Lessons from Berkshire Hathaway’s 1972 Letter
Berkshire Hathaway's 1972 letter highlights Buffett’s strategic shift from textiles to insurance and banking, boosting profitability through diversification and disciplined management.
Hi, everyone! 👋
This time I’ll take you on a journey back to 1972 with insights from Berkshire Hathaway’s annual letter. 📜 Warren Buffett’s strategy was a shift from textiles to insurance and banking. 🚀
Enjoy!
And remember:
🐦 Follow me on Twitter
💼 Follow me on LinkedIn
🎉 BREAKING! I’ve just released a series of brand-new, free ebooks designed to help you master the strategies of some of the greatest investors of all time.
📥 Download them below!
In this post, we explore the key takeaways from Berkshire Hathaway’s 1972 annual letter to shareholders, offering insights into Warren Buffett's continued strategic evolution. You’ll learn how Berkshire maintained its focus on expanding beyond the textile industry into more profitable sectors like insurance and banking. We'll highlight the company's exceptional insurance underwriting performance, strategic financial moves, and disciplined approach to managing capital and growth.
TL; DR
Berkshire Hathaway achieved a 19.8% return on equity in 1972, driven by strong insurance performance.
The insurance division saw high profit margins but anticipates increased competition.
The textile business recovered slightly, but challenges remain in maintaining profitability.
Berkshire strategically expanded into insurance and banking, focusing on long-term growth.
The company secured a US$20 million loan to support future insurance expansion.
Overview
Berkshire Hathaway's operating earnings in 1972 were highly satisfactory, at 19.8% of beginning shareholders' equity, marking a substantial improvement across all major lines of business. The standout performance was in insurance underwriting, benefiting from favorable conditions that are not expected to persist at the same level.
Due to an unusual convergence of favorable factors—diminishing auto accident frequency, moderating accident severity, and an absence of major catastrophes—underwriting profit margins achieved a level far above averages of the past or expectations of the future.
— WARREN BUFFETT
Since the policy control change in May 1965, the diversification strategies have significantly elevated Berkshire's earning power beyond what would have been possible with a sole focus on the textile business. The compounded annual growth in book value per share from the end of fiscal year 1964 to 1972 was 16.5%.
While we anticipate a modest decrease in operating earnings during 1973, it seems clear that our diversification moves of recent years have established a significantly higher base of normal earning power. Your present management assumed policy control of the company in May, 1965. Eight years later, our 1972 operating earnings of $11,116,256 represent a return many-fold higher than would have been produced had we continued to devote our resources entirely to the textile business. At the end of the 1964 fiscal year, shareholders’ equity totaled $22,138,753. Since that time, no additional equity capital has been introduced into the business, either through cash sale or through merger. On the contrary, some stock has been reacquired, reducing outstanding shares by 14%. The increase in book value per share from $19.46 at fiscal year-end 1964 to $69.72 at 1972 year-end amounts to about 16.5% compounded annually.
Our three major acquisitions of recent years have all worked out exceptionally well—from both the financial and human standpoints. In all three cases, the founders were major sellers and received significant proceeds in cash—and, in all three cases, the same individuals, Jack Ringwalt, Gene Abegg and Vic Raab, have continued to run the businesses with undiminished energy and imagination which have resulted in further improvement of the fine records previously established.
— WARREN BUFFETT
Textile Operations
The textile industry saw some recovery in 1972. Berkshire's efforts in developing a robust sales organization and restructuring manufacturing operations to complement sales capabilities began to pay off. Despite general industry challenges, Berkshire managed better inventory control and product mix, which contributed to improved profitability relative to the industry.
Helped by the industry recovery, we experienced some payoff from these efforts in 1972. Inventories were controlled, minimizing close-out losses in addition to minimizing capital requirements; product mix was greatly improved. While the general level of profitability of the industry will always be the primary factor in determining the level of our textile earnings, we believe that our relative position within the industry has noticeably improved. The outlook for 1973 is good.
— WARREN BUFFETT
Insurance Operations
The traditional insurance operations at National Indemnity saw unexpected high profit margins due to reduced auto accident frequencies and other favorable conditions. However, this led to increased competition, which might reduce profitability in the coming years.
Substantial new competition was forecast in our annual report for last year and we experienced in 1972 the decline in premium volume that we stated such competition implied. Our belief is that industry underwriting profit margins will narrow substantially in 1973 or 1974 and, in time, this may produce an environment in which our historical growth can be resumed. Unfortunately, there is a lag between deterioration of underwriting results and tempering of competition. During this period we expect to continue to have negative volume comparisons in our traditional operation. Our seasoned management, headed by Jack Ringwalt and Phil Liesche, will continue to underwrite to produce a profit, although not at the level of 1972, and base our rates on long-term expectations rather than short-term hopes. Although this approach has meant dips in volume from time to time in the past, it has produced excellent long-term results.
— WARREN BUFFETT
Reinsurance and New Ventures
The reinsurance division faced competitive pressures similar to traditional insurance but performed well in an unusually catastrophe-free year.
Also as predicted in last year’s report, our reinsurance division experienced many of the same competitive factors in 1972. A multitude of new organizations entered what has historically been a rather small field, and rates were often cut substantially, and we believe unsoundly, particularly in the catastrophe area. The past year turned out to be unusually free of catastrophes and our underwriting experience was good.
George Young has built a substantial and profitable reinsurance operation in just a few years. In the longer term we plan to be a very major factor in the reinsurance field, but an immediate expansion of volume is not sensible against a background of deteriorating rates. In our view, underwriting exposures are greater than ever. When the loss potential inherent in such exposures becomes an actuality, repricing will take place which should give us a chance to expand significantly.
— WARREN BUFFETT
The "home state" insurance operations expanded, showing promise particularly in Nebraska through the Cornhusker Casualty Company.
Our two smaller companies, in Minnesota and Texas, had unsatisfactory loss ratios on very small volume. The home state managements understand that underwriting profitably is the yardstick of success and that operations can only be expanded significantly when it is clear that we are doing the right job in the underwriting area. Expense ratios at the new companies are also high, but that is to be expected when they are in the development stage.
Last year it was reported that we had acquired Home and Automobile Insurance Company of Chicago. We felt good about the acquisition at the time, and we feel even better now. Led by Vic Raab, this company continued its excellent record in 1972. During 1973 we expect to enter the Florida (Dade County) and California (Los Angeles) markets with the same sort of specialized urban auto coverage which Home and Auto has practiced so successfully in Cook County. Vic has the managerial capacity to run a much larger operation. Our expectation is that Home and Auto will expand significantly within a few years.
— WARREN BUFFETT
Insurance Investment Results
Buffett discusses on how insurance investment results focuses on how the company adeptly managed a significant increase in premium volume between 1969 and 1971. During a period of high interest rates, Berkshire Hathaway capitalized on this influx by strategically investing in tax-exempt bonds. This investment choice not only maximized returns but also minimized tax liabilities due to the low effective tax rate on the income generated from these bonds. As a result, investment income saw substantial growth, rising from US$2,025,201 in 1969 to US$6,755,242 in 1972. However, Warren anticipates that this rapid growth in investment income will moderate in the coming years due to expected decreases in premium volume growth.
Our bond portfolio possesses unusually good call protection, and we will benefit for many years to come from the high average yield of the present portfolio. The lack of current premium growth, however, will moderate substantially the growth in investment income during the next several years.
— WARREN BUFFETT
Banking Operations
The Illinois Bank and Trust Co. of Rockford continued to demonstrate industry-leading profitability, with after-tax earnings of 2.2% on average deposits. The bank's efficient management under Gene Abegg and Bob Kline was highlighted, with a conservative loan policy that significantly minimized charge-offs compared to industry averages. Despite the bank's strong performance, new regulatory changes and market conditions are expected to make significant earnings growth challenging in 1973.
Berkshire borrowed some money
The company secured a US$20 million loan to strengthen the financial flexibility of its insurance operations, preparing for potential opportunities for significant expansion. Also, they used some of this loan to repay their bank loan.
On March 15, 1973, Berkshire Hathaway borrowed $20 million at 8% from twenty institutional lenders. This loan is due March 1, 1993, with principal repayments beginning March 1, 1979. From the proceeds, $9 million was used to repay our bank loan and the balance is being invested in insurance subsidiaries. Periodically, we expect that there will be opportunities to achieve significant expansion in our insurance business and we intend to have the financial resources available to maximize such opportunities.
Our subsidiaries in banking and insurance have major fiduciary responsibilities to their customers. In these operations we maintain capital strength far above industry norms, but still achieve a good level of profitability on such capital. We will continue to adhere to the former objective and make every effort to continue to maintain the latter.
— WARREN BUFFETT
Summary
The post explores Berkshire Hathaway's 1972 annual letter, highlighting Warren Buffett's strategic shift from the struggling textile industry to more profitable sectors, particularly insurance and banking. The company's 19.8% return on equity was primarily driven by strong performance in its insurance underwriting, although competition and future challenges were noted. Additionally, Berkshire's disciplined financial management, including strategic investments in tax-exempt bonds, boosted investment income significantly. Readers learned how Berkshire’s diversification and focus on financial stability allowed the company to achieve sustainable growth, while preparing for further expansion in its insurance operations with a newly secured US$20 million loan.
Download BRK’s full letter 👇
Download this post 👇
Got a burning question or a topic you're curious about? I'd love to hear from you! Please drop a comment 💬 below or shoot me an email 📧 at grahamqualityinvestor@gmail.com