A case study of Warren Buffett and Charlie Munger’s investment in and management of Blue Chip Stamps that includes letters from 1978 to 1982 (final letter before merger with Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B))
Charlie Munger’s Letter to Stockholders
Consolidated normal operating income (i.e., before parent company gains from sale of securities) for the calendar year 1978 increased slightly, to $13,553,000 ($2.62 per share) from $12,893,000 ($2.49 per share) in the previous fiscal year. Consolidated net income (i.e. , after parent company gains from sale of securities) decreased to $14,280,000 ($2.76 per share) from $16,993,000 ($3.28 per share) in the previous fiscal year.
Our constituent businesses produce fluctuating returns from normal operations as well as from gains or losses on sale of securities held to offset liabilities to trading stamp savers and others. Given this situation, our objective is to earn from all sources a fluctuating return on our shareholders’ equity which amounts to a respectable average annual return over a period of years. Last year’s total consolidated net income of $14,280,000 represented a return of 14.4% of our shareholders’ equity of $99,251,000 at the start of the year. Over the last five years return on shareholders’ equity has averaged 15%.
We have three major subsidiaries, See’s Candy Shops, Incorporated (100% owned), Wesco Financial Corporation (80% owned) and Buffalo Evening News, Inc. (100% owned). If we used “equity accounting” instead of “consolidated accounting” for See’s and the Buffalo Evening News as well as Wesco, our consolidated income for our two reporting years just ended would break down as follows:
- 1 After reducing income by amortization· of intangibles arising from purchase of See’s at a large premium over its book value.
- 2 After increasing income by amortization of the discount from Wesco book value at which the interest was acquired.
- 3 After reducing income by amortization of relatively minor intangibles arising at acquisition of the newspaper in April 1977;
- 4 After deduction of interest and other general corporate expenses. In each year there was an operating loss before securities transactions and before.crediting income for (i) interest and dividends resulting from investment of the funds available through “float” caused by trading stamps issued but not yet redeemed, plus (ii) income tax benefit caused by 85% exclusion of dividends in computing federal income taxes.
- 5 The 1978 amounts include $727,000 or $.14 per Blue Chip share from securities gains, net of taxes. In 1977 such securities gains were $4,100,000 or $.79 per Blue Chip share.
Charlie Munger: See’s Candy Shops, Incorporated
By a razor-thin margin, our 100%-owned subsidiary, See’s Candy Shops, lncorporated, had another record year under
the skilled leadership of Charles Huggins. The nominal percentage gain in earnings (less than 1%) was much lower than
the percentage gain in sales (17%). Comparative figures for See’s for the last two years are set forth below:
These earnings figures are a little higher than Blue Chip Stamps’ share of See’s earnings shown in the table above because Blue Chip’s share reflects (i) deduction of the approximately 1% share of See’s earnings owned by minority stockholders of See’s prior to June 6, 1978. (ii) amortization of intangibles arising from purchase of See’s stock at a large premium over book value, and (iii) state income taxes on See’s dividends received by Blue Chip.
Boxed chocolate consumption’ per capita in the United States continues to be essentially static, and the candy-store business has been subject to extraordinary cost pressure. Despite substantial increases in See’s retail prices, its profits lagged substantially below year-earlier levels until December when an extraordinary burst of holiday-period sales caused the lag to be eliminated. It is very difficult to cope so successfully with the production and distribution problems of a seasonal sales peak which becomes more extreme each year, and the flat earnings trend of 1978 represented outstanding managerial achievement.