To the Shareholders of Berkshire Hathaway Inc.

# 1976 Letter to Shareholders ## To the Shareholders of Berkshire Hathaway Inc. After two years of disappointing results, 1976 produced a dramatic improvement. Operating earnings reached $16.07 million, or $16.47 per share—a new record. Return on equity was 17.3%, well above our long-term average and significantly better than American industry as a whole, though below our 1972 peak of 19.8%. Much of this improvement came from insurance operations, where [[Phil Liesche]]'s team at National Indemnity continued to demonstrate exceptional underwriting discipline. ## The GEICO Opportunity But the most important development of 1976 was our investment in [[GEICO]]. In 1975, GEICO faced an existential crisis. Rapid, unmanaged growth had produced catastrophic underwriting losses. The company was losing money at a rate that threatened its solvency. The stock price collapsed from $61 per share to $2 per share. Professional analysts were writing obituaries. [[Charlie Munger]] and I saw something different. We saw: **A Fundamental Competitive Advantage**: GEICO's direct-to-consumer model eliminates the insurance agent commission—typically 10-15% of premium. This gives GEICO a 30% cost advantage over competitors using agents. No matter how bad management's errors, this advantage would remain once management corrected its course. **An Identifiable Temporary Problem**: GEICO's losses came from expanded underwriting of high-risk drivers—people the company had no experience pricing correctly. This was a management error, not a structural failure. **A Permanent Advantage in Jeopardy**: The company's brand, customer relationships, and cost structure remained intact. Only the management was broken. We acted decisively. In the last quarter of 1975 and throughout 1976, we accumulated approximately one-third of GEICO's outstanding shares at a cost of about $4.2 million. This was, at the time, one of the largest investments we had ever made relative to its price. > "The GEICO investment illustrates a key principle: the best opportunities come from temporarily troubled companies with permanent advantages. When you can buy a business with a genuine moat at a price reflecting its temporary problems, the margin of safety is extraordinary." By year-end 1976, GEICO had returned to profitability. The new management team—led by John J. Byrne—had implemented dramatic changes. The cost advantage was being preserved while underwriting standards were restored. Our $4.2 million investment was worth significantly more, and the long-term prospects looked excellent. This investment would become one of the most profitable in Berkshire's history. ## Insurance Operations [[Phil Liesche]]'s managerial group at National Indemnity again produced outstanding results. The company maintained strict underwriting standards while many competitors were cutting prices to gain market share. In insurance, as in everything else, the disciplined approach produces superior long-term results. Our insurance float continued to grow, providing us with increasing amounts of capital to invest. This float—the money we hold as premiums before paying claims—is the foundation of Berkshire's financial power. We can invest it for our benefit while most other companies must use their capital immediately. ## The Diversified Retailing Merger In early 1976, we completed the merger with Diversified Retailing Company (DRC), a company controlled by [[Charlie Munger]]. This merger added several retailing businesses to our portfolio, including Sunbeam (appliances) and other well-known brands. The merger was structured as a tax-free exchange, and it aligned the interests of our two organizations. [[Charlie Munger]] had built DRC with the same long-term, value-oriented philosophy that guides Berkshire. Combining our companies made both stronger. This merger would later lead to the creation of Blue Chip Stamps, another Munger-controlled entity, which would eventually become part of the Berkshire corporate structure. ## Textile Operations Our textile business improved somewhat in 1976, but it continued to disappoint. Return on sales and return on capital employed were both inadequate. The competitive environment remains challenging, and our forecasting abilities in textiles—already suspect—continue to be tested. > "Our textile division was a significant disappointment during 1976. This may say something about our forecasting abilities, or about the nature of the textile business itself. In any case, we are determined to manage these businesses as effectively as possible while not pouring good money after bad." The lesson is clear: we should not continue to invest in businesses with poor long-term economics simply because they generate short-term cash. We will continue to operate our textile businesses efficiently, but we will not make major capital investments in an industry that cannot earn adequate returns. ## Looking Forward to 1977 We expect 1977 to produce improved operating earnings in absolute terms. However, return on equity may decline somewhat as our equity base grows. We are building for the long term, not optimizing for short-term ratios. The most important developments will be in insurance, particularly [[GEICO]]. If the company continues on its current path—preserving its cost advantage while restoring underwriting discipline—it will become one of Berkshire's most valuable assets. [[Charlie Munger]] continues to be my most important collaborator. His intellectual rigor, his commitment to ethical business practices, and his ability to see through complex situations are invaluable. Everything I have built at Berkshire has been strengthened by his partnership. Warren E. Buffett March 1977