%, gas was $0.24/gallon, and the average salary was $4,500/year. The S&P 500 Index was introduced in 1957 as well.
There were many other global events in 1957: the Suez Canal crisis, the Asian Flu, Singapore’s self-rule, the Treaty of Rome was signed (forming the EEC, precursor to the EU), troops were sent to Arkansas to enforce anti-segregation laws, and Congress was convicting people for being Communists. Basically, it was a normal year in America.
The 1957 stock market was, overall, a bear market:
In his 1957 partnership letter, Warren Buffett (“WB”) told his partners that the year prior he said that he felt the market was over-valued, at least as related to blue-chips, and if the market enters bear territory he would shift from various work-out situations (probably “special situations”) and focus more on buying general issues and he might even borrow money to do so. These general issues, as he called them, are today referred to as “cigar butts” or “net nets”.
As for his investing activities in 1957, he was not wrong. The market entered bear market territory, and his portfolio had more general issues than special situations – a ratio of about 85% to 15%. He also gave his definition of “work out” as:
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.
These are situations where WB assessed the risk of them not returning great returns to be minimal, but they also took a bit to realize – he estimated they could take as long as 5 years. However, he also noted that whether or not these situations worked out was not tied to the performance of the market.
WB’s partnership returned 9.3% to his partners in 1957 against the Dow’s return of -8.4%. He went on to explain that his hope was to perform better than the market when the market is down, and about average with the market when the market is performing well.
The most interesting part of this letter to me is that despite many macro events going on in the world, WB felt no need to comment on them. I won’t read too much into this or give my opinion as to why (only WB knows for sure) but I just wanted to point out this observation.