1997

At the 1997 Berkshire annual meeting, Buffett and Munger were asked to explain how they decided whether to buy a business. The afternoon session produced one of the clearest distillations of the joint filter the two men applied. The first cut was whether they could genuinely understand the business - not the stock, not the industry narrative, but the unit economics, the moat, and the trajectory of intrinsic value over a decade. If that test was failed, they moved on without remorse. Munger's contribution to the answer was characteristically about the negative space. The discipline was less about saying yes to the right business and more about saying no to the wrong ones, fast. He told the audience that they did not have a list of businesses they wanted to be in; they had a list of businesses they refused to be in. The screening-by-exclusion was the actual operating system. Most deals, in most years, did not pass the first screen. The second cut was management. They had to be people Buffett and Munger would trust to run the business correctly without supervision - not people they would have to monitor, but people they could empower and leave alone. Munger's standard for managers was character first, judgment second, energy third. He told the room that you could not fix a character problem with compensation, and you could not fix a judgment problem with effort. The filter was severe, which was the whole point of having a filter at all.

Bezos's 1997 letter to shareholders, written as Amazon's first annual report following its IPO, framed the company's entire philosophy around long-term market leadership rather than short-term profitability. He declared that a fundamental measure of success would be the shareholder value Amazon created over the long term, a direct result of its ability to extend its market leadership position. He told shareholders they would see the company make investment decisions guided by long-term market leadership considerations rather than short-term Wall Street reactions, and that when forced to choose between optimizing the appearance of GAAP accounting and maximizing the present value of future cash flows, Amazon would take the cash flows. The letter described market leadership as the engine translating into higher revenue, greater capital velocity, and stronger returns on invested capital, and anchored the entire approach in relentless customer obsession, framing it as the foundation of the company's culture.

Daily Journal Corporation's late-1990s filings are notable for what they do and do not show. The company had, under Munger's chairmanship, avoided the speculative derivatives exposure that had destroyed several of its peers in the savings-and-loan and publishing-adjacent industries during the savings-and-loan crisis. The 10-K filings disclose a conservatively-financed publisher with a real moat - the appellate-decisions monopoly - and no exposure to the structured products that had ruined other ostensibly conservative companies in the same region. Munger's role at DJCO throughout the 1990s was, in effect, the same role he played at Berkshire: the disciplined refuser. He had refused to let Daily Journal take on the leverage that the cheap-money years of the mid-1990s had tempted other small public companies to take on. He had refused to chase the incremental yield that derivatives contracts appeared to offer. He had insisted that the company finance itself conservatively, hold its franchise honestly, and let the cash earnings of the legal publishing monopoly compound rather than leveraging them up in the name of growth. The retrospective lesson, visible in the 1997 10-K, was that avoidance was the operating decision. The companies that failed in the savings-and-loan crisis had not failed because they were stupid; they had failed because they had taken on exposure they did not need to take on, in pursuit of returns they did not need to pursue. Daily Journal, under Munger, had refused the exposure and survived the crisis with its franchise intact and its balance sheet clean. The same discipline would, two decades later, allow Daily Journal to pivot into court-automation software with the financial strength to absorb the long, slow, expensive slog of building that business. The avoidance had bought the optionality.

WESCO FINANCIAL CORPORATION LETTER TO SHAREHOLDERS To Our Shareholders: Consolidated ""normal'' net operating income (i.e., before irregularly occurring items shown in the table below) for the calendar year 1997 increased to $38,262,000 ($5.38 per share) from $30,720,000 ($4.32 per share) in the previous year. Consolidated net income (i.e., after irregularly occurring items shown in the table below) increased to $101,809,000 ($14.30 per share) from $30,619,000 ($4.30 per share) in the previous year. Wesco has three major subsidiaries: (1) Wesco-Financial Insurance Company (""Wes-FIC''), headquartered in Omaha and engaged principally in the reinsurance business, (2) The Kansas Bankers Surety Company (""KBS''), purchased by Wes-FIC in July 1996 and specializing in insurance products tailored to midwestern banks, and (3) Precision Steel, headquartered in Chicago and engaged in the steel warehousing and specialty metal products businesses. Consolidated net income for the two years just ended breaks down as follows (in 000s except for per-share amounts)(1) : Year Ended December 31, 1997 December 31, 1996 Per Per Wesco Wesco Amount Share(2) Amount Share(2) ""Normal'' net operating income of: Wes-FIC and KBS insurance businessesÏÏÏÏÏÏÏÏÏÏÏ $ 33,507 $ 4.71 $27,249 $3.83 Precision Steel businesses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,622 .51 3,033 .43 All other ""normal'' net operating income(3) ÏÏÏÏÏÏÏÏÏ 1,133 .16 438 .06 38,262 5.38 30,720 4.

Munger used the 1997 platform to restate what he considered Berkshire's single most underappreciated advantage: the willingness to do less. He had tried, he said, never to operate under the illusion that he could hire a bunch of bright young people and have them know more than anybody about every industry under the sun. The honest framing was that with very hard work he and Buffett could find a few things where they were right, and the few things were enough. That was a reasonable expectation. Anything more ambitious than that, Munger suggested, was self-flattery. He contrasted Berkshire's approach with the institutional investor's approach. The fund manager was paid to be in the market, paid to have a view, paid to look active. Berkshire was paid by no one to be active. It could sit. It could go years without a serious move, then move aggressively when the rare opportunity arrived. The structural asymmetry - Berkshire had no benchmark to defend, no client to appease, no quarterly questionnaire to answer - was, in Munger's view, the single most underrated edge in long-term investing. He connected the do-less philosophy to position sizing. When the rare opportunity did arrive, the discipline was to size it correctly. A great idea deserves serious capital. Munger told the room that the temptation, when the world is calm, was to spread bets in the name of safety; the temptation, when the world is in crisis, was to small-size the great opportunity in the name of risk management. Both temptations were to be resisted. The whole trick was recognizing the rare fat pitch and then swinging hard.

The 1997 letter reported Amazon's first-year milestones: 1.5 million customers served, 838% revenue growth to $147.8 million, and market leadership extended despite aggressive competitive entry. Bezos framed this as Day 1 for the Internet, predicting that online commerce would evolve from saving customers money and time toward accelerating the process of discovery through personalization. He committed Amazon to measuring itself by the metrics most indicative of market leadership — customer and revenue growth, repeat-purchase behavior, and brand strength — rather than near-term profit. He pledged to invest aggressively to expand and leverage the customer base, brand, and infrastructure as Amazon moved to establish an enduring franchise. The letter explicitly warned that the strategy carried risk, including capable and well-funded competition, execution risk, and the need for large continuing investments, but asserted that online commerce would prove to be a very large market.

32 Realized net securities gains (losses)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 62,697 8.80 (115) (.02) Gain on sales of foreclosed properties ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 850 .12 14 Ì Wesco consolidated net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $101,809 $14.30 $30,619 $4.30 (1) All Ñgures are net of income taxes. (2) Per-share data is based on 7,119,807 shares outstanding. Wesco has had no dilutive capital stock equivalents. (3) After deduction of interest and other corporate expenses, and costs and expenses associated with delinquent loans and foreclosed real estate previously charged against Wesco's former Mutual Savings and Loan Association subsidiary. Income was from ownership of the Wesco headquarters oÇce building, primarily leased to outside tenants, interest and dividend income from cash equivalents and marketable securities owned outside the insurance subsidiaries, and, in 1997, the reduction of loss reserves provided in prior years against possible losses on sales of foreclosed real estate. This supplementary breakdown of earnings diÅers somewhat from that used in audited Ñnancial statements which follow standard accounting convention. The supplementary breakdown is furnished because it is considered useful to shareholders. Wesco-Financial Insurance Company (""Wes-FIC'') Wes-FIC's normal net income for 1997 was $33,507,000, versus $27,249,000 for 1996.by

The 1997 letter's decision-making framework, presented to shareholders so they could confirm that Amazon's philosophy aligned with their own, made several explicit commitments. Bezos pledged to make bold rather than timid investment decisions where the company saw a sufficient probability of gaining market leadership advantages, accepting that some of these investments would fail and that the company would learn from each. He committed to measuring programs analytically, jettisoning those that did not produce acceptable returns, and stepping up investment in those that worked. When forced to choose between optimizing GAAP appearance and maximizing the present value of future cash flows, he wrote, Amazon would take the cash flows. The framework also promised to share strategic thought processes with shareholders when making bold choices and to maintain a culture of careful spending. This charter became the operating constitution Bezos cited in every subsequent annual letter.

The Kansas Bankers Surety Company (""KBS'') following its purchase by Wes-FIC early in the third quarter of 1996. The purchase of KBS is discussed in the section, ""The Kansas Bankers Surety Company,'' below. At the end of 1997 Wes-FIC retained about $27.5 million in invested assets, oÅset by claims reserves, from its former reinsurance arrangement with Fireman's Fund Group. This arrangement was terminated August 31, 1989. However, it will take a long time before all claims are settled, and, meanwhile, Wes-FIC is being helped over many years by proceeds from investing ""Öoat.'' We previously informed shareholders that Wes-FIC had entered into the busi- ness of super-cat reinsurance through retrocessions from the Insurance Group of Berkshire Hathaway, Wesco's ultimate parent. Wes-FIC's entry into the super-cat reinsurance business early in 1994 followed the large augmentation of its claims- paying capacity caused by its merger with Mutual Savings, the former savings and loan subsidiary of Wesco. In 1994, in recognition of Wes-FIC's sound Ñnancial condition, Standard and Poor's Corporation assigned to Wes-FIC the highest possible claims-paying-ability rating: AAA. The super-cat reinsurance business, in which Wes-FIC is engaged, continues to be a very logical business for Wes-FIC. Wes-FIC has a large net worth in relation to annual premiums being earned.

And this is exactly the condition rationally required for any insurance company planning to be a ""stand alone'' reinsurer covering super- catastrophe risks it can't safely pass on to others sure to remain solvent if a large super-catastrophe comes. Such a ""stand alone'' reinsurer must be a kind of Fort Knox, prepared occasionally, without calling on any other reinsurers for help, to pay out in a single year many times more than premiums coming in, as it covers losses from some super catastrophe worse than Hurricane Andrew. In short, it needs a balance sheet a lot like Wes-FIC's. In connection with the retrocessions of super-cat reinsurance to Wes-FIC from the Berkshire Hathaway Insurance Group, the nature of the situation as it has evolved is such that Berkshire Hathaway, owning 100% of its Insurance Group and only 80% of Wesco and Wes-FIC, does not, for some philanthropic reason, ordinarily retrocede to Wes-FIC any reinsurance business that Berkshire Hathaway considers desirable and that is available only in amounts below what Berkshire Hathaway wants for itself on the terms oÅered. Instead, retrocessions occur only occasionally, under limited conditions and with some compensation to Berkshire Hathaway.

Such retrocessions ordinarily happen only when (1) Berkshire Hathaway, for some reason (usually a policy of overall risk limitation), desires lower amounts of business than are available on the terms oÅered and (2) Wes-FIC has adequate capacity to bear the risk assumed and (3) Wes-FIC pays a fair ceding commission designed to cover part of the cost of getting and managing insurance business.make

large and plain giveaways of Berkshire Hathaway assets or business to a partially owned subsidiary like Wes-FIC. Given Berkshire Hathaway's unwillingness to make plain giveaways to Wes-FIC and reductions in opportunities in the super-cat reinsurance market in recent years, prospects are often poor for Wes-FIC's acquisition of retroceded super-cat reinsurance. Moreover, Wesco shareholders should continue to realize that super-cat rein- surance is not for the faint of heart. A huge variation in annual results, with some very unpleasant future years for Wes-FIC, is inevitable. But it is precisely what must, in the nature of things, be associated with these bad possibilities, with their huge and embarrassing adverse consequences in occasional years, that makes Wes-FIC like its way of being in the super-cat business. Buyers (particularly wise buyers) of super-cat reinsurance often want to deal with Berkshire Hathaway subsidiaries (possessing as they do the highest possible credit ratings and a reliable corporate personality) instead of other reinsurers less cautious, straightforward and well endowed.

And many competing sellers of super-cat reinsurance are looking for a liberal ""intermediary's'' proÑt, hard to get because they must Ñnd a ""layoÅ'' reinsurer both (1) so smart that it is sure to stay strong enough to pay possible losses yet (2) so casual about costs that it is not much bothered by a liberal proÑt earned by some intermediary entity not willing to retain any major risk. Thus the forces in place can rationally be expected to cause acceptable long-term results for well-Ñnanced, disciplined decision makers, despite horrible losses in some years and other years of restricted opportunity to write business. And, again, we wish to repeat that we expect only acceptable long-term results. We see no possibility for bonanza. It should also be noted that Wes-FIC, in the arrangements with the Insurance Group of Berkshire Hathaway, receives a special business-acquisition advantage from using Berkshire Hathaway's general reputation. Under all the circumstances, the 3% ceding commission now being paid seems more than fair to Wes-FIC. Certainly and obviously, Berkshire Hathaway would not oÅer terms so good to any other entity outside the Berkshire Hathaway aÇliated group. Finally, we repeat an important disclosure about Wes-FIC's super-cat-reinsur- ance-acquisition mechanics. It is impractical to have people in California make complex accept-or-reject decisions for Wes-FIC when retrocessions of reinsurance are oÅered by the Berkshire Hathaway Insurance Group.

But, happily, the Berkshire Hathaway Insurance Group executives making original business-acquisition deci- sions are greatly admired and trusted by the writer and will be ""eating their own cooking.'' Under such circumstances, Wesco's and Wes-FIC's boards of directors, on the writer's recommendation, have simply approved automatic retrocessions of reinsurance to Wes-FIC as oÅered by one or more wholly owned Berkshire Hathaway subsidiaries. Each retrocession is to be accepted forthwith in writing in Nebraska by agents of Wes-FIC who are at the same time salaried employees of wholly owned subsidiaries of Berkshire Hathaway. Moreover, each retrocession will be made at a 3%-of-premiums ceding commission.be

satisÑed: (1) Wes-FIC must get 20% or less of the risk (before taking into account eÅects from the ceding commission) and (2) wholly owned Berkshire Hathaway subsidiaries must retain at least 80% of the identical risk (again, without taking into account eÅects from the ceding commission). We will not ordinarily describe individual super-cat reinsurance contracts in full detail to Wesco shareholders. That would be contrary to our competitive interest. Instead, we will try to summarize reasonably any items of very large importance. Will more reinsurance be later available to Wes-FIC through Berkshire Hathaway subsidiaries on the basis and using the automatic procedure we have above described? Well, we have often proved poor prognosticators. We can only say that we hope so and that more reinsurance should come, albeit irregularly and with long intermissions. No new contracts became available to Wes-FIC in 1997, although one super-cat contract of three-years' duration, written in 1996, became eÅective in January 1997, and another expired during the year. As of 1997 yearend, the one remaining super-cat contract, plus one other contract, not a super-cat contract, and renewed during the year, represented Wes-FIC's active reinsurance business. We continue to examine other possible insurance-writing opportunities, and also insurance company acquisitions, like and unlike the purchase of KBS.

Wes-FIC is now a very strong insurance company, with very low costs, and, one way or another, in the future as in the past, we expect to continue to Ñnd and seize at least a few sensible insurance opportunities. On super-cat reinsurance accepted by Wes-FIC to date (March 9, 1998) there has been no loss whatsoever that we know of, but some ""no-claims'' contingent commissions have been paid to original cessors of business (i.e., cessors not including Berkshire Hathaway). Super-cat underwriting proÑt of $2.3 million, before taxes, beneÑted 1997 earnings, versus $3.9 million in 1996. The balance of pre-tax underwriting proÑt, amounting to $2.8 million for 1997, came mostly from favorable revision of loss reserves on the old Fireman's Fund contract. Our accounting policy requires contract expiration before super-cat underwriting proÑt is recognized. Needless to say, we would not have similar reluctance to report losses before contract expirations. The Kansas Bankers Surety Company (""KBS'') KBS, purchased by Wes-FIC early in the third quarter of 1996 for approximately $80 million in cash, contributed $6,044,000 to the normal net operating income of the insurance businesses in 1997 and $2,288,000 in 1996, after reductions for goodwill amortization under consolidated accounting convention of $508,000, after taxes, in 1997 and $275,000 in 1996.

KBS was chartered in 1909 to underwrite deposit insurance for Kansas banks. Its oÇces are in Topeka, Kansas. Over the years its service has continued to adapt to the changing needs of the banking industry. Today its customer base, consisting mostly of small and medium-sized community banks, is spread throughout 25 mainly midwestern states. In addition to bank deposit guaranty bonds which insure deposits in excess of FDIC coverage, KBS also oÅers directors and oÇcers indemnity policies, bank employment practices policies, bank annuity and mutual funds indemnity policies and bank insurance agents professional errors and omissions indemnity policies. KBS is run by Donald Towle, President, assisted by 13 dedicated oÇcers and employees. Precision Steel The businesses of Wesco's Precision Steel subsidiary, headquartered in the outskirts of Chicago at Franklin Park, Illinois, contributed $3,622,000 to normal net operating income in 1996, up 19% compared with $3,033,000 in 1996. The improve- ment in 1997 earnings was attributable mainly to a 15% increase in pounds of product sold. Revenues were up only 6.3%. Under the skilled leadership of David Hillstrom, Precision Steel's businesses in 1997 continued to provide an excellent return on resources employed.

Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of assets and liabilities with a net book value of about $13 million. In 1997, MS Property Company shrunk by approximately half after sales of several foreclosed properties and contribution of $12,750,000 in cash to Wesco. MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the foregoing breakdown of earnings within ""all other 'normal' net operating income.'' Of course, the main tag end from Wesco's savings and loan days is 28,800,000 shares of Federal Home Loan Mortgage Corporation (""Freddie Mac''), purchased by Mutual Savings for $72 million at a time when Freddie Mac shares could be lawfully owned only by a savings and loan association. This holding, with a market value of $1.2 billion at yearend 1997, now reposes in Wes-FIC. All Other ""Normal'' Net Operating Income All other ""normal'' net operating income, net of interest paid and general corporate expenses, increased to $1,133,000 in 1997 from $438,000 in 1996.of

liquidating tag-end foreclosed real estate. In 1997, reversals of reserves for possible losses on sales of such tag-end real estate, expensed in prior years, beneÑted this category of earnings by about $1.1 million, after income tax eÅect. The 1997 and 1996 ""other 'normal' net operating income'' Ñgures also include intercompany charges for interest expense ($172,000 and $298,000 after taxes, respectively) on borrowings from Wes-FIC principally made late in 1993 to facilitate the transfer of loans and foreclosed properties to MS Property Company. This intercompany interest expense does not aÅect Wesco's consolidated net income inasmuch as the same amount is included as interest income in Wes-FIC's ""normal'' net operating income. Net Securities Gains and Losses Wesco's earnings for 1997 contained securities gains of $62,697,000, after income taxes, versus losses of $115,000, after income taxes, in 1996. Of the 1997 Ñgure, only $93,000 was realized through the sale of securities; the balance, $62,604,000, resulted from the exchange of the preferred and common shares of Salomon Inc (""Salomon'') owned by Wesco for preferred and common shares of Travelers Group Inc. (""Travelers'') late in 1997 in connection with the merger of Salomon with a subsidiary of Travelers.

Accounting standards promulgated by the Financial Accounting Standards Board require that the fair (market) value of shares received in such an exchange be recorded as the new cost basis as of the date of the exchange, with the diÅerence, after appropriate reserves for future income tax on the gain, recognized in the Ñnancial statements as a realized after-tax gain. For income tax purposes the exchange is recorded at the original cost of the securities ex- changed; no gain is reported on the tax return, and no taxes are yet due. Although the realized gain had a material impact on Wesco's reported earnings, it had a very minor impact on Wesco's shareholders' equity. Inasmuch as $48,504,000 of the after-tax gain had previously been reÖected in the unrealized gain component of Wesco's shareholders' equity as of September 30, 1997, that amount was merely switched from unrealized gains to retained earnings, another component of share- holders' equity. Convertible Preferred Stockholdings At the end of 1997, Wesco and its subsidiaries owned $52 million, at original cost, in convertible preferred stocks of Travelers Group Inc. (""Travelers'') and US Airways Group, Inc. (""US Air''). The Travelers preferred stock was received in late 1997 (see the preceding section) in exchange for the Wesco group's remaining shares of Salomon Inc preferred stock, which originally cost $40 million, and whose cost was adjusted upwards to $90 million as of the date of the exchange.

The US Air preferred stock originally cost $12 million; that Ñgure was adjusted down to $3 mil- lion when we decided in 1994 that an other-than-temporary decline in the value of its stock had occurred. Both issues require redemption at par value or conversion to common stock within the next two years.

The investments are carried on Wesco's consolidated balance sheet at fair value, with any diÅerence between adjusted cost and market value included in sharehold- ers' equity, net of income tax eÅect, without aÅecting reported net income, accord- ing to accounting convention. Following is a summary of these investments in convertible preferred stocks at yearend 1997: Conversion Price 12/31/97 at Which Par Market Price Yearend Preferred Par Value Value May Be of Common Carrying Dividend of Exchanged for Stock on Value of Security Rate Holding Common Stock 12/31/97 Holding Travelers Group Inc. ÏÏÏ 9.00% $40 Million $22.42 $53.875 $ 96 Million US Airways Group, Inc. 9.25% 12 Million 38.74 62.50 19.2 Million These convertible preferred stocks were obtained at the same time Wesco's parent corporation, Berkshire Hathaway, obtained additional amounts of the same stocks at the same price per share. The preferred stock of Travelers was obtained in exchange for the remaining shares of preferred stock of Salomon Inc which Wesco and its subsidiaries had acquired in 1987. On October 31, 1995, in accordance with the terms of its convertible preferred stock, Salomon redeemed $20 million par value of its preferred shares owned by Wesco at cost plus accrued dividends.

On October 31, 1996 and October 31, 1997, Wesco converted an aggregate of $40 mil- lion par value of its remaining preferred shares of Salomon to 1,052,628 shares of Salomon common stock, with Wesco continuing to hold par value of $40 million of Salomon preferred stock. On November 28, 1997, Wesco and its subsidiaries received $40 million par value of Travelers 9% preferred stock plus 1,784,204 shares of Travelers common stock, in exchange for the Salomon holdings, in connection with a merger of Salomon into Travelers. Fair value of the Travelers preferred and common shares, carried on Wesco's consolidated balance sheet in the categories ""securities with Ñxed maturities'' and ""marketable equity securities,'' were $96.0 million and $96.1 million, respectively, at yearend 1997, versus the adjusted costs of $90.0 and $90.8 million, respectively, at which they were carried. US Air has called its convertible preferred stock for redemption on March 15, 1998. On March 13, 1998, Wesco converted its shares, acquired for $12 million in 1989 and written down to an adjusted cost of $3 million in 1994, to 309,718 shares of US Air common. In previous years we noted that ""few, if any, investors have ever prospered mightily from investing in convertible preferred stocks of leading corporations.'' Our experience proves, yet again, what poor prognosticators we are.

We estimate that (1) our investment in preferred and common stock of Travelers, acquired in 1997 through its merger with Salomon, in which we originally invested $80 million, net, was worth about $112.1 million more than we paid, and (2) our $12 million US Air holding was at yearend 1997 worth about $7.2 million more than we paid. These Ñgures when combined created $119.3 million more than actual cost. In addition, Wesco's investment in convertible preferred stock of The Gillette Company, made in 1989 at cost of $40 million, and converted into Gillette common stock in 1991 is carried at a $321.4 million yearend market value in Wesco's consolidated 1997 balance sheet.This

is $281.4 million more than the investment cost. Also, in 1995, Wesco realized a gain of $6.9 million, before taxes ($4.2 million after taxes), on sale of its $23 million investment in preferred stock of Champion International Corporation. Consolidated Balance Sheet And Related Discussion As indicated in the accompanying Ñnancial statements, Wesco's net worth increased, as accountants compute it under their conventions, to $1.76 billion ($248 per Wesco share) at yearend 1997 from $1.25 billion ($176 per Wesco share) at yearend 1996. The $513 million increase in reported net worth in 1997 was the result of three factors: (1) $419 million resulting from continued net appreciation of investments after provision for future taxes on capital gains; plus (2) $94 million from retention of 1997 net income, including $63 million realized on the exchange of Salomon stock for Travelers stock, discussed above; less (3) dividends paid. The foregoing $248-per-share book value approximates liquidation value assum- ing that all Wesco's non-security assets would liquidate, after taxes, at book value. Probably, this assumption is too conservative.

But our computation of liquidation value is unlikely to be too low by more than two or three dollars per Wesco share, because (1) the liquidation value of Wesco's consolidated real estate holdings (where interesting potential now lies almost entirely in Wesco's equity in its oÇce property in Pasadena) containing only 125,000 net rentable square feet, and (2) unrealized appreciation in other assets (primarily Precision Steel) cannot be large enough, in relation to Wesco's overall size, to change very much the overall computation of after-tax liquidating value. Of course, so long as Wesco does not liquidate, and does not sell any appreciated assets, it has, in eÅect, an interest-free ""loan'' from the government equal to its deferred income taxes on both the unrealized gains and gains deferred from the merger of Salomon into Travelers in 1997, subtracted in determining its net worth. This interest-free ""loan'' from the government is at this moment working for Wesco shareholders and amounted to about $102 per Wesco share at yearend 1997. However, some day, perhaps soon, major parts of the interest-free ""loan'' must be paid as assets are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $102 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $102 per Wesco share.

In the writer's judgment, the value of Wesco's advantage from its temporary, interest-free ""loan'' was probably about $25 per Wesco share at yearend 1997. After the value of the advantage inhering in the interest-free ""loan'' is estimated, a reasonable approximation can be made of Wesco's intrinsic value per share. This approximation is made by simply adding (1) the value of the advantage from the interest-free ""loan'' per Wesco share and (2) liquidating value per Wesco share. Others may think diÅerently, but the foregoing approach seems reasonable to the writer as a way of estimating intrinsic value per Wesco share.

Decision — Converted long/short fund to long-only after a near-death experience. Context: His own account: PCA p.61 + the 2006 Columbia lecture. Outcome (known): Long-only concentration discipline became the core philosophy; Munger’s ~$88M entrustment followed.

Thus, if the value of the advantage from the interest-free tax-deferral ""loan'' present was $25 per Wesco share at yearend 1997, and after-tax liquidating value was then about $248 per share (Ñgures that seem rational to the writer), Wesco's intrinsic value per share would become about $273 per share at yearend 1997, up 39% from intrinsic value as guessed in a similar calculation at the end of 1996. And, Ñnally, this reasonable-to-this-writer, $273-per-share Ñgure for intrinsic per share value of Wesco stock should be compared with the $300 per share price at which Wesco stock was selling on December 31, 1997. This comparison indicates that Wesco stock was then selling about 10% above intrinsic value. As Wesco's unrealized appreciation has continued to grow in frothy markets for securities, it should be remembered that it is subject to market Öuctuation, possibly dramatic on the downside, with no guaranty as to its ultimate full realization. Unrealized after-tax appreciation represents 73% of Wesco's shareholders' equity at 1997 yearend), versus 70% and 63% one and two years earlier. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally-good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier.

Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, been widening in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for invest- ment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. We are not now pessimists, on a long-term basis, about business expansion. Despite present super-ebullient markets for entire businesses, making it hard for Wesco to Ñnd attractive opportunities, we do not believe that such opportunities will never come. On January 28, 1998 Wesco increased its regular dividend from 27¥ cents per share to 28¥ cents per share, payable March 11, 1998, to shareholders of record as of the close of business on February 11, 1998. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Charles T.1998

Decision — Founded Aquamarine Fund in Zurich, modeled on the Buffett partnerships. Context: “Leave Wall Street norms behind” arc detailed in the memoir. Outcome (known): Fund ran 28 years; cumulative ~1,185.6%.

Decision — AMG acquired 70% of the firm for $300M. Context: Confirms the 1997 (not later) dating; funds distributed by AMG Distributors. Outcome (known): Ownership structure set; same ecosystem as Akre Capital.