At a current market cap of roughly ₩160B, investors are getting a highly profitable, sound operating business for less than zero.

Kukbo is no longer just an interior contractor, but has transformed into a massive, heavily concentrated technology hedge fund. The company holds ₩529.5B in net surplus assets, and the stock currently trades at a mere 0.37x of its conservative liquidation value.

Instead of returning this excess capital to owners, management is churning nearly a trillion won in financial assets in a single half year period, betting aggressively on global AI and semiconductor stocks. Meanwhile, the dividend payout ratio sits at a meager 5%, and the CEO extracts an extreme $1.7M annual salary. The market is looking at this extreme capital hoarding and rightfully penalizing the stock as a perpetual value trap.

For the careful security analyst, this presents a fascinating opportunity and serves as a very interesting case study. The downside is heavily insulated by an enormous cushion of cash and liquid securities, alongside a core enterprise that consistently grows and operates with a structurally negative cash conversion cycle.

The genuine risk here is not necessarily a permanent loss of capital, but the opportunity cost of dead money. But the regulatory landscape is shifting. With South Korea’s recent corporate Value-Up program targeting asset bloated balance sheets and introducing new incentives for capital returns, value is increasingly becoming more likely to be unlocked.

This report breaks down the entire business, the normalized earning power of the core operations, calculates the realizable value of the hidden portfolio, and analyses both management and the specific catalysts, even if undated, that could finally unlock this extreme margin of safety for the minority shareholder.

After countless hours of research, analysis and writing conducted this past month, I believe Kukbo Design represents one of the more unusual deep-value opportunities I have come across in the Korean market.

Business Overview

Kukbo Design is a South Korean interior-construction company that designs and builds interior spaces for commercial, corporate, hospitality, residential, and specialized facilities.

Its services cover the full interior construction process, including space planning, design, construction, and supervision. Customers hire Kukbo to design and execute the interiors of buildings such as offices, hotels, resorts, retail spaces, hospitals, museums, and other facilities. The company also undertakes remodeling projects, which are becoming increasingly important as Korea’s existing building stock ages.

In plain English, Kukbo takes an empty or an existing building and turns it into a finished interior handling everything from the initial design to the construction.

The business is almost completely project based. In the most recent annual report, the parent company generated ₩377.4B of revenue, which was 99.5% generated from domestic construction projects, and 0.5% coming from overseas projects.

Kukbo’s customer base is quite wide, including retailers, corporations, financial institutions, hotels and resorts, and operators of specialized facilities such as hospitals and museums. The company does not appear to be dependent on a single customer either, as no individual customer accounted for more than 10% of standalone revenue.

The company was founded in 1983 and has spent more than four decades building its position in Korea’s interior construction industry. Kukbo states their primary competitive advantage is its ability to provide an integrated “design-to-construction” service, combined with its long operating history and financial strength. Kukbo has ranked first in Korea’s interior construction contracting rankings every year since 2012, despite operating in what’s considered a very fragmented market. Nevertheless, competitive advantages will be further discussed later.

The group also operates several subsidiaries, including furniture manufacturing, distribution, and overseas interior construction and remodeling subsidiaries. However, these remain small relative to the main interior business. In 2025, the interior segment generated ₩440.3B of segment revenue, compared with ₩6.0B from distribution and ₩2.5B from furniture manufacturing.

In short, Kukbo is best thought of as a leading specialized construction contractor rather than a traditional interior-design studio: it wins large projects, designs the space, manages the construction, and recognizes revenue as the work is completed.

Industry Background

All of the following sections include management’s own industry assessments, extracted from the filings, and manually verified from external reliable sources.

Industry Overview

Kukbo Design operates in Korea’s interior construction industry, which management divides into six principal areas: residential interiors, commercial interiors, office interiors, hotels or leisure and national infrastructure, specialized facilities, and remodeling.

Management views the industry as benefiting from the increasing importance placed on the functionality, comfort and quality of residential and working spaces. As economic development and living standards have improved, they believe interior design can affect the value of an asset, the competitiveness of a company and sales.

The company therefore sees the market moving toward more differentiated, customized and higher value interior work, rather than simply expanding in line with the number of buildings constructed.

Residential Interiors

Management states they believe residential interiors are increasingly becoming an expression of “lifestyle, personal taste and economic status”, rather than merely a means of making a home functional.

This has increased demand, in management’s view, for high end and customized interiors.

The company also points to changes in household structure. The formation of nuclear families and the increase in one and two person households are increasing demand for smaller houses and apartments and, consequently, for interiors that make better use of limited space.

The opportunity is therefore not simply more housing, but more interior value per unit of space.

Commercial Interiors

Management sees a similar development in commercial properties.

Kukbo describes interior design as increasingly becoming a form of “spatial marketing.” The argument is that the physical environment in which a product is sold can influence the customer’s perception of both the brand and the product itself.

Accordingly, Kukbo believes commercial interiors are increasingly being used to:

• establish brand identity;

• influence consumer sentiment;

• increase the perceived value of products; and

• encourage purchasing.

Interior construction is therefore becoming more closely connected with marketing and brand strategy, rather than being treated solely as a construction expenditure.

Hotels, Leisure & National Infrastructure

Kukbo also does interior work for hotels, condominiums, convention facilities and other infrastructure related with tourism.

Management believes the development of higher quality accommodation and themed tourism facilities should support demand for higher end interior construction.

Specialized Facilities

Hospitals, senior care facilities, museums and performance venues are all considered specialized markets.

They believe these facilities increasingly require interiors designed around specialized functional and user requirements, creating another area of demand for higher value interior construction.

Remodeling

Of the industry’s various opportunities, management places particular emphasis on remodeling.

They state that Korea accumulated a substantial stock of residential, office and industrial buildings during the country’s rapid urbanization and industrialization. The company says approximately 47% of the existing building stock is more than 30 years old.

Management interprets this aging building stock as entering a remodeling cycle.

The attraction of remodeling, in Kukbo’s view, is that an existing building can be upgraded without being completely replaced.

My findings are highly aligned with this statement, as South Korea’s official macroeconomic data do validate this focus on the remodeling market.

Remodeling can “improve functionality, make better use of existing space, increase the reuse value of a building, and incorporate environmentally friendly improvements”.

Kukbo and official MOLIT statistics alongside external market reports consequently expect remodeling demand to increase, which could eventually become one of the fundamental segments of the construction industry.

Industry Structure

The Korean interior construction market is highly fragmented.

Kukbo states that the 2025 industry ranking contained 12,036 companies. Despite this large number of competitors, management describes the economically important part of the market somewhat differently.

A relatively small number of companies have the capability to provide the complete service Kukbo offers.

Management believes these integrated companies account for a substantial proportion of available projects, while companies lacking the same breadth of capabilities compete more intensely for the remaining work.

This is important to Kukbo’s investment case as the company is not presenting itself as merely another interior contractor in a market containing thousands of firms. Its argument is that the scale, capabilities and financial capacity matter materially more when competing for larger projects.

Competitive Advantages

Kukbo ranked number one in the 2025 interior construction ranking, among the 12,036 companies included.

More importantly, it has maintained that position since 2012, so it maintained said ranking for 14 consecutive years.

This position is likely due to its long operating history, industry knowledge, experience, and financial strength.

In addition, Kukbo was established in 1983, giving it more than 40 years of operating history.

Financial Strength as a Competitive Advantage

Apart from the obvious, management actually makes a concrete, and rather interesting argument about why financial strength matters in this industry.

Management points to the IMF crisis, during which major companies in the industry failed. This experience changed the way customers evaluated contractors - financial stability became more important when selecting a company capable of executing a project.

The company’s argument is that a contractor is not merely selling design. It is accepting responsibility for delivering a large project over time, making the contractor’s ability to remain financially sound throughout the project important to the customer.

Therefore, the financial position and strength also contributed to its ability to win projects and improve its competitive position.

Future Reliability & Stability

I strongly believe one of the most relevant questions when conducting qualitative judgement in security analysis is whether there is sufficient evidence that the company can continue generating roughly comparable operating earnings and cash flows over a normal business cycle.

I believe the filings provide several reasons to think that it can.

First, Kukbo has a substantial amount of work already contracted. At the end of 2025, the consolidated group had ₩310.7B of transaction prices allocated to remaining performance obligations, against ₩438.8B of consolidated construction revenue recognized during the year.

This does not make the revenue recurring, as seen in SaaS enterprises. However, most future revenue is already secured through existing contracts, rather than having to be replaced entirely by new orders each year.

I’ve also found that the business doesn’t require significant reinvestment to maintain operating capacity. The consolidated property, plant and equipment was only ₩9B at FY 2025, compared with ₩473.2B of total assets. The company is therefore not a capital intensive manufacturer that must continually reinvest large sums merely to preserve its productive capacity.

There is, however, an important qualification every security analyst of such industry must condone. Construction earnings are not perfectly stable. Kukbo recognizes interior construction revenue over time, and changes in estimates of total contract revenue and costs can affect current and future profit.

For the reasons stated above, I would not simply use the most recent earnings figure to determine rough intrinsic value - that would be a material error in the conduct of fundamental analysis. Rather, the more realistic and conservative approach is to estimate and normalize operating owner earnings across several years and ask whether that normalized figure is supported by demonstrated earning power.

Indeed, the normalization of historical operating owner earnings may be conservative rather than aggressive if the current business maintains its recent economics.

This will be further discussed in the “Valuation” section.

Finally, their historical record is undoubtedly impressive for the sector they operate in. Revenue and operating income CAGR for the past 20 and 10 years has been roughly 10% and 8%, as well as 12% and 15%, respectively.

Industry Peer Profitability Comparison

To put into perspective, I’ve gathered the data and average revenue and operating income CAGR of their direct, publicly traded industry competitors:

• Sigong Tech (KOSDAQ: 020710)

• HDC Labs (KOSDAQ: 039570)

Why is this list so short? While we do know Kukbo’s competitors and how they are ranked, none of them trade publicly. The most similar publicly traded companies I’ve found are Sigong Tech and HDC Labs. These are still very rough comparisons, but can serve as a useful proxy.

Revenue Comparison:

• Sigong Tech Co., Ltd. (KOSDAQ: 020710) 20-year revenue CAGR: 5%

• HDC Labs Co., Ltd. (KOSDAQ: 039570) 19-year revenue CAGR: 13%

• Sigong Tech Co., Ltd. (KOSDAQ: 020710) 10-year revenue CAGR: 7.7%

• HDC Labs Co., Ltd. (KOSDAQ: 039570) 10-year revenue CAGR: 13%

Operating Income Comparison:

• Sigong Tech Co., Ltd. (KOSDAQ: 020710) 20-year operating income CAGR: 6.8%

• HDC Labs Co., Ltd. (KOSDAQ: 039570) 19-year operating income CAGR: 3%

• Sigong Tech Co., Ltd. (KOSDAQ: 020710) 9-year operating income (2017 had negative operating income, so I’ve used the 2018 figure) CAGR: 0%

• HDC Labs Co., Ltd. (KOSDAQ: 039570) 10-year operating income CAGR: -2%

Restating Kukbo’s operating income and revenue CAGR:

Revenue and operating income CAGR for the past 20 and 10 years has been roughly 10% and 8%, as well as 12% and 15%, respectively.

As observed at the gross level, Kukbo has experienced very similar growth relative to the average of their peers. However, at the operating level, Kukbo’s growth seems largely unmatched.

Gross Margin Comparison:

Kukbo’s gross margin is not only above peers, but has also remained relatively stable, which does suggest a somewhat more favorable project mix and disciplined cost management.

Operating Margin Comparison:

Kukbo’s operating margin is also both relatively stable and noticeably above peers, which reflects strong operating efficiency and some operating leverage.

Analysing Management

Skin in the Game

Management’s insider ownership could provide some degree of alignment with the minority shareholder. However, while substantial, it’s concentrated overwhelmingly in the CEO rather than broadly distributed among management:

• Hwang Chang-yeon, the CEO and largest shareholder, owns 38.11% (2,858,089 shares).

• Hwang Seon-eung, a specially related shareholder, owns 6.26% (469,409 shares).

• Hwang Seon-jun, a specially related shareholder, owns 5.66% (424,161 shares).

• Seo Eun-mi, a specially related shareholder, owns 3.16% (236,800 shares).

• The remaining specially related shareholders own another 0.48%.

Hwang Chang-yeon and the specially related shareholders control 53.67% of Kukbo Design, which is a material portion of the business.

Thus, we could conclude that management’s incentives are aligned with the minority shareholders.

Right?

Shareholder Alignment

While management’s ownership does provide a substantial degree of alignment with minority shareholders, the more important question is what management does with the capital that belongs to all shareholders.

Kukbo has paid a cash dividend for 18 consecutive years, and has been slowly increasing over the years. The total dividend was ₩3.4B in the most recent semi annual report, against free cash flow of ₩61B, for a 5% cash payout ratio. There has been no special dividend nor buyback, however they have historically repurchase some shares, though sporadically to “enhance shareholder value”.

The dividend record is therefore consistent, but the distribution is extremely small relative to the cash flow generation and especially to the financial assets of the company. Kukbo states that it “considers its business circumstances when determining its dividend policy” and has said that improvements to the dividend will be reviewed based on future business conditions. They don’t, however, specify a concrete amount of capital required for future growth or a target cash balance.

This becomes particularly important when looking at the operating requirements of the business.

The operating business has historically required very little working capital. Using the reported receivables, contract assets, inventory and trade payables, I estimated the cash conversion cycle was approximately 3.1 days for the past 3 years (further details expanded in the “Valuation” section).

Most recently they’ve had negative CCC, which is particularly interesting. Kukbo currently receives cash from customers or suppliers which finance part of the operating cycle before the company itself has to fund the working capital.

Even the worst year in this period, 2024, produced a CCC of only around 10 days. Therefore, there’s little evidence in the historical financial statements that the operating business needs a large permanent cash reserve merely to finance its day to day working capital requirements, even in worst case scenarios.

This matters because Kukbo’s cash and short-term investments are extremely large relative to both market cap and total assets.

The company therefore does not appear to have accumulated its liquid financial assets simply because the operating business requires them to function.

Most recently, the consolidated balance sheet contained ₩120.9B of cash and cash equivalents, ₩31.7B of short-term deposits and ₩179.7B of current financial assets (measured at fair value through profit or loss). It also held ₩265B of non current investments in equity securities.

So Kukbo hasn’t just accumulated a large cash balance, but also an increasingly big securities portfolio. This purchase of securities began in 2021, and aggressively accelerated in 2024.

During the first half of 2026, the group sold ₩398.2B of FVPL financial assets and purchased ₩359B, while selling ₩498.5B of FVOCI financial assets and purchasing ₩524.8B. An interior contractor is churning nearly ₩1T in financial assets.

In other words, the balance sheet is now increasingly being used to run a substantial financial investment portfolio, apart from the interior construction business.

Why should a team whose expertise is in interior construction and remodeling be trusted to manage such a portfolio of public equities?

I strictly believe that management is only justified in retaining earnings if they can demonstrate that it can earn a higher rate of return inside the business than the shareholder could earn elsewhere.

And Kukbo is not reinvesting this cash into heavy machinery, factories, or massive inventory to support growth.

The reasonable approach would therefore be to return it to the owners via material dividends or share buybacks. As seen previously, this is not the case.

The company has not announced a special dividend or a general policy of returning excess capital, and the ordinary dividend remains modest.

So why not return a reasonable sum of the stationary cash and securities portfolio to further create value for shareholders? Wouldn’t that benefit management too?

Hwang’s (CEO) ownership means that he participates heavily in every dividend and in any increase or decrease in the value of the company’s shares. His interests are substantially tied to the same asset that minority shareholders own.

However, the compensation record is less attractive. Far less attractive.

Hwang received ₩2.4B in 2025, all classified as earned income. In USD, it’s $1.7M.

While his ownership would naturally give him a clear incentive to increase shareholder value through higher dividends or share repurchases, the ₩2.4B annual compensation is itself a substantial source of personal income.

In other words, his economic exposure as a shareholder is significant, but so too is the private benefit he receives from continuing to operate the company and retain capital within it.

I would consequently not characterize the compensation as owner aligned. It is a substantial managerial salary.

Thus, I believe management’s intentions appear potentially misaligned from those of the minority shareholder. Unless the securities portfolio was explicitly approved by owners, or can be evidenced to be a one-off measure that will eventually benefit the common stockholder, I see no reason why the payout remains so vastly modest while management continues buying into junior issues.

However, there is a compelling reason for optimism. South Korea’s “Corporate Value-Up Program” and other recent legal overhauls serve as an undated, though powerful, turning point to unlock value. This will be further expanded upon in the following sections.

Important Risks

• Construction contract estimation risk:
  Revenue and profit are recognized based on progress and estimated total contract revenue and costs. Management explicitly says these estimates are subject to significant uncertainty because material costs, labor costs, construction periods, change orders, incentives and penalties can differ from expectations.
  This is probably the most important operating risk, as a project can look profitable based on today’s estimates and subsequently produce lower margins.

• Construction delay and penalty risk:
  Contract revenue can be reduced by penalties when completion is delayed for reasons attributable to Kukbo.

• Financial market risk from the securities portfolio:
  Kukbo now has a very large portfolio of equity securities. The company explicitly identifies equity price risk and reports that its financial assets measured at FVPL and FVOCI are exposed to changes in market prices.
  This is unusually important for Kukbo because the financial portfolio is now large relative to the operating business. A market decline can therefore materially reduce reported equity and earnings or OCI.

• Fair value risk:
  For financial instruments that do not trade in active markets, Kukbo uses valuation techniques and assumptions based on market conditions. There remains uncertainty in those fair value estimates.

• Credit and receivables risk:
  Kukbo is exposed to the possibility that customers or counterparties fail to meet their obligations. Its expected credit loss calculations depend on assumptions regarding default probabilities, expected loss rates, overdue balances and other information.
  The risk appears manageable historically, but it is inherent in a construction business with substantial contract receivables and assets.

• Foreign-exchange risk:
  Kukbo operates through subsidiaries in the United States, China, Vietnam, India, Russia, Hungary and Saudi Arabia, among others.

• Overseas subsidiary or international expansion risk:
  The group now has 14 consolidated subsidiaries across multiple countries, including several relatively small and even loss making operations.
  I would regard this as a secondary risk, rather than a central one.

• Investment allocation risk:
  Management is increasingly deploying the company’s substantial financial resources into securities and startup investments.
  The risk is therefore that capital which the operating business does not require is allocated to investments that ultimately earn inadequate returns or lose money.

• Liquidity risk:
  The company explicitly manages liquidity risk and maintains policies concerning funding and operating-capital requirements. This is not currently a major solvency risk but it remains a financial management consideration.

• Concentration in the Korean interior construction market:
  A downturn in construction, commercial development, remodeling or corporate capital expenditure in Korea could affect revenue.

Interpretation of Financial Statements

Financial Statements

You can skim through this. Useful for anyone willing to conduct additional due diligence in a short period of time or just curious of the financial statements.

Income Statement - Overview

Balance Sheet - Overview

Cash Flow Statement - Overview

Financial Metrics - Highlights

20-Year Historical Margins:

Margins have been slightly volatile, as expected for a project based construction business, and there is no obvious margin deterioration. More recently, profitability has remained at relatively healthy levels.

20-Year Historical Revenue:

Revenue has grown substantially over the long term. Individual years can fluctuate materially, but the broader trend is clearly upward, with revenue reaching a record level in the most recent period.

20-Year Free Cash Flow compared to Dividends:

Kukbo has consistently generated far more cash than it has distributed to shareholders. The dividend has remained small and relatively stable, while free cash flow has become increasingly substantial and volatile, while cash & securities keep on piling up.

20-Year Total Common Equity compared to Cash and Securities:

Total equity has compounded steadily, while the recent increase in cash and investments has been quite drastic. A substantial part of the company’s current value is therefore represented by financial assets rather than simply the operating interior construction business.

Cash Return On Capital since 2019:

Current operating ROC is 41%. This is calculated by taking the year’s current operating cash flow and dividing by that year’s invested capital minus cash equivalents and short term investments.

Valuation

This is a rather interesting case study. Kukbo is, on one hand, a profitable and growing interior construction business with a long operating history. On the other, the company has accumulated a financial asset portfolio that has become extraordinarily large relative to the operating requirements of the business.

Instead of distributing such amounts of excess cash to create meaningful value for shareholders, they have retained and invested a meaningful portion of it into securities.

Thus, the security analyst should not fall into the misleading error of valuing Kukbo as a conventional operating company.

A substantial part of what the shareholder owns today is no longer represented by the interior construction business itself, but by cash, deposits and financial securities sitting on the balance sheet.

The valuation therefore requires us to answer two separate questions:

1. What is the earning power of the operating business?

2. How much of the company’s financial assets can reasonably be considered surplus (non-operating) and subsequently attributable to the shareholder?

Earning Power of the Operating Business

Determining the company’s earning power is a necessary step in determining a rough range of intrinsic value. These type of enterprises should not be relied upon a single year or earnings - such figure would be highly misleading.

A sound approach to conducting this analysis would be:

1. to normalize their operating margins over the span of a full business cycle, excluding abnormal or non-recurrent years;

2. utilizing contract backlog to figure out if the recent increase in revenue is a structural change or not;

3. adjusting the resulting figure to reflect true cash flows.

In addition, this normalization is conducted by isolating only the core interior contracting operations - completely ignoring investment income, interest, or equity portfolio fluctuations, for now.

For 2025, the company reported operating income of ₩45.1B on a record consolidated revenue of ₩438.8B. I require to look past the immediate turnover of the income statement and check the underlying economics of the order book.

Reported contract backlog for FY2025 stood at ₩241.3B. When we compare this to the year’s total sales, we get a ratio of 0.52x. In plain terms, the signed contracts cover only about 6months of forward revenue.

While such a low ratio usually signals an impending revenue cliff, Kukbo has expanded its operations with consistency year after year since 2007, suffering only minor declines in revenue in 2010, 2013, and 2018.

Therefore, the fact that the backlog is smaller than annual revenue does not signal an upcoming disaster. Rather, it reveals how Kukbo actually operates. The business executes contracts rapidly, collects the cash, and continuously renews the pipeline.

Now, the relevancy of the backlog ratio is to compare it to recent history. If this ratio has remained consistent throughout the past cycle, then the current year’s revenue figure could actually prove to be a very useful starting point for normalization.

As a fair assumption, the macroeconomic cycle for Kukbo Design lasts for around 10 years. Thus, it would be appropriate to calculate every year’s backlog ratio from the past cycle:

The average backlog ratio is around 0.61, representing about 7 months of forward revenue coverage.

This consistency confirms that the FY2025 ratio of 0.52x is entirely in line with Kukbo’s historical operational baseline. It also strongly suggests that the record high revenue was generated through rapid project execution rather than an unrepeatable liquidation of an accumulated backlog.

Consequently, the most recent revenue figure serves as a reasonable foundation to which the normalized operating margin can be applied to estimate normalized earning power.

Looking at the 10-year operating margin immediately reveals a clear, observable outlier: FY2019.

Is 2019 therefore an exceptional year? Maybe, but careful consideration must be applied.

The filing does not, from what I’ve found, give us an obvious explanation. The problem was that its project economics deteriorated. Cost of sales grew substantially faster than revenue, compressing gross margin from about 14.8% to 12.0%.

So 2019 was clearly an unusually weak profitability year, but I haven’t found concrete evidence to establish that it was a non-recurring year.

As a result, I included this in the cycle average. The 10-year macroeconomic average yields a normalized operating margin of 7.7%, requiring no further adjustments.

*The following figures used in the valuation are the most recent (June 30, 2026).

The last 12 months of revenue is ₩439.1B. Hence, after multiplying by the cycle’s average operating margin, normalized operating income is roughly ₩33.8B.

The standard statutory corporate tax rate in South Korea for a company earning Kukbo’s income is 22%, plus a local income tax, totaling roughly 24%. The business’s average effective tax rate is around 27%. However, this is likely because of non deductible investment losses or taxes on foreign subsidiaries. Thus, the more reliable choice for the operating business is the former.

This results in an estimated NOPAT of ₩25.7B

Finally, adjustments for non-cash items in normalized NOPAT must be done to reflect true operating earning power.

Depreciation has historically accounted for a very insignificant portion of total revenues, but is still materially more than capital expenditures. Most recent reported D&A is ₩468M, compared to ₩3.5M of CapEx.

As depreciation has remained relatively stable, at around ₩400-500M, using the most recent figure is quite reasonable.

Now, CapEx has been much smaller (on average) and volatile. There have been years in which reported CapEx was 0, and others in which it has gone up to ₩1.2B. Most years since 2017, CapEx has been remarkably low; however, in FY2019 it spiked to ₩1.2B and subsequently fell to normal levels.

The 2019 consolidated cash flow statement breaks the investment spending down:

• Land acquisition: ₩630.6M

• Building acquisition: ₩291.5M

• Investment property acquisition: ₩861.3M

• Equipment: only ₩1.75M

In addition, 2019 also had a ₩5.66B gain from selling investment property. This is a clear indication that Kukbo was already conducting activities with property and investment assets in 2019 that are separate from the core interior contracting business.

Accordingly, a 10-year average (excluding 2019) provides a conservative baseline for maintenance CapEx, resulting in roughly ₩150M.

The business has neglectable short term and long term lease liabilities, so there isn’t any real cash leaving the company to maintain its leases. Normally, these cash payments should be included in maintenance CapEx, if they where to be meaningful.

Estimating incremental required working capital is very straight forward. As discussed previously in the “Analysing Management: Shareholder Alignment” section, Kukbo’s CCC is structurally negative. So the business requires no additional working capital to maintain its competitive position and unit volume.

Therefore, we can now estimate its earning power from the core, operating business by using the following formula:

This results in the business’s earning power, or normalized operating owner earnings, of approximately ₩26B:

Operating Business Value

To finally value the operating business, I capitalize normalized operating owner earnings using a range of capitalization rates. The current 10-year South Korean government bond yield is approximately 4.3%, which is what I’ll use as the risk-free rate.

Rather than relying on one single capitalization rate, I apply a range of equity risk premiums.

Given Kukbo’s construction market & industry risks, potential contract mismatches, and size, a sound range of the risk premium should be around 6.5% to 9%, which corresponds to a capitalization range of 10.8% to 13.3%.

No growth is assumed. This estimate is a measure of the company’s true intrinsic worth based strictly on its current, sustainable operating cash flow, ignoring any speculative assumptions about future growth.

This brings our estimate of the operating business value from about ₩195.5B to ₩240.7B.

Net Surplus Assets

There are 2 adjustments we must make to correctly estimate the value of their net surplus assets, which are non-operating assets net of debt:

1. Roughly estimate excess cash, as it’s not typically disclosed as a standalone metric.

2. Haircut the securities portfolio based on liquidity, valuation uncertainty, and realization risk.

Fortunately, the filings and type of business provides enough information to conduct such due diligence.

Excess Cash Estimation

To estimate required operating cash, I usually use 2 different approaches:

1. Allocating a specific buffer equivalent to a set number of months of cash operating expenses to protect against short-term liquidity shocks.

2. Estimate the cash tied up in the working capital cycle by multiplying the company’s daily Cash Operating Expenses by its Cash Conversion Cycle (CCC) in days.

For contract-heavy, project-based businesses, the second approach is the more appropriate due to the variable nature of their cost structures and the importance of working capital mechanics in their daily solvency.

However, as discussed previously, the business maintains a negative CCC. This does not mean they can operate with the absence of a cash buffer. So, I usually exclude Days Payable Outstanding (DPO) from the equation.

In the real world, a company can suffer adverse macroeconomic conditions, in which suppliers might panic and demand immediate payment. If that happens, the company instantly needs enough cash to cover the operating cycle (Days Sales Outstanding and Days Inventory Outstanding).

In essence, the estimated cash buffer looks like this:

*Note: In Cash Operating Expenses, I also include COGS.

Therefore, multiplying the daily burn rate by DSO + DIO gives the true rough operating floor.

Kukbo’s current SG&A is approximately ₩26B, they report no R&D (or they include it inside SG&A), and reported ₩368B of COGS. Together, the Cash OpEx totals ₩394B for the most recent period.

DSO is calculated as follows:

Construction and B2B design is fully credit based, so total revenue should be used.

Average accounts receivable for the year are ₩43B and TTM revenue is ₩439B, leading to DSO of approximately 36 days.

As Kukbo operates with no inventory, DIO is excluded from the equation.

Accordingly, the estimated operating cash buffer for Kukbo is roughly ₩39B.

Value of Surplus Assets

The securities portfolio consists almost entirely on publicly traded securities.

The footnotes disclose all of these assets rather than merely the accounting type. Here’s the breakdown of haircuts applied to each surplus asset:

Reasons for the haircuts:

• Cash & equivalents: No discount. It’s just liquid cash sitting in a bank account.

• Short-term deposits: Due to it being available in less than a year, I believe a 5% rate covers comfortably any early cancellation penalty or loss of accrued interest the bank might apply for terminating the contract early.

• Current financial assets at FVTPL (equity securities at level 1): These are highly liquid, publicly traded common stocks (which will all be stated in the following chart). A 3% haircut is enough to account for absorbing brokerage fees and some fluctuation in price during a fast sale.

• Long-term deposits (not cash equivalents): Since the term exceeds one year, bank penalties for early withdrawal are generally higher.

• Non-current financial assets at FVTPL (financial assets at level 3): Non-current assets valued using mark-to-model suffer major write downs during a liquidation. A 60% haircut is a conservative assumption for such opaque assets.

• Non-current investments at FVOCI (equity securities at level 1): Even though the asset is classified as non-current due to company strategy, they are still level 1 common stocks. The 4% figure is slightly higher than the 3% applied to current trading securities, as the larger blocks of shares might be subject to a small blockage discount if sold all at once.

• Non-current investments at FVOCI (equity securities at level 3): These are shares in private companies with no public market, so valuation is based on estimates. A 60% discount is applied due to Discount for Lack of Marketability (DLOM) in a liquidation scenario.

The final estimated value of surplus assets is roughly ₩575.7B.

Additionally - and in a rather fortunate way - management discloses most of their stock holdings. Unfortunately, they are substantially concentrated in the semiconductor industry:

I’ll later discuss in further detail how a material collapse in the market of AI companies could affect valuation.

Total Value of Net Surplus Assets

Combining all of the adjustments produces the following estimate of net non-operating assets:

• Intrinsic worth of financial assets: ₩575.7B

• Deferred tax liabilities: ₩4.3B (the required amount of tax to pay if the business where to sell their securities portfolio)

• Operating liquidity buffer: ₩39B

• Short-term borrowings: ₩3.2B

• Total lease liabilities: ₩648M

• Net Surplus Assets = ₩529.5B

Although the balance sheet reports financial assets at fair value, this estimate is intentionally more conservative.

It reflects only the portion of cash that is truly excess to operational requirements, discounts less liquid investments to better approximate realizable value, and deducts all interest-bearing obligations.

As a result, the estimated ₩529.5B represents a reasonable approximation of the value of the assets not used in the business’s core operations, net of debt.

Intrinsic Value

Adding the estimated value of the operating business to net non-operating assets produces the following intrinsic value range:

• Operating value: ₩195.5B to ₩240.7B

• Net surplus assets: ₩529.5B

• Total intrinsic value range: ₩724.1B to ₩769.3B

A material portion of its intrinsic value is supported by the adjusted securities portfolio and cash.

The current market capitalization is ₩160B, against the intrinsic value range of ₩724.1B to ₩769.3B. The implied margin of safety to this rather educated estimation is from 77.9% to 79.2%.

Even more notably, the company’s estimated ₩529.5B of net surplus assets alone exceed the entire market cap by approximately 3.3x, so investors are purchasing those assets at a 69.8% discount while assigning a deeply negative implied value to the profitable, #1 interior-construction business in South Korea.

The Case for Pessimism

Why Could the Market Be Right?

There are several reasons to why the market could be correctly discounting Kukbo.

First and foremost, as is the case with securities I cover, this discount could persist longer than many can remain solvent due to limited liquidity. The company is a microcap (market cap in USD is $116M) with an average daily trading volume of around $150k, and has no analyst coverage.

Businesses of this size frequently remain undervalued for extended periods regardless of operating performance.

Secondly, the business retains an extremely large investment portfolio, and management hasn’t given investors any sign of increased capital return. This is most definitely my biggest concern - management indefinitely hoarding cash & securities with no plan to distribute.

While the CEO maintains a substantial share ownership in the business, the salary compensation he receives provides an alternative and private way to extract wealth.

Rather than pursuing capital efficiency through distributions, the executive team is rewarded for maintaining substantial cash and financial assets, utilizing internal capital to keep their high salaries.

Furthermore, this capital retention exposes shareholders to severe reinvestment and market risk. An interior contractor is currently churning nearly ₩1T in financial assets in a single half-year period, basically operating a highly concentrated semiconductor and AI-infrastructure hedge fund on the side.

And the market is right to penalize this behavior. Every won hoarded is a won exposed to the volatile and, dare I say, speculative price levels of global tech stocks like Nvidia, Micron, and SK Hynix. If a cyclical downturn hits the semiconductor industry, a material portion of Kukbo’s ₩531.8B asset cushion could disappear before owners ever get a single distribution of excess capital.

Lastly, there is the now well known “Korea Discount”. Without an activist catalyst or a binding regulatory mandate, Kukbo can remain a capital hoarding company indefinitely.

All of the previous observations clearly justify a degree of caution and likely explain why the market applies a meaningful discount to the business.

Bear Scenarios

#1: Securities portfolio and operating business collapse

In this scenario, I assume their portfolio of junior issues falls a total of 70%, management sells everything at the bottom, and never recovers the lost value.

Simultaneously, the operating business completely collapses and is worth $0.

Under these outcomes, the liquid equity securities portfolio (Level 1), which accounted for ₩435.2B of the balance sheet, loses ₩304.6B in value. However, cash & short term investments, which account for ₩154.7B, remain intact in the bank.

The other financial assets are worth their previously estimated realizable value.

Thus, the remaining ₩130.6B of securities now assumed to be permanently converted to cash, with ₩152.3B of cash, short term investments and other surplus assets net of short-term borrowings and total lease liabilities, and an operating business worth zero, results in a total fair value of ₩282.9B.

This scenario implies a margin of safety of 43.4% (!!!).

#2: The perpetual value trap

This scenario is the most realistic, and probably the main reason Kukbo trades at such a discount.

Here, the operating business does not collapse; it remains consistently profitable, generating the baseline ₩26B in normalized owner earnings year after year. Similarly, the ₩531.8B net surplus asset portfolio suffers no material market drawdown. Instead, the failure is entirely institutional.

I assume that all pessimistic governance assumptions occur simultaneously: management completely ignores the South Korean “Corporate Value-Up Program,” refuses to implement any capital return policies, keeps the ordinary payout capped at a modest 5%, and chooses to hoard all future cash flows inside the balance sheet indefinitely.

Because minority shareholders can neither force a liquidation nor access the underlying assets, this capital remains trapped inside.

I think the first step for this scenario should be to apply a punitive value trap and governance discount ranging from 50% to 60% against the total intrinsic value (note that this is a reasonable proxy rather than an observable fact).

Applying a conservative 55% haircut to our previously established baseline intrinsic value range of ₩727.3B to ₩772.5B compresses the investable valuation down to a range of ₩327.3B to ₩347.6B.

Remarkably, this scenario still yields an implied margin of safety of 51.1% to 54%.

However, the security analyst must evaluate true performance of an investment with a total absence of a catalyst. While the mathematics prove the stock remains deeply undervalued even after this governance haircut, the reality is that without a catalyst, even if undated, to force a capital distribution, this valuation gap will take far longer to close than many can remain solvent and rational.

As a result, in this scenario the market price is highly likely to remain stagnant at the ₩160B level “indefinitely”.

This presents a unique risk profile for the common stockholder: fundamental downside but with almost zero true capital appreciation upside. The true expected investable return is therefore reduced to the modest 2% annual dividend yield.

Or is it?

The business is most definitely going to continue on growing and compounding intrinsic value for the foreseeable future. However, even if its at a modest rate, the market can still take a long time to price in this growth.

Therefore, the genuine risk in this scenario is not the permanent loss of capital, but opportunity cost. Capital remains in a stagnant asset earning returns below the cost of capital.

Conservative Liquidation Value

Liquidation value is generally not so useful for asset-light businesses, as most of its value comes from its earning power rather than asset value.

However, while this estimate usually serves as an extreme floor for deteriorating businesses - usually not for profitable going concerns - Kukbo has accumulated an exceptionally large portfolio of cash and securities, making its asset value the major component of intrinsic value.

Therefore, a conservative estimate of orderly liquidation value serves as a reasonable, absolute floor to valuation:

*Note: Securities are not stated at cost (book value) in this chart but rather at fair value.

The estimated liquidation value is ₩433.7B, implying a margin of safety of 63.1%.

Summarized reasons for the discounts:

• Cash is cash. Fully liquid.

• Short-term deposits: Bank deposits have minor early-withdrawal breakage.

• FVTPL current securities: Liquid listed stocks, accounting for brokerage fees and possible, normal trading price movement.

• Trade & other receivables: Clients often withhold on a vendor’s wind down.

• Contract assets: Unbilled revenue on in-progress projects, so a 45% discount seems appropriate.

• Inventory: They have no inventory.

• Loans & related receivables: Insignificant amounts.

• Other non-financial assets: These are prepayment receivables that have little resale value.

• Long-term deposits: Bank deposits with longer tenor.

• Long-term receivables: Retention receivables with higher uncertainty.

• Long-term loans & related receivables: Employee related loans.

• FVTPL non-current: Non-current assets valued using mark-to-model suffer major write downs during a liquidation.

• Investment in associates: Startup funds are very illiquid.

• PP&E: Mostly office fit outs & equipment, which have limited resale value.

• Intangible assets: The conservative treatment of intangible assets is to assume these are worth nothing in a liquidation.

• Investment property: This is all real estate (which is the most “hard asset” realizable item).

• Net defined benefit asset: This is a pension surplus, and extraction depends on plan termination rules.

• Deferred tax assets: If theres no income, there’s nothing to be recovered.

With the company currently trading at ₩160B, investors are purchasing the business at just 0.37x liquidation value.

Again, I don’t think the market is solely discounting the securities, but rather a combination of both uncertainty on such a large portfolio and the likelihood that management hoard these financial assets indefinitely.

The Case for Optimism

Why Could the Market Be Wrong? - Paths to Re-rating

As mentioned various times throughout the report, I don’t believe the market is completely ignoring the surplus assets and the business. Rather, it is applying a significant discount to the fact that they are:

1. Running a massive “hedge fund” worth more than the core business;

2. The securities portfolio is largely concentrated on AI companies;

3. And the unwillingness of management to do anything.

By now, you may be wondering why this constitutes the optimistic case.
Where’s all the optimism?

The main catalyst to unlocking value is South Korea’s “Corporate Value-Up” program, a mandate made to target asset-hoarding enterprises like Kukbo. This serves as the strongest driver for optimism, turning Kukbo from a value trap into a genuinely mispriced stock.

To finally put an end to the “Korea Discount,” the South Korean government has put out a series of punitive laws targeting asset-bloated companies, inspired after Japan’s TSE initiative.

First, while Value-Up disclosures remain voluntary across the KOSDAQ, regulators have designed the framework to pressure these kinds of balance sheets. With total assets sitting at ₩669.9B, Kukbo Design has a very high probability of being placed under institutional scrutiny and making it a primary candidate for compliance under the Value-Up benchmarks.

Second, the 2026 tax regime introduces incentives for capital efficiency, offering a better dividend tax treatment for shareholders and corporate tax credits for capital returns. It does not, however, solely compel Kukbo to distribute its surplus financial assets merely because its balance sheet is asset-heavy.

Third, proposed amendments to the Commercial Act are seeking to increasingly include the interests of all shareholders, rather than just the corporate entity. While this remains as an active legislative proposal, the policy trajectory still favors expanding shareholder protections and serves as a potential catalyst.

Importantly, the government has also proposed reductions in dividend income tax rates, capital gains tax adjustments, and reforms to the 60% effective inheritance tax rate.

This puts Kukbo, and many other Korean asset-hoarding companies, in a very interesting position. If the controlling family realizes that returning capital now yields higher post-tax wealth than holding trapped assets inside an increasingly penalized corporate shell, their private incentives finally align with minority shareholders.

An activist on the board is also quite possible, and would materially increase the speed and certainty at which value is realized.

Kukbo is a very attractive target for activist intervention. Activists no longer need to win outright proxy battles to drive structural change; rather, the combination of public campaigns, targeted shareholder proposals at the AGM, and regulatory alignment under the Value-Up program creates governance pressure on insiders.

Time also favours Kukbo. This is no declining or stagnant business; it has been growing revenue at a satisfactory CAGR of 10% for the past 20 years. So intrinsic value will most probably continue growing.

A fair conclusion is that the market is currently pricing in absolute management avoidance; any regulatory framework or activist that disrupts this avoidance will trigger a significant rerating.

The Verdict & Thesis

*This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk. Conduct your own due diligence!

Since inception in April 2026, the portfolio has returned 8.8%, compared with 8.2% for the S&P 500. The portfolio has broadly kept pace with the general market, despite the ongoing speculative valuations around AI companies.

I will not address the exact percentage of monthly outperformance or underperformance. Unless the difference is really attributable to something beyond short-term market movements, I do not think it is particularly meaningful to mention whether we outperformed or underperformed by a small amount in any given month.

This month, the Korean market has declined substantially. However, our Korean junior issues have remained largely uncorrelated, with some materially increasing in price. These holdings were added based on an extreme valuation disconnect, downside protection, and the additional characteristics of obscurity and illiquidity. Importantly, I also saw aligned management and evidence that value will eventually be unlocked, even if the timeline is undated. This, in my view, could offer one of the surest means of both principal protection and capital creation.

The relative attractiveness of the portfolio’s special situations is not particularly satisfactory. I’ve failed to identify sufficiently appealing opportunities compared with the core, general holdings, or to create reasonable diversification within said category of issues. While the search for these opportunities will continue, my research will now also be devoted to undervalued senior securities. I believe this offers a more promising hunting ground for attractive risk-adjusted returns, particularly where seniority provides meaningful downside protection.

However, only time can tell whether this shift in focus will prove more fruitful.

Holdings as of August 2026:

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Publishing here also encouraged me to write the kind of investment research I wanted to read myself: deep value opportunities no one covered, where the downside is extremely capped (usually prefer buying the cash and getting the business for free) and the business is shareholder friendly.

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A few newsletters I recommend

Many of the ideas and mental models that have shaped my own approach came from reading the work of others.

Of course, it mainly includes well known investors such as Warren Buffett, Charlie Munger, Ben Graham, and many more.

However, if you’re looking for thoughtful investment research beyond the writings of these well known investors, here are a few newsletters I regularly enjoy reading:

• - Hugo uncovers undercovered smallcaps, combining deep fundamental research with emphasis on catalysts, not just cheap valuations.

• - Specializes in buying healthy cash generative businesses trading at deep discounts to private market value, without chasing growth.

• - Focuses on overlooked European small, micro and nanocaps that institutional investors can’t own.

• - Concise write ups on deep value opportunities centered on tangible asset backing and downside protection.

• - Trying to identify high quality compounders in the small cap space (mainly), writing very dense and complete deep dives.

• - Applies expectations investing with evidence based decision making rather than relying on conventional multiples.

The added descriptions highlight the aspects of each publication that I personally find most valuable. None of these writers focuses exclusively on the themes mentioned above.

These are all publications I believe are well worth your time.

Revenue has declined since the 2022 merger, growth appears modest, and it’s a very illiquid security. To most, it looks like another overlooked microcap software business. And I wouldn’t blame you for thinking so.

Nevertheless, I believe that interpretation misses how the business actually works.

Beneath the surface there’s a highly recurring maintenance business embedded within the core infrastructure of Korean banks.

Once installed into the bank’s infrastructure, Inzisoft’s software becomes costly and risky to replace.

So the business is remarkably defensive and capital light that consistently generates cash while requiring very little reinvestment to maintain that base.

Over time, management has reinvested that cash into an increasingly valuable portfolio of mostly liquid financial assets.

Currently, the company owns substantially more cash and securities than its entire marketcap, which immediately reminded me of one of Buffett’s earliest and most successful investments: Sanborn Map.

It’s strikingly similar in some aspects.

In both cases, investors could purchase a company for substantially less than the value of its financial assets, effectively receiving the operating business for free (further comparison will be made in the final section).

However, I believe Inzisoft is an even better business (by a large margin).

When Buffett invested in Sanborn, the operating business had been deteriorating for years. Unlocking value required an activist and a restructuring.

Inzisoft is very different.

The operating business remains profitable, highly cash generative, with a growing base of recurring maintenance revenue.

Moreover, management is already behaving in favor of shareholders through rising dividends, repurchasing shares, and the proposed cancellation of nearly 20% of the company’s treasury shares.

So, how can a profitable, highly defensive software business with conservatively estimated net assets worth substantially more than its marketcap still trade at such a large discount?

After thorough research and a careful valuation, if my analysis is correct, the investor today is not just buying a software company at an attractive valuation, but also purchasing a growing and shareholder friendly business for less than the value of the most liquid assets sitting on its balance sheet.

Business Summary

Inzisoft is a South Korean software company that builds imaging and document automation software for the financial sector.

Its technologies are: optical character recognition and electronic form processing, which it packages into digital teller window systems, document or image management (ECM) systems, non-face-to-face identity-verification solutions, and robotic process automation (RPA).

In plain english, Inzisoft makes software that reads documents and handles digital paperwork, and it sells that as pre built tools for banks.

Its customers are almost entirely domestic banks, securities firms, and insurers, where the software is embedded into core business systems and then maintained under long-running service contracts.

The company was founded in 2000 and listed on KOSDAQ in 2010, operating under the name Mobile Leader until a September 2022 merger with the Inzisoft software business, after which it adopted the current name.

It’s led by CEO Jeong Jeong-gi (a former Samsung SDS executive who is also the largest shareholder, I’ll expand more on this in the following sections), and employs 142 people, which are all research and office staff with no contract workers.

Industry Background & Future

Inzisoft operates in the “packaged software” segment of the Korean IT market, specifically the financial vertical, selling document and image processing software to banks, insurers, and securities firms.

Growth Potential

*Interpreted from management’s own words.

The software industry holds important significance as a core platform of the knowledge and information society, as we live in a world where everyone and everything is now mainly connected by computers and the internet.

Moreover, as global economic volatility is putting pressure on South Korea’s more traditional, capital-heavy industries, the nation is shifting toward a more digital economy. And Inzisoft enables its clients’ businesses to move away from physical processes.

Furthermore, consumers are shifting from buying simple products to more digitized solutions and services. Software is the cornerstone of said change, allowing traditional businesses to increase operational efficiency and create new revenue streams.

Market Characteristics

In terms of market deployment, Inzisoft secures contracts in the financial sector in two ways:

• For large-scale projects, two to three major server overhauls per year continuously arise from large banks. Since these projects cover the entire bank's infrastructure, massive conglomerates secure the main contract, and Inzisoft acts as the subcontractor - selling and integrating its proprietary software into the broader system.

• For individual system orders, the company participates directly in bidding and wins business through price and technology competition.

Market Share

For the company’s non-face-to-face identity verification solution and image system, it maintains the top market share. They hold the number one market share across both major commercial banks and smaller tier-two financial institutions.

They also hold a top-tier share in the digital bank teller market. They won this business by leveraging their existing relationships, since their teller software connects perfectly with the image systems banks already bought from them.

In addition, the RPA market is still growing. While foreign companies occupy much of Korea’s market, Inzisoft is raising its share through new contracts.

Competitive Advantages

Inzisoft’s moat is primarily in the Korean financial sector imaging software business:

• As mentioned previously, according to company disclosures, the company holds the highest market share (according to company disclosures) across first and second-tier Korean financial institutions for its non-face-to-face identity verification and image systems, and a top-tier share in digital teller window systems.

• Financial imaging software has high entry barriers, and Inzisoft owns the technology they build rather than licensing it from others. That lowers costs and lets it adapt quickly to new technology, which is hard for a more general IT firm to replicate.

• Beyond the software, its engineers integrate these systems into banks’ infrastructure, thereby ensuring they also have the knowledge accumulated over two decades that competitors can’t easily replicate.

• Because its image systems are already embedded at major banks, its digital teller systems win partly on their ability to connect to that existing infrastructure.

• Their financial position might be one of the biggest, though underrated, competitive advantages. They maintain a 3% debt-to-equity ratio, a 7.2x current ratio, and an A- credit rating - all of which materially help fund R&D internally - while still maintaining a very consistent dividend.

Future Reliability

Once Inzisoft’s systems are embedded in a bank’s infrastructure, they generate maintenance revenue that is highly resilient to economic downturns (maintenance is basically recurring revenue), and they do not swing the way project revenue does.

Once Inzisoft's systems are embedded within a bank's infrastructure, replacing them takes substantial time and contains multiple risks.

Any replacement requires months of development, testing and regulatory approvals, while carrying significant operational risk. These switching costs makes it very hard for a bank to justify replacing proven systems, resulting in highly recurring maintenance revenue.

The annual reports clearly show it: in 2024 total revenue fell about 22% as project revenue dropped from ₩18.0B to ₩11.8B, yet maintenance revenue rose, and it has risen in every year on record, from ₩6.2B in 2023 to ₩7.1B in 2024 to ₩7.9B in 2025, growing at 13% a year since the merger.

The company has been consistently profitable, with positive operating income in each of the last three years, as well as nearly every year before the merger.

The project line seems to be breakeven at the gross level, whose real purpose is to win and refresh the installed base, and because the business needs almost no capital to run, that recurring revenue converts into cash.

So the fair characterisation is it’s a stable, highly cash generative business whose high-margin recurring portion is compounding at very satisfactory rates.

Analysing Management

Skin in the Game

Insider ownership consists mainly on one person, the CEO, with the Vice-President owning substantially less. The outside director and the statutory auditor hold none:

• Jeong Jeong-gi, the CEO and largest holder, sits at 34.66% (1,138,076 shares)

• Kang Gyeong-nam, the Vice-President, sits at 1.02% (33,545 shares)

• Outside director & auditor own nothing

Jeong was a professional tech expert working at Samsung SDS and became the controlling shareholder and CEO through the 2022 merger. The filings credit him with 25 years in the business.

They are also paid like owners, not a managers. Cash compensation is remarkably modest. The two inside directors (Jeong and Kang) shared ₩308M in total pay, or ₩154M each on average.

The CEO makes far more when the stock rises and pays a dividend than he does as an employee. This is actually an ideal owner alignment: his downside and upside are the shareholders’.

Integrity and Honesty

I’m assessing what’s observable, such as audit history, restatements, related party transparency, pay discipline, and whether they do what they say or not:

• very restrained pay: directors and the auditor drew about ₩332M against a ₩1.1B approved cap and pay actually fell YoY even though profits grew, so alignment with shareholders is strong;

• the accounts are pre-AGM so any change there would require a correction filing;

• they’ve stated the capital policy is centered around “maximizing shareholder interest”, and management followed through, raising the dividend to ₩3B and running a ₩1.5B buyback;

• but there is no audit committee (although none is required at this size, it’s the Korean microcap standard), just one part time auditor and an outside director, and no committees within the board.

On the observable evidence, management is definitively shareholder aligned, and nothing else seems to be out of the ordinary in terms of governance.

Capital Allocation and Shareholder Value

This is where it starts getting interesting.

The business is extremely capital-light: on a 3 year average basis, operating cash flow was ₩5B against capex of just ₩50M, and the balance sheet is effectively debt-free, with a total debt to equity ratio of bearly 5%.

On direct returns, as mentioned previously management is genuinely shareholder friendly, and increasingly so. In 2025 they raised the dividend 50%, to ₩3.0B, and ran a ₩1.5B buyback, roughly ₩4.5B returned in a single year, about a 10% shareholder yield without including debt repayment.

Capital allocation can be better judged by looking at the ₩74B investment portfolio. The operating business earns 35% pre-tax ROIC, which is far above any reasonable estimate of cost of capital.

However, reinvestment opportunities seem scarce relative to the sheer amount of cash they generate. If reinvestment opportunities don’t create value, the rational course of action would be to return most of the earnings back to shareholders.

Over the last three years the company generated about ₩14.7B of free cash flow and paid ₩14.4B to create value for shareholders: ₩6.0B in dividends, ₩4.0B in buybacks, ₩3.5B in lease payments. They basically paid out almost 100% of free cash flow.

So, if cash flows are being fully paid out, where did the ₩74B portfolio come from?

From roughly ₩23B around the time of the merger, the liquid pile grew to ₩33B in 2023, ₩38B in 2024, ₩55B in 2025, and ₩74B as of March 2026 (most recent filed quarter). Practically all of that growth is the portfolio’s own investment income. Realized proceeds never left, they were just reinvested into more securities.

Most of the recent surge in cash is due to the selling of K-Bank. They had been buying before it finally listed on 5 March 2026. Following the IPO, Inzisoft sold most of their position in K-Bank, and cash jumped from ₩0.8B to ₩14.4B.

Furthermore, until the middle of March, the 20.9% treasury shares had never been canceled, so they could reissue them whenever convenient.

Then came the AGM. Item 7 of the March convocation allocates just 75,700 treasury shares (2.3%) to settle employee stock grants through 2029, and states that the remaining 609,788 shares (18.57% of the entire company) are headed for “review-for-cancellation” within the period the amended Commercial Act prescribes.

In addition, directors’ duties are rewritten to run to the company and its shareholders, with a new obligation to protect and treat all shareholders’ interests fairly, and the old 50% cap on share cancellation is deleted.

Dividend record dates can now be set after the dividend is known, and a second ₩8B of share premium has been shifted into distributable reserves (₩16B of payout capacity), meaning legally that capital can be used to payout dividends and buybacks.

Important Risks

As South Korea doesn’t require companies to disclose their major risks in the annual or semi-annual reports, I’ll have to infer most of the risks myself from all publicly available information. The key risks include:

1. Investment portfolio market and price risk: marked-to-market book can fall, affecting the balance sheet and reported earnings.

2. Earnings quality risk: most recent reported profit is overwhelmingly investment gains, volatile and mostly non-operating.

3. Portfolio concentration & Level-3 valuation risk: a large single position in the securities portfolio can materially affect the balance sheet, and level 3 marked assets subject to judgment.

4. Business concentration in one vertical, one country, and with a finite customer base.

5. Flat or declining organic growth: the business maturing and project revenue shrinking are all a possibility while it remains a going concern.

6. Competitive and OCR commoditization risk: generative AI can erode the OCR moat.

7. Customer concentration: top client is around 15.5% of revenue. However, no other client represents more than 10% of revenue.

8. Project cyclicality, as project revenue is tied to banks’ cycles.

9. Governance & key person risk: controlling founder, and no outside directors.

10. Litigation (₩4.1B in claims, tied up ₩336M deposit) & venture credit risk.

11. R&D dependence on specialized engineers.

12. Disclosed financial risks (such as credit, liquidity, FX, and interest rate), are all minor. The company is essentially debt free, cash rich, essentially no FX, no floating rate debt.

Interpretation of Financial Statements

Financial Statements

You can skim through this. Useful for anyone willing to conduct additional due diligence in a short period of time or just curious of the financial statements.

Income Statement - Overview

Balance Sheet - Overview

Cash Flow Statement - Overview

Financial Metrics - Highlights

*Disclosures for maintenance and project revenue begun only after the 2022 merger. More detailed dissection between maintenance and project revenue is mentioned in the valuation section. The black line represented in some of the charts indicate the day of the merger. Returns on Equity, Assets, and the common ROIC will not be included, as these are highly distorted due to cash & securities and reported earnings biased due to securities being sold for cash.

10-Year Historical Margins:

These are blended margins between project revenue and maintenance revenue. The volatility of said margins are highly linked to the volatility of project revenue.

10-Year Historical Revenue:

Revenue includes both the project and maintenance segment. Most of the volatility in recent years is due to project revenue.

10-Year Free Cash Flow vs Dividends and Share Repurchases:

10-Year Total Common Equity & Cash and Securities:

Valuation

Estimating a fair, intrinsic value for Inzisoft requires a more complex approach than that of an average business, as it must be separated into three distinct valuation components:

• Maintenance revenue

• Project revenue

• The investment portfolio

To value the business accurately, maintenance and project revenue must first be converted into actual operating earnings, and then the sum of these converted into operating owner earnings.

Each of these revenue streams has costs which are not linear. Project revenue sustains much higher costs than maintenance requires.

Furthermore, the investment portfolio must not be taken at face value. It might require haircuts depending on illiquidity and other valuation risks.

Simplified, the value of a business to equity holders can be divided into two:

Value of the Operating Business

Normalized Operating Owner Earnings

The core operating business cannot be valued using a normal operating profit multiple. Doing so would be inaccurate.

Instead, this approach separates investments required to maintain current earning power from those intended to generate future growth.

In a normalized year, project revenue is approximately sufficient to cover its direct delivery costs, but not the operating expenses required to sustain the implementation business.

As a result, the project segment operates at an estimated operating loss after R&D and allocated overhead, while the recurring maintenance business generates substantially all normalized operating owner earnings.

To arrive to a reasonable normalized figure, the analysis starts with recurring maintenance revenue, as project revenue and cost of sales roughly offset each other in a normalized year.

Based on the most recent quarter, annualized maintenance revenue is approximately ₩8.4B. Deducting normalized SG&A (excluding R&D), using the 3-year average of ₩3.3B, results in normalized operating income of ₩5.1B.

The adjusted normalized operating income formula therefore is:

The reason I didn’t directly include R&D is the following:

For software businesses, maintenance investment is primarily driven by R&D rather than physical assets. A portion of annual R&D spending is required to maintain the existing software platform, deliver regulatory updates, fix bugs, and preserve the current earning power of the already installed customer base.

Only this maintenance portion of R&D should be deducted when estimating normalized operating owner earnings. The rest represents growth investment rather than a cost of sustaining the existing business.

Of course, they don’t disclose which portion of R&D is maintenance and which is for growth. Nevertheless, the filings state that R&D contains OCR, AI, RPA, cloud services, new solution development, and technical support for customer implementation.

This suggests that R&D is certainly not all maintenance. Given that maintenance revenue accounts for roughly 44% of total revenue, I conservatively allocate that 40% of total R&D represents maintenance investment required to sustain the existing installed base, while the remaining 60% is attributed to implementation activities and future growth. This is a reasonable proxy rather than an observable fact.

With the maintenance portion of R&D estimated, the remaining inputs required to derive normalized operating owner earnings can now be determined.

I assume that the average capital expenditure over the past three years represents maintenance CapEx in its entirety, as there are no indications that the company is making investments in property, plant and equipment for future growth.

Finally, because depreciation has not been deducted within the normalized operating income estimate, adding it back in full would result in an overstatement. Instead, only the tax shield for depreciation is added back after applying tax to the adjusted normalized operating income.

This produces an estimate of the normalized operating income generated by the recurring maintenance business before considering the ongoing investment required to sustain its earning power.

Therefore, normalized operating owner earnings are calculated as:

*The reason I didn’t include maintenance R&D inside adjusted normalized operating income is to better visualize the distinction between operating profit and maintenance investment.

The business requires no additional incremental WC to maintain competitive position and unit volume, so it’s excluded in its entirety. The resulting equation is as follows:

This results in a normalized operating owner earnings of roughly ₩3.5B. Again, this is not an exact figure to rely on, but rather a highly educated estimation, where the margin of safety is crucial to the final investment decision.

Intrinsic Value of the Operating Business

To finally value the operating business, I capitalize normalized operating owner earnings using a range of capitalization rates. The current 10-year South Korean government bond yield is approximately 4.3%, which is what I’ll use as the risk-free rate.

Rather than relying on one single capitalization rate, I apply a range of equity risk premiums.

Given Inzisoft’s small size and exposure to the Korean financial sector, a reasonable discount rate range is around 8% to 12%, which corresponds to equity risk premiums of roughly 4-8%.

While I generally assume no perpetual growth when valuing a business, I believe doing so would materially understate the value of Inzisoft, for all the reasons mentioned throughout the entire report.

Assuming the business suddenly stops growing in perpetuity would therefore be a clear understatement of true value. Accordingly, I incorporate a conservative 2% growth rate to the capitalization rate, so all ranges will be subtracted by 2%.

This results in the operating value of the business being roughly ₩35-58B.

Value of Net Non-Operating Assets

Inzisoft’s net non-operating assets consist of their total excess cash + short-term investments + securities portfolio + long-term investments (which include securities) - interest-bearing debt.

Of course, almost everything here can be directly found in the balance sheet:

• Total cash reserves are ₩14.4B

• Short-term investments are ₩21.7M

• Securities portfolio is valued at ₩59.7B

• Long-term investments are ₩6.7B

• Current portion of leases are ₩1.2B

• Long-term leases are ₩1.4B

However, there are 2 adjustments we must make to correctly estimate the value of net non-operating assets:

1. Roughly estimate excess cash, as it’s not typically disclosed as a standalone metric.

2. Haircut the securities portfolio based on liquidity, valuation uncertainty, and realization risk.

Fortunately, the filings and type of business provides enough information to conduct such due diligence.

Excess Cash Estimation

Estimating the operating liquidity buffer is rather simple for capital-light firms (keep in mind that estimating the required operating cash buffer is a very subjective practice, some analysts use different approaches and others don’t even estimate it).

For such business, a reasonable proxy would be around a month of total normalized operating expenses. I’ll use the past 3-year average as the normalized figure:

While OpEx has recently been declining, im not too sure if that’s a structural change. Thus I believe the appropriate course of action would be averaging instead of relying on a single year.

Using the three-year average, I estimate that Inzisoft requires approximately ₩1.5B of operating cash to comfortably fund its daily activities. Consequently, of the ₩14.4B reported in cash and cash equivalents, around ₩1.5B is treated as a required operating liquidity buffer, while the remaining ₩12.9B is excess cash available to shareholders.

Value of Non-Operating Assets

Although the securities portfolio is already reported at fair value, accounting fair value doesn’t equal realizable intrinsic value.

Fortunately, Inzisoft provides a surprisingly detailed breakdown of its financial assets by fair value. As of the date of this report, approximately 86% of the portfolio consists of Level 1 assets, 5.8% of Level 2 assets, and only 7.9% of Level 3 assets (which is an unusually high quality portfolio).

More importantly, the footnotes disclose all of these assets rather than merely the accounting type. Here’s the breakdown of haircuts applied to each non-operating asset:

Reasons for the applied haircuts:

• Cash: The most liquid asset. No discount applied.

• Listed stocks: Small haircut due to fees and bid-ask spread.

• ETFs: Slightly more liquid than listed stocks.

• Beneficial certificates: Still liquid, however there’s the possibility of tax liabilities upon liquidating or distributing these units.

• Capital contributions: These are subject to lock-up periods, so I require a marketability discount.

• Capital contributions at cost: Holding private assets at a historic cost implies they are unable to be properly marked to market. Far larger discount is required relative to normal capital contributions.

• Unlisted common shares: Discounted heavily for lack of marketability.

• Unlisted preferred shares: Discounted for lack of marketability, however it has been slightly less haircuted due to preferred rights.

• Unlisted equity carried at cost: The most illiquid asset on the list. Discounted far more than unlisted common and preferred shares.

The final estimated intrinsic value of non-operating assets is roughly ₩76.4B.

Final Value of Net Non-Operating Assets

Combining all of the adjustments produces the following estimate of net non-operating assets:

Although the balance sheet reports financial assets at fair value, this estimate is intentionally more conservative.

It reflects only the portion of cash that is truly excess to operational requirements, discounts less liquid investments to better approximate realizable value, and deducts all interest-bearing obligations.

As a result, the estimated ₩72.3B represents a reasonable approximation of the value of net assets not used in operations.

Intrinsic Value

Adding the estimated value of the operating business to net non-operating assets produces the following intrinsic value range:

• Operating value: ₩35-58B

• Net non-operating assets: ₩72.3B

• Total intrinsic value range: ₩107-130B

A material portion of its intrinsic value is supported by the adjusted securities portfolio.

The current market capitalization is ₩45B, against an intrinsic value range of ₩107-130B. The implied margin of safety to this rather educated estimation is 58%-65%.

Even more notably, the company’s estimated ₩72.3B of net non-operating assets alone exceed the entire marketcap by approximately 61%, so investors are purchasing those assets at a 38% discount while assigning a negative implied value to a profitable operating business.

The Case for Pessimism

For Inzisoft, I believe the downside can be analyzed in 3 severe cases:

1. The market may be correctly discounting the business.

2. The operating business deteriorates materially.

3. The company is liquidated tomorrow.

Why Could the Market Be Right?

There are several reasons why the market could continue discounting Inzisoft indefinitely.

One of the most evident reasons is liquidity. The company is a Korean nanocap (marketcap in USD is around $32M) with very low liquidity (average daily trading volume is just bearly $18k) and no analyst coverage.

Businesses of this size frequently remain undervalued for extended periods regardless of operating performance.

The operating business itself also has its fair share of risks. Revenue is concentrated in the Korean financial sector, project revenue is cyclical, customer concentration exists, and advances in AI could commoditize the OCR tech.

Finally, while management has demonstrated shareholder friendly behavior, shareholder value is still dependent on the investment portfolio. If these assets continue to be retained rather than distributed, investors may continue to apply a discount to the shares.

All of the previous observations clearly justify a degree of caution and likely explain why the market applies a meaningful discount to the business.

However, they do not appear sufficient to explain why the company trades substantially below the value of its conservatively estimated net non-operating assets and, as we’ll see in the following sections, below liquidation value.

A Scenario: Permanent Impairment

Suppose project revenue continues to decline, maintenance revenue eventually stagnates, competition intensifies, and the operating business loses its competitive position.

Under these assumptions, I assume the operating business is worth nothing.

Shareholders would therefore be left solely with the company’s adjusted net non-operating assets.

Even under this assumption, those assets are estimated at approximately ₩72.3B, compared with a current market capitalization of roughly ₩45B.

In other words, investors are purchasing the company’s financial assets at approximately a 38% discount, while assigning a negative implied value of roughly ₩27B to a business that has remained profitable, generates positive owner earnings and is consistently producing material free cash flow.

The only way Inzisoft is not undervalued but rather fairly priced is if:

1. The value of the adjusted securities portfolio drastically loses half of its value while the operating business becomes worthless.

2. Management retains excess cash and investments indefinitely while earning returns below the cost of capital, destroying shareholder value.

3. Management deploys the company’s cash and investment portfolio into value destructive acquisitions or investments instead of returning it through dividends, buybacks, or reinvestment at reasonable returns.

Based on all available evidence, these scenarios seem unlikely to materialize. Even under these assumptions, we would be paying fair price.

Conservative Liquidation Value

Liquidation value is generally not so useful for asset-light businesses, as most of its value comes from earnings power rather than asset value.

However, as we’ve seen throughout the report, Inzisoft is clearly not your typical software company. Alongside its software operations, it has accumulated an exceptionally large portfolio of cash and securities, making its asset value a meaningful component of intrinsic value.

Therefore, liquidation value would provide an absolute floor for valuation:

The ₩76.4B of cash and securities is the same figure used in the previous section to calculate non-operating assets.

Discounts to the remaining assets:

• Trade receivables are invoices already issued to customers for completed work. Therefore they’re assumed to recover at 80%.

• Other receivables receive a 90% recovery rate as they primarily consist of tax receivables, interest receivable, and other financial claims with relatively low collection risk.

• Contract assets include revenue recognized on projects that has not yet been invoiced. These assets are considerably less certain in a liquidation, so an 80% haircut seems reasonable.

• Property, plant and equipment are the most discounted asset by far, of course excluding intangibles. This is because it’s mainly constituted by ROU assets. Right-of-use assets are included within property, plant and equipment alongside the lease obligations. Given that Inzisoft is an asset-light software business and that lease liabilities and net PPE are almost identical, it is likely that a substantial portion of it consists of right-of-use assets, and also office equipment. Right-of-use assets have little or no recoverable value in liquidation, while office equipment and computers are typically not fully recovered, so a 95% haircut seems appropriate.

• Intangible assets and deferred tax assets are assigned no value in a liquidation scenario.

After applying these discounts, total gross recoverable assets are approximately ₩80.9B. Deducting ₩12.9B of total liabilities, results in a net liquidation value of approximately ₩68B.

With the company currently trading at ₩45B, investors are purchasing the business at only 0.66x liquidation value.

This means that, under highly conservative assumptions that assign virtually no value to Inzisoft’s software, recurring earnings power, or future growth, the company’s liquidation value alone exceed its current market value by approximately ₩23B.

This provides an unusually strong margin of safety, something I’ve rarely seen in public markets for such a company.

The Case for Optimism

Why Could the Market Be Wrong?

I believe the market is overlooking the way this business actually functions and how value is being created rather than destroyed.

The operating business remains consistently profitable, highly cash generative, and requires almost no capital to sustain itself.

Most importantly, recurring maintenance revenue has continued growing every year, even when project revenue declined due to how the business is being operated and structured. This has created a very reliable and stable way for cash generation.

At the same time, the balance sheet has become increasingly valuable. Since the 2022 merger, cash and financial assets have grown from roughly ₩23B to ₩76B, despite management returning almost all free cash flow to shareholders through dividends, buybacks, and lease payments.

I believe this combination is highly unusual.

The market appears to value Inzisoft primarily as a declining software business, while largely ignoring the fact that its adjusted net non-operating assets substantially exceed its entire market capitalization.

Of course, the first reasons to why the market could be rightly discounting the business is exactly the reasons why this discount could be irrational: liquidity.

While it’s a curse for institutions, the lack of liquidity is precisely what probably created this opportunity in the first place.

So we’ve got a profitable operating business, earning attractive returns on capital, trading for less than the conservative liquidation value of its net assets and far below any conservative intrinsic value estimate.

In addition, unlike the typical net-net, intrinsic value does not depend on a turnaround.

If the market continues ignoring the shares, management can simply continue operating the business, generating cash, investing excess capital, and returning funds to shareholders.

Realistic Paths to Rerating

There are multiple independent paths through which the gap between price and intrinsic value could eventually narrow.

The first is simply intrinsic value continuing to compound. If the share price remains unchanged while net assets continue growing, the discount becomes increasingly difficult to justify.

Capital allocation also provides an undated catalyst. As mentioned in the Business Summary section, over the last several years they have increased the dividend, repurchased shares, and have very recently proposed cancelling 18.6% of outstanding treasury shares.

This with the Korean Commercial Act (which “strengthen directors’ duties toward shareholders and increase flexibility to distribute capital”) could accelerate the market’s recognition of value.

Another possibility is simply the placing emphasis on the balance sheet. As the balance sheet continues growing (if they don’t pay a massive special dividend or buyback more shares), it becomes increasingly difficult to justify valuing the company solely as a “low growth” software business.

Another reason for rerating is simply institutional awareness. As intrinsic value compounds and shareholder friendly capital allocation continues, the probability of market recognition should increase.

Nonetheless, these outcomes aren’t strictly required individually.

Time may prove to be the most powerful catalyst.

And while we wait, we get paid a very satisfactory 6.7% annual dividend yield.

The Verdict & Thesis

*This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk. Conduct your own due diligence!

Since inception in April 2026, the portfolio has returned 7.9%, compared with 5.8% for the S&P 500. As expected, the portfolio has gradually shifted into Japanese and Korean markets. Relative to the last portfolio letter, it is highly probable this trend will continue. However, this shift has not developed quite as I originally anticipated. Going into the year, I expected Japan to represent the larger allocation, with Korea remaining a smaller part of the portfolio. After much more extensive research, my view has evolved.

While I continue to believe Japan offers a meaningful number of highly undervalued securities, I have found Korea to present a considerably broader opportunity set at even more absurd valuations. Nevertheless, I can’t predict how allocation will evolve from here. Capital will continue to follow value wherever it is most abundant, and only time will tell whether that results in a greater concentration in Japan, Korea, or elsewhere.

Holdings as of July 2026:

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But how did he amass such wealth before managing Berkshire?

Before the holding company, before the insurance float, he ran money out of a bedroom in Omaha for a handful of friends and relatives.

Seven limited partners. $105k. No office, no staff, and exactly one promise: he would not tell you where the market was going, because he had no idea, and neither did anyone else.

By the time he closed it, that $105k had become more than a $100M. He beat the market every one of those years, in up and down markets.

Then, at the top, he handed it all back and walked away. But not because he had to. Because he could no longer find enough cheap things to buy, and he refused to charge for pretending otherwise.

How he did it is not a secret. He wrote it down. Those letters are the closest thing we have to watching a great investor learn in real time, and starting out with similar amounts of capital as many reading.

The investor in these pages is not quite the one from that opening line. He is not yet buying wonderful businesses and holding on for dear life. He is a bargain hunter, chasing cheap, unglamorous, statistically obvious securities, in a very similar way as his mentor Ben Graham.

This is all of it. Every partnership letter, 1957 to 1970, curated for better readability but in his own words, arranged into a single continuous read.

Not another listicle of ten timeless Buffett quotes. The actual text, with some light commentary from me.

One note before you start: it’s long. Nearly 40k words, and around 3 hours of reading. I put the great majority of his letters in on purpose, because the entire point is to read him at the source.

But if you do not have the hours, read only the passages marked with an asterisk (*). Those are the core paragraphs. The rest is laid out in six parts, roughly in order, from the first letter to the last.

Drop in wherever you like, but read it start to finish at least once if you can.

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Part One: The Founding Voice (1957 to 1960)

1. The bear-market covenant

The design of the whole fourteen years, stated in year two, when he ran $303,726 out of his house. He tells his partners exactly which markets will make him look good and which will make him look ordinary.

In last year’s letter to partners, I said the following: My view of the general market level is that it is priced above intrinsic value. This view relates to blue-chip securities. This view, if accurate, carries with it the possibility of a substantial decline in all stock prices, both undervalued and otherwise.

In any event I think the probability is very slight that current market levels will be thought of as cheap five years from now. Even a full-scale bear market, however, should not hurt the market value of our work-outs substantially. If the general market were to return to an undervalued status our capital might be employed exclusively in general issues and perhaps some borrowed money would be used in this operation at that time.

Conversely, if the market should go considerably higher our policy will be to reduce our general issues as profits present themselves and increase the work-out portfolio. All of the above is not intended to imply that market analysis is foremost in my mind. Primary attention is given at all times to the detection of substantially undervalued securities.

The past year witnessed a moderate decline in stock prices. I stress the word “moderate” since casual reading of the press or conversing with those who have had only recent experience with stocks would tend to create an impression of a much greater decline. Actually, it appears to me that the decline in stock prices has been considerably less than the decline in corporate earning power under present business conditions.

This means that the public is still very bullish on blue chip stocks and the general economic picture.

I make no attempt to forecast either business or the stock market; the above is simply intended to dispel any notions that stocks have suffered any drastic decline or that the general market, is at a low level. I still consider the general market to be priced on the high side based on long term investment value.

The market decline has created greater opportunity among undervalued situations so that, generally, our portfolio is heavier in undervalued situations relative to work-outs than it was last year.

Perhaps an explanation of the term “work-out” is in order. 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.

At the end of 1956, we had a ratio of about 70-30 between general issues and work-outs. Now it is about 85-15. During the past year we have taken positions in two situations which have reached a size where we may expect to take some part in corporate decisions.

One of these positions accounts for between 10% and 20% of the portfolio of the various partnerships and the other accounts for about 5%. Both of these will probably take in the neighborhood of three to five years of work but they presently appear to have potential for a high average annual rate of return with a minimum of risk. While not in the classification of work-outs, they have very little dependence on the general action of the stock market. Should the general market have a substantial rise, of course, I would expect this section of our portfolio to lag behind the action of the market.

2. Wanting the stock to go nowhere

While he is buying, a rising price is a cost.

To some extent our better than average performance in 1957 was due to the fact that it was a generally poor year for most stocks.

Our performance, relatively, is likely to be better in a bear market than in a bull market so that deductions made from the above results should be tempered by the fact that it was the type of year when we should have done relatively well. In a year when the general market had a substantial advance I would be well satisfied to match the advance of the Averages.

I can definitely say that our portfolio represents better value at the end of 1957 than it did at the end of 1956. This is due to both generally lower prices and the fact that we have had more time to acquire the more substantially undervalued securities which can only be acquired with patience.

Earlier I mentioned our largest position which comprised 10% to 20% of the assets of the various partnerships. In time I plan to have this represent 20% of the assets of all partnerships but this cannot be hurried.

Obviously during any acquisition period, our primary interest is to have the stock do nothing or decline rather than advance. Therefore, at any given time, a fair proportion of our portfolio may be in the sterile stage. This policy, while requiring patience, should maximize long term profits.

I have tried to cover points which I felt might be of interest and disclose as much of our philosophy as may be imparted without talking of individual issues. If there are any questions concerning any phase of the operation, I would welcome hearing from you.

3. Commonwealth Trust*

The earliest Buffett documented investment, and one of the only explained generals. Chosen by him as a typical situation. A $50 bank against $125 of conservatively computed value, a blocked merger as the eventual key, and a negotiated exit at $80.

So that you may better understand our method of operation, I think it would be well to review a specific activity of 1958.

Last year I referred to our largest holding which comprised 10% to 20% of the assets of the various partnerships. I pointed out that it was to our interest to have this stock decline or remain relatively steady, so that we could acquire an even larger position and that for this reason such a security would probably hold back our comparative performance in a bull market.

This stock was the Commonwealth Trust Co. of Union City, New Jersey. At the time we started to purchase the stock, it had an intrinsic value $125 per share computed on a conservative basis. However, for good reasons, it paid no cash dividend at all despite earnings of about $10 per share which was largely responsible for a depressed price of about $50 per share.

So here we had a very well managed bank with substantial earnings power selling at a large discount from intrinsic value. Management was friendly to us as new stockholders and risk of any ultimate loss seemed minimal. Commonwealth was 25.5% owned by a larger bank (Commonwealth had assets of about $50 Million – about half the size of the First National in Omaha), which had desired a merger for many years. Such a merger was prevented for personal reasons, but there was evidence that this situation would not continue indefinitely.

Thus we had a combination of:

1. Very strong defensive characteristics;

2. Good solid value building up at a satisfactory pace and;

3. Evidence to the effect that eventually this value would be unlocked although it might be one year or ten years.

If the latter were true, the value would presumably have been built up to a considerably larger figure, say, $250 per share. Over a period of a year or so, we were successful in obtaining about 12% of the bank at a price averaging about $51 per share. Obviously it was definitely to our advantage to have the stock remain dormant in price.

Our block of stock increased in value as its size grew, particularly after we became the second largest stockholder with sufficient voting power to warrant consultation on any merger proposal. Commonwealth only had about 300 stockholders and probably averaged two trades or so per month, so you can understand why I say that the activity of the stock market generally had very little effect on the price movement of some of our holdings.

Unfortunately we did run into some competition on buying, which raised the price to about $65 where we were neither buyer nor seller. Very small buying orders can create price changes of this magnitude in an inactive stock, which explains the importance of not having any “Leakage” regarding our portfolio holdings. Late in the year we were successful in finding a special situation where we could become the largest holder at an attractive price, so we sold our block of Commonwealth obtaining $80 per share although the quoted market was about 20% lower at the time.

It is obvious that we could still be sitting with $50 stock patiently buying in dribs and drabs, and I would be quite happy with such a program although our performance relative to the market last year would have looked poor. The year when a situation such at Commonwealth results in a realized profit is, to a great extent, fortuitous. Thus, our performance for any single year has serious limitations as a basis for estimating long term results.

However, I believe that a program of investing in such undervalued well protected securities offers the surest means of long term profits in securities. I might mention that the buyer of the stock at $80 can expect to do quite well over the years. However, the relative undervaluation at $80 with an intrinsic value $135 is quite different from a price $50 with an intrinsic value of $125, and it seemed to me that our capital could better be employed in the situation which replaced it. This new situation is somewhat larger than Commonwealth and represents about 25% of the assets of the various partnerships.

While the degree of undervaluation is no greater than in many other securities we own (or even than some) we are the largest stockholder and this has substantial advantages many times in determining the length of time required to correct the undervaluation. In this particular holding we are virtually assured of a performance better than that of the Dow-Jones for the period we hold it.

4. Creating his own work-outs

One paragraph, and the next decade of his career is announced in it.

The higher the level of the market, the fewer the undervalued securities and I am finding some difficulty in securing an adequate number of attractive investments. I would prefer to increase the percentage of our assets in work-outs, but these are very difficult to find on the right terms. To the extent possible, therefore, I am attempting to create my own work-outs by acquiring large positions in several undervalued securities. Such a policy should lead to the fulfillment of my earlier forecast – an above average performance in a bear market. It is on this basis that I hope to be judged. If you have any questions, feel free to ask them.

5. The New Era warning

1959: the Dow is roaring, the biggest closed-end fund in America is bewildered, and a twenty-nine-year-old states the stance he will still be holding in 1999.

The Dow-Jones Industrial Average, undoubtedly the most widely used index of stock market behavior, presented a somewhat faulty picture in 1959. This index recorded an advance from 583 to 679, or 16.4% for the year. When the dividends which would have been received through ownership of the average are added, an overall gain of 19.9% indicated for 1959.

Despite this indication of a robust market, more stocks declined than advanced on the New York Stock Exchange during the year by a margin of 710 to 628. Both the Dow-Jones Railroad Average and Utility Average registered declines. Most investment trusts had a difficult time in comparison with the Industrial Average. Tri-Continental Corp. the nation’s largest closed-end investment company (total asset $400 million) had an overall gain of about 5.7% for the year.

Fred Brown, its President, had this to say about the 1959 marked in a recent speech to the Analysts Society: “But, even though we like the portfolio, the market performance of Tri-Continental’s holdings in 1959 was disappointing to us. Markets in which investor sentiment and enthusiasm play so large a part as those of 1959, are difficult for investment managers trained in values and tuned to investing for the long-term.

Perhaps we haven’t had our space boots adjusted properly. However, we believe that there is a limit to risks that an investing institution such as Tri-Continental should take with its stockholders’ money, and we believe that the portfolio is in shape for the year ahead.” Massachusetts Investors Trust, the country’s largest mutual fund with assets of $1.5 billion showed an overall gain of about 9% for the year. Most of you know I have been very apprehensive about general stock market levels for several years.

To date, this caution has been unnecessary. By previous standards, the present level of “blue chip” security prices contains a substantial speculative component with a corresponding risk of loss. Perhaps other standards of valuation are evolving which will permanently replace the old standard.

I don’t think so.

I may very well be wrong; however, I would rather sustain the penalties resulting from over-conservatism than face the consequences of error, perhaps with permanent capital loss, resulting from the adoption of a “New Era” philosophy where trees really do grow to the sky.

6. “Beating par”

Results only mean anything against the course being played.

A year ago, I commented on the somewhat faulty picture presented in 1959 by the Dow-Jones Industrial Average which had advanced from 583 to 679, or 16.4%. Although practically all investment companies showed gains for that year, less than 10% of them were able to match or better the record of the Industrial Average. The Dow-Jones Utility Average had a small decline and the Railroad Average recorded a substantial one. In 1960, the picture was reversed. The Industrial Average declined from 679 to 616, or 9.3%. Adding back the dividends which would have been received through ownership of the Average still left it with an overall loss of 6.3%.

On the other hand, the Utility Average showed a good gain and, while all the results are not now available, my guess is that about 90% of all investment companies outperformed the Industrial Average. The majority of investment companies appear to have ended the year with overall results in the range of plus or minus 5%. On the New York Stock Exchange, 653 common stocks registered losses for the year while 404 showed gains.

7. Sanborn Map*

His first published control operation, and still one of the best case studies ever written: a monopoly in decline, a hidden portfolio, a board of nine insurance executives owning 46 shares among them, and an exit that left every stockholder better off.

Last year mention was made of an investment which accounted for a very high and unusual proportion (35%) of our net assets along with the comment that I had some hope this investment would be concluded in 1960. This hope materialized. The history of an investment of this magnitude may be of interest to you.

Sanborn Map Co. is engaged in the publication and continuous revision of extremely detailed maps of all cities of the United States. For example, the volumes mapping Omaha would weigh perhaps fifty pounds and provide minute details on each structure. The map would be revised by the paste-over method showing new construction, changed occupancy, new fire protection facilities, changed structural materials, etc. These revisions would be done approximately annually and a new map would be published every twenty or thirty years when further pasteovers became impractical.

The cost of keeping the map revised to an Omaha customer would run around $100 per year. This detailed information showing diameter of water mains underlying streets, location of fire hydrants, composition of roof, etc., was primarily of use to fire insurance companies. Their underwriting departments, located in a central office, could evaluate business by agents nationally. The theory was that a picture was worth a thousand words and such evaluation would decide whether the risk was properly rated, the degree of conflagration exposure in an area, advisable reinsurance procedure, etc. The bulk of Sanborn’s business was done with about thirty insurance companies although maps were also sold to customers outside the insurance industry such as public utilities, mortgage companies, and taxing authorities.

For seventy-five years the business operated in a more or less monopolistic manner, with profits realized in every year accompanied by almost complete immunity to recession and lack of need for any sales effort. In the earlier years of the business, the insurance industry became fearful that Sanborn’s profits would become too great and placed a number of prominent insurance men on Sanborn’s board of directors to act in a watch-dog capacity. In the early 1950’s a competitive method of under-writing known as “carding” made inroads on Sanborn’s business and after-tax profits of the map business fell from an average annual level of over $500,000 in the late 1930’s to under $100,000 in 1958 and 1959. Considering the upward bias in the economy during this period, this amounted to an almost complete elimination of what had been sizable, stable earning power.

However, during the early 1930’s Sanborn had begun to accumulate an investment portfolio. There were no capital requirements to the business so that any retained earnings could be devoted to this project. Over a period of time, about $2.5 million was invested, roughly half in bonds and half in stocks. Thus, in the last decade particularly, the investment portfolio blossomed while the operating map business wilted.

Let me give you some idea of the extreme divergence of these two factors. In 1938 when the Dow-Jones Industrial Average was in the 100-120 range, Sanborn sold at $110 per share. In 1958 with the Average in the 550 area, Sanborn sold at $45 per share. Yet during that same period the value of the Sanborn investment portfolio increased from about $20 per share to $65 per share. This means, in effect, that the buyer of Sanborn stock in 1938 was placing a positive valuation of $90 per share on the map business ($110 less the $20 value of the investments unrelated to the map business) in a year of depressed business and stock market conditions. In the tremendously more vigorous climate of 1958 the same map business was evaluated at a minus $20 with the buyer of the stock unwilling to pay more than 70 cents on the dollar for the investment portfolio with the map business thrown in for nothing.

How could this come about? Sanborn in 1958 as well as 1938 possessed a wealth of information of substantial value to the insurance industry. To reproduce the detailed information they had gathered over the years would have cost tens of millions of dollars. Despite “carding” over $500 million of fire premiums were underwritten by “mapping” companies. However, the means of selling and packaging Sanborn’s product, information had remained unchanged throughout the year and finally this inertia was reflected in the earnings.

The very fact that the investment portfolio had done so well served to minimize in the eyes of most directors the need for rejuvenation of the map business. Sanborn had a sales volume of about $2 million per year and owned about $7 million worth of marketable securities. The income from the investment portfolio was substantial, the business had no possible financial worries, the insurance companies were satisfied with the price paid for maps, and the stockholders still received dividends. However, these dividends were cut five times in eight years although I could never find any record of suggestions pertaining to cutting salaries or director’s and committee fees.

Prior to my entry on the Board, of the fourteen directors, nine were prominent men from the insurance industry who combined held 46 shares of stock out of 105,000 shares outstanding. Despite their top positions with very large companies which would suggest the financial wherewithal to make at least a modest commitment, the largest holding in this group was ten shares. In several cases, the insurance companies these men ran owned small blocks of stock but these were token investments in relation to the portfolios in which they were held.

For the past decade the insurance companies had been only sellers in any transactions involving Sanborn stock. The tenth director was the company attorney, who held ten shares. The eleventh was a banker with ten shares who recognized the problems of the company, actively pointed them out, and later added to his holdings. The next two directors were the top officers of Sanborn who owned about 300 shares combined. The officers were capable, aware of the problems of the business, but kept in a subservient role by the Board of Directors.

The final member of our cast was a son of a deceased president of Sanborn. The widow owned about 15,000 shares of stock. In late 1958, the son, unhappy with the trend of the business, demanded the top position in the company, was turned down, and submitted his resignation, which was accepted. Shortly thereafter we made a bid to his mother for her block of stock, which was accepted. At the time there were two other large holdings, one of about 10,000 shares (dispersed among customers of a brokerage firm) and one of about 8,000. These people were quite unhappy with the situation and desired a separation of the investment portfolio from the map business, as did we.

Subsequently our holdings (including associates) were increased through open market purchases to about 24,000 shares and the total represented by the three groups increased to 46,000 shares. We hoped to separate the two businesses, realize the fair value of the investment portfolio and work to re-establish the earning power of the map business. There appeared to be a real opportunity to multiply map profits through utilization of Sanborn’s wealth of raw material in conjunction with electronic means of converting this data to the most usable form for the customer.

There was considerable opposition on the Board to change of any type, particularly when initiated by an outsider, although management was in complete accord with our plan and a similar plan had been recommended by Booz, Allen & Hamilton (Management Experts). To avoid a proxy fight (which very probably would not have been forthcoming and which we would have been certain of winning) and to avoid time delay with a large portion of Sanborn’s money tied up in blue-chip stocks which I didn’t care for at current prices, a plan was evolved taking out all stockholders at fair value who wanted out. The SEC ruled favorably on the fairness of the plan. About 72% of the Sanborn stock, involving 50% of the 1,600 stockholders, was exchanged for portfolio securities at fair value. The map business was left with over $1.25 million in government and municipal bonds as a reserve fund, and a potential corporate capital gains tax of over $1 million was eliminated. The remaining stockholders were left with a slightly improved asset value, substantially higher earnings per share, and an increased dividend rate.

Necessarily, the above little melodrama is a very abbreviated description of this investment operation. However, it does point up the necessity for secrecy regarding our portfolio operations as well as the futility of measuring our results over a short span of time such as a year. Such control situations may occur very infrequently. Our bread-and-butter business is buying undervalued securities and selling when the undervaluation is corrected along with investment in special situations where the profit is dependent on corporate rather than market action. To the extent that partnership funds continue to grow, it is possible that more opportunities will be available in “control situations.” The auditors should be mailing your financial statement and tax information within about a week. If you have any questions at all regarding either their report or this letter, be sure to let me know.

Part Two: The Constitution (1961 to 1963)

8. The deal terms

The alignment architecture, in his own dry prose: a 6 percent hurdle, a quarter of the excess, deficiencies carried forward, and his family’s entire net worth riding inside.

In the past, partners have commented that a once-a-year letter was “a long time between drinks,” and that a semi-annual letter would be a good idea. It really shouldn’t be too difficult to find something to say twice a year; at least it isn’t this year. Hence, this letter which will be continued in future years. During the first half of 1961, the overall gain of the Dow-Jones Industrial Average was about 13%, including dividends. Although this is the type of period when we should have the most difficulty in exceeding this standard, all partnerships that operated throughout the six months did moderately better then the Average.

Partnerships formed during 1961 either equaled or exceeded results of the Average from the time of formation, depending primarily on how long they were in operation. Let me, however, emphasize two points. First, one year is far too short a period to form any kind of an opinion as to investment performance, and measurements based upon six months become even more unreliable. One factor that has caused some reluctance on my part to write semi-annual letters is the fear that partners may begin to think in terms of short-term performance which can be most misleading.

My own thinking is much more geared to five year performance, preferably with tests of relative results in both strong and weak markets. The second point I want everyone to understand is that if we continue in a market which advances at the pace of the first half of 1961, not only do I doubt that we will continue to exceed the results of the DJIA, but it is very likely that our performance will fall behind the Average. Our holdings, which I always believe to be on the conservative side compared to general portfolios, tend to grow more conservative as the general market level rises. At all times, I attempt to have a portion of our portfolio in securities as least partially insulated from the behavior of the market, and this portion should increase as the market rises.

Progress has been made toward combining all partners at yearend. I have talked with all partners joining during this past year or so about this goal, and have also gone over the plans with representative partners of all earlier partnerships. Some of the provisions will be: A merger of all partnerships, based on market value at yearend, with provisions for proper allocation among partners of future tax liability due to unrealized gains at yearend. The merger itself will be taxfree, and will result in no acceleration of realization of profits; A division of profits between the limited partners and general partner, with the first 6% per year to partners based upon beginning capital at market, and any excess divided one-fourth to the general partner and three-fourths to all partners proportional to their capital.

Any deficiencies in earnings below the 6% would be carried forward against future earnings, but would not be carried back. In the event of losses, there will be no carry back against amounts previously credited to me as general partner. Although there will be a carry-forward against future excess earnings. However, my wife and I will have the largest single investment in the new partnership, probably about one-sixth of total partnership assets, and thereby a greater dollar stake in losses than any other partner of family group, I am inserting a provision in the partnership agreement which will prohibit the purchase by me or my family of any marketable securities.

In other words, the new partnership will represent my entire investment operation in marketable securities, so that my results will have to be directly proportional to yours, subject to the advantage I obtain if we do better than 6%; A provision for monthly payments at the rate of 6% yearly, based on beginning of the year capital valued at market. Partners not wishing to withdraw money currently can have this credited back to them automatically as an advance payment, drawing 6%, to purchase an additional equity interest in the partnership at yearend. This will solve one stumbling block that has heretofore existed in the path of consolidation, since many partners desire regular withdrawals and others wish to plow everything back; The right to borrow during the year, up to 20% of the value of your partnership interest, at 6%, such loans to be liquidated at yearend or earlier.

This will add a degree of liquidity to an investment which can now only be disposed of at yearend. It is not intended that anything but relatively permanent funds be invested in the partnership, and we have no desire to turn it into a bank. Rather, I expect this to be a relatively unused provision, which is available when something unexpected turns up and a wait until yearend to liquidate part of all of a partner’s interest would cause hardship; An arrangement whereby any relatively small tax adjustment, made in later years on the partnership’s return will be assessed directly to me. This way, we will not be faced with the problem of asking eighty people, or more, to amend their earlier return over some small matter. To prevent this, any change amounting to less than $1,000 of tax will be charged directly to me.

9. A Word About Par*

The most important section he ever wrote about the manager & client relationship.

The outstanding item of importance in my selection of partners, as well as in my subsequent relations with them, has been the determination that we use the same yardstick. If my performance is poor, I expect partners to withdraw, and indeed, I should look for a new source of investment for my own funds. If performance is good, I am assured of doing splendidly, a state of affairs to which I am sure I can adjust.

The rub, then, is in being sure that we all have the same ideas of what is good and what is poor. I believe in establishing yardsticks prior to the act; retrospectively, almost anything can be made to look good in relation to something or other. I have continuously used the Dow-Jones Industrial Average as our measure of par. It is my feeling that three years is a very minimal test of performance, and the best test consists of a period at least that long where the terminal level of the Dow is reasonably close to the initial level.

While the Dow is not perfect (nor is anything else) as a measure of performance, it has the advantage of being widely known, has a long period of continuity, and reflects with reasonable accuracy the experience of investors generally with the market. I have no objection to any other method of measurement of general market performance being used, such as other stock market averages, leading diversified mutual stock funds, bank common trust funds, etc. You may feel I have established an unduly short yardstick in that it perhaps appears quite simple to do better than an unmanaged index of 30 leading common stocks. Actually, this index has generally proven to be a reasonably tough competitor. Arthur Wiesenberger’s classic book on investment companies lists performance for the 15 years 1946-60, for all leading mutual funds.

There is presently over $20 billion invested in mutual funds, so the experience of these funds represents, collectively, the experience of many million investors. My own belief, though the figures are not obtainable, is that portfolios of most leading investment counsel organizations and bank trust departments have achieved results similar to these mutual funds. Wiesenberger lists 70 funds in his “Charts & Statistics” with continuous records since 1946. I have excluded 32 of these funds for various reasons since they were balanced funds (therefore not participating fully in the general market rise), specialized industry funds, etc. Of the 32 excluded because I felt a comparison would not be fair, 31 did poorer than the Dow, so they were certainly not excluded to slant the conclusions below.

10. The three categories*

Generals, work-outs, controls: the all-weather machine drawn out for the first time, including the two-strings logic by which a sleeping general becomes a control.

Our avenues of investment break down into three categories. These categories have different behavior characteristics, and the way our money is divided among them will have an important effect on our results, relative to the Dow in any given year. The actual percentage division among categories is to some degree planned, but to a great extent, accidental, based upon availability factors.

• The first section consists of generally undervalued securities (hereinafter called “generals”) where we have nothing to say about corporate policies and no timetable as to when the undervaluation may correct itself. Over the years, this has been our largest category of investment, and more money has been made here than in either of the other categories. We usually have fairly large positions (5% to 10% of our total assets) in each of five or six generals, with smaller positions in another ten or fifteen. Sometimes these work out very fast; many times they take years. It is difficult at the time of purchase to know any specific reason why they should appreciate in price. However, because of this lack of glamour or anything pending which might create immediate favorable market action, they are available at very cheap prices. A lot of value can be obtained for the price paid. This substantial excess of value creates a comfortable margin of safety in each transaction. This individual margin of safety, coupled with a diversity of commitments creates a most attractive package of safety and appreciation potential. Over the years our timing of purchases has been considerably better than our timing of sales. We do not go into these generals with the idea of getting the last nickel, but are usually quite content selling out at some intermediate level between our purchase price and what we regard as fair value to a private owner. The generals tend to behave market-wise very much in sympathy with the Dow. Just because something is cheap does not mean it is not going to go down. During abrupt downward movements in the market, this segment may very well go down percentage-wise just as much as the Dow. Over a period of years, I believe the generals will outperform the Dow, and during sharply advancing years like 1961, this is the section of our portfolio that turns in the best results. It is, of course, also the most vulnerable in a declining market.

• Our second category consists of “work-outs.” These are securities whose financial results depend on corporate action rather than supply and demand factors created by buyers and sellers of securities. In other words, they are securities with a timetable where we can predict, within reasonable error limits, when we will get how much and what might upset the applecart. Corporate events such as mergers, liquidations, reorganizations, spin-offs, etc., lead to work-outs. An important source in recent years has been sell-outs by oil producers to major integrated oil companies. This category will produce reasonably stable earnings from year to year, to a large extent irrespective of the course of the Dow. Obviously, if we operate throughout a year with a large portion of our portfolio in workouts, we will look extremely good if it turns out to be a declining year for the Dow or quite bad if it is a strongly advancing year. Over the years, work-outs have provided our second largest category. At any given time, we may be in ten to fifteen of these; some just beginning and others in the late stage of their development. I believe in using borrowed money to offset a portion of our work-out portfolio since there is a high degree of safety in this category in terms of both eventual results and intermediate market behavior. Results, excluding the benefits derived from the use of borrowed money, usually fall in the 10% to 20% range. My self-imposed limit regarding borrowing is 25% of partnership net worth. Oftentimes we owe no money and when we do borrow, it is only as an offset against work-outs.

• The final category is “control” situations where we either control the company or take a very large position and attempt to influence policies of the company. Such operations should definitely be measured on the basis of several years. In a given year, they may produce nothing as it is usually to our advantage to have the stock be stagnant market-wise for a long period while we are acquiring it. These situations, too, have relatively little in common with the behavior of the Dow. Sometimes, of course, we buy into a general with the thought in mind that it might develop into a control situation. If the price remains low enough for a long period, this might very well happen. If it moves up before we have a substantial percentage of the company’s stock, we sell at higher levels and complete a successful general operation. We are presently acquiring stock in what may turn out to be control situations several years hence.

11. The Question of Conservatism*

You are not right because people agree with you. The epistemology of the entire operation, in a page.

The above description of our various areas of operation may provide some clues as to how conservatively our portfolio is invested. Many people some years back thought they were behaving in the most conservative manner by purchasing medium or long-term municipal or government bonds. This policy has produced substantial market depreciation in many cases, and most certainly has failed to maintain or increase real buying power. Conscious, perhaps overly conscious, of inflation, many people now feel that they are behaving in a conservative manner by buying blue chip securities almost regardless of price-earnings ratios, dividend yields, etc. Without the benefit of hindsight as ill the bond example, I feel this course of action is fraught with danger. There is nothing at all conservative, in my opinion, about speculating as to just how high a multiplier a greedy and capricious public will put on earnings. You will not be right simply because a large number of people momentarily agree with you. You will not be right simply because important people agree with you. In many quarters the simultaneous occurrence of the two above factors is enough to make a course of action meet the test of conservatism.

You will be right, over the course of many transactions, if your hypotheses are correct, your facts are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason. I might add that in no way does the fact that our portfolio is not conventional prove that we are more conservative or less conservative than standard methods of investing. This can only be determined by examining the methods or examining the results. I feel the most objective test as to just how conservative our manner of investing is arises through evaluation of performance in down markets. Preferably these should involve a substantial decline in the Dow. Our performance in the rather mild declines of 1957 and 1960 would confirm my hypothesis that we invest in an extremely conservative manner. I would welcome any partner’s suggesting objective tests as to conservatism to see how we stack up. We have never suffered a realized loss of more than 0.5% of 1% of total net assets, and our ratio of total dollars of realized gains to total realized losses is something like 100 to 1. Of course; this reflects the fact that on balance we have been operating in an up market. However, there have been many opportunities for loss transactions even in markets such as these (you may have found out about a few of these yourselves) so I think the above facts have some significance.

12. And a Prediction

The only forecast he allows himself: a structural one, with error bars, including the guess that a 35 to 40 percent Dow decline is coming sometime in the decade.

Regular readers (I may be flattering myself) will feel I have left the tracks when I start talking about predictions. This is one thing from which I have always shied away and I still do in the normal sense. I am certainly not going to predict what general business or the stock market are going to do in the next year or two since I don’t have the faintest idea. I think you can be quite sure that over the next ten years there are going to be a few years when the general market is plus 20% or 25%, a few when it is minus on the same order, and a majority when it is in between. I haven’t any notion as to the sequence in which these will occur, nor do I think it is of any great importance for the long-term investor.

Over any long period of years, I think it likely that the Dow will probably produce something like 5% to 7% per year compounded from a combination of dividends and market value gain. Despite the experience of recent years, anyone expecting substantially better than that from the general market probably faces disappointment. Our job is to pile up yearly advantages over the performance of the Dow without worrying too much about whether the absolute results in a given year are a plus or a minus. I would consider a year in which we were down 15% and the Dow declined 25% to be much superior to a year when both the partnership and the Dow advanced 20%. I have stressed this point in talking with partners and have watched them nod their heads with varying degrees of enthusiasm. It is most important to me that you fully understand my reasoning in this regard and agree with me not only in your cerebral regions, but also down in the pit of your stomach. For the reasons outlined in my method of operation, our best years relative to the Dow are likely to be in declining or static markets.

Therefore, the advantage we seek will probably come in sharply varying amounts. There are bound to be years when we are surpassed by the Dow, but if over a long period we can average ten percentage points per year better than it, I will feel the results have been satisfactory. Specifically, if the market should be down 35% or 40% in a year (and I feel this has a high probability of occurring one year in the next ten--no one knows which one), we should be down only 15% or 20%. If it is more or less unchanged during the year, we would hope to be up about ten percentage points. If it is up 20% or more, we would struggle to be up as much. The consequence of performance such as this over a period of years would mean that if the Dow produces a 5% to 7% per year overall gain compounded, I would hope our results might be 15% to 17% per year. The above expectations may sound somewhat rash, and there is no question but that they may appear very much so when viewed from the vantage point of 1965 or 1970. It may turn out that I am completely wrong. However, I feel the partners are certainly entitled to know what I am thinking in this regard even though the nature of the business is such as to introduce a high probability of error in such expectations. In anyone year, the variations may be quite substantial. This happened in 1961, but fortunately the variation was on the pleasant side. They won’t all be!

13. Eating his own words

Six months later the market collapses, and he opens the mid-1962 letter by reprinting that entire prediction section (reproduced just above) before reporting the first-half result.

Between yearend 1961 and June 30, 1962 the Dow declined from 731.14 to 561.28. If one had owned the Dow during this period, dividends of approximately $11.00 would have been received so that overall a loss of 21.7% would have been the result of investing in the Dow. For the statistical minded, Appendix A gives the results of the Dow by years since formation of the predecessor partnerships. As stated above, a declining Dow gives us our chance to shine and pile up the percentage advantages which, coupled with only an average performance during advancing markets, will give us quite satisfactory long-term results. Our target is an approximately 1/2% decline for each 1% decline in the Dow and if achieved, means we have a considerably more conservative vehicle for investment in stocks than practically any alternative.

As outlined in Appendix B, showing combined predecessor partnership results, during the first half of 1962 we had one of the best periods in our history, achieving a minus 7.5% result before payments to partners, compared to the minus 21.7% overall result on the Dow. This 14.2 percentage points advantage can be expected to widen during the second half if the decline in the general market continues, but will probably narrow should the market turn upward. Please keep in mind my continuing admonition that six-months’ or even one-year’s results are not to be taken too seriously. Short periods of measurement exaggerate chance fluctuations in performance. While circumstances contributed to an unusually good first half, there are bound to be periods when we do relatively poorly. The figures for our performance involve no change in the valuation of our controlling interest in Dempster Mill Manufacturing Company, although developments in recent months point toward a probable higher realization.

14. The Ground Rules*

Warren Buffett’s ground rules, one of the most important sections I’ll be outlining. By the way, he made partners re-read this every year.

Some partners have confessed (that’s the proper word) that they sometimes find it difficult to wade through my entire annual letter. Since I seem to be getting more long-winded each year, I have decided to emphasize certain axioms on the first pages. Everyone should be entirely clear on these points. To most of you this material will seem unduly repetitious, but I would rather have nine partners out of ten mildly bored than have one out of ten with any basic misconceptions.

1. In no sense is any rate of return guaranteed to partners. Partners who withdraw one-half of 1% monthly are doing just that--withdrawing. If we earn more than 6% per annum over a period of years, the withdrawals will be covered by earnings and the principal will increase. If we don’t earn 6%, the monthly payments are partially or wholly a return of capital.

2. Any year in which we fail to achieve at least a plus 6% performance will be followed by a year when partners receiving monthly payments will find those payments lowered.

3. Whenever we talk of yearly gains or losses, we are talking about market values; that is, how we stand with assets valued at market at yearend against how we stood on the same basis at the beginning of the year. This may bear very little relationship to the realized results for tax purposes in a given year.

4. Whether we do a good job or a poor job is not to be measured by whether we are plus or minus for the year. It is instead to be measured against the general experience in securities as measured by the Dow-Jones Industrial Average, leading investment companies, etc. If our record is better than that of these yardsticks, we consider it a good year whether we are plus or minus. If we do poorer, we deserve the tomatoes.

5. While I much prefer a five-year test, I feel three years is an absolute minimum for judging performance. It is a certainty that we will have years when the partnership performance is poorer, perhaps substantially so, than the Dow. If any three-year or longer period produces poor results, we all should start looking around for other places to have our money. An exception to the latter statement would be three years covering a speculative explosion in a bull market.

6. I am not in the business of predicting general stock market or business fluctuations. If you think I can do this, or think it is essential to an investment program, you should not be in the partnership.

7. I cannot promise results to partners. What I can and do promise is that: a. Our investments will be chosen on the basis of value, not popularity; b. That we will attempt to bring risk of permanent capital loss (not short-term quotational loss) to an absolute minimum by obtaining a wide margin of safety in each commitment and a diversity of commitments; and c. My wife, children and I will have virtually our entire net worth invested in the partnership.

15. Columbus, appraised

Compounding sermon number one. Isabella’s $30,000, the psychic income of discovering a hemisphere, and the tables underneath the joke.

I have it from unreliable sources that the cost of the voyage Isabella originally underwrote for Columbus was approximately $30,000. This has been considered at least a moderately successful utilization of venture capital. Without attempting to evaluate the psychic income derived from finding a new hemisphere, it must be pointed out that even had squatter’s rights prevailed, the whole deal was not exactly another IBM. Figured very roughly, the $30,000 invested at 4% compounded annually would have amounted to something like $2,000,000,000,000 (that’s $2 trillion for those of you who are not government statisticians) by 1962.

Historical apologists for the Indians of Manhattan may find refuge in similar calculations. Such fanciful geometric progressions illustrate the value of either living a long time, or compounding your money at a decent rate. I have nothing particularly helpful to say on the former point.

The following table indicates the compounded value of $100,000 at 5%, 10% and 15% for 10, 20 and 30 years. It is always startling to see how relatively small differences in rates add up to very significant sums over a period of years. That is why, even though we are shooting for more, we feel that a few percentage points advantage over the Dow is a very worthwhile achievement. It can mean a lot of dollars over a decade or two.

16. Dempster by the numbers*

How he valued a control for partners entering and leaving, and the six-days-from-handshake hiring of Harry Bottle.

The high point of 1962 from a performance standpoint was our present control situation --73% owned Dempster Mill. Dempster has been primarily in farm implements (mostly items retailing for $1,000 or under), water systems, water well supplies and jobbed plumbing lines. The operations for the past decade have been characterized by static sales, low inventory turnover and virtually no profits in relation to invested capital.

We obtained control in August, 1961 at an average price of about $28 per share, having bought some stock as low as $16 in earlier years, but the vast majority in an offer of $30.25 in August. When control of a company is obtained, obviously what then becomes all-important is the value of assets, not the market quotation for a piece of paper (stock certificate). Last year, our Dempster holding was valued by applying what I felt were appropriate discounts to the various assets. These valuations were based on their status as non-earning assets and were not assessed on the basis of potential, but on the basis of what I thought a prompt sale would produce at that date. Our job was to compound these values at a decent rate. The consolidated balance sheet last year and the calculation of fair value are shown below.

Dempster’s fiscal year ends November 30th, and because the audit was unavailable in complete form, I approximated some of the figures and rounded to $35 per share last year. Initially, we worked with the old management toward more effective utilization of capital, better operating margins, reduction of overhead, etc. These efforts were completely fruitless. After spinning our wheels for about six months, it became obvious that while lip service was being given to our objective, either through inability or unwillingness, nothing was being accomplished. A change was necessary.

A good friend, whose inclination is not toward enthusiastic descriptions, highly recommended Harry Bottle for our type of problem. On April 17, 1962 I met Harry in Los Angeles, presented a deal which provided for rewards to him based upon our objectives being met, and on April 23rd he was sitting in the president’s chair in Beatrice. Harry is unquestionably the man of the year. Every goal we have set for Harry has been met, and all the surprises have been on the pleasant side. He has accomplished one thing after another that has been labeled as impossible, and has always taken the tough things first. Our breakeven point has been cut virtually in half, slowmoving or dead merchandise has been sold or written off, marketing procedures have been revamped, and unprofitable facilities have been sold. The results of this program are partially shown in the balance sheet below, which, since it still represents nonearning assets, is valued on the same basis as last year.

Three facts stand out: (1) Although net worth has been reduced somewhat by the housecleaning and writedowns ($550,000 was written out of inventory; fixed assets overall brought more than book value), we have converted assets to cash at a rate far superior to that implied in our year-earlier valuation. (2) To some extent, we have converted the assets from the manufacturing business (which has been a poor business) to a business which we think is a good business --securities. (3) By buying assets at a bargain price, we don’t need to pull any rabbits out of a hat to get extremely good percentage gains.

17. The cornerstone

The single sentence Buffett labels the cornerstone of the whole philosophy. He builds the margin of safety into the purchase, so the exit never has to be brilliant.

This is the cornerstone of our investment philosophy: “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results. The better sales will be the frosting on the cake.”

18. The safe-deposit box

A term loan lets Dempster hold a securities portfolio worth more per share than Buffett paid for the whole company, and he splits the valuation into a manufacturing stub and a securities book run just like the partnership.

On January 2, 1963, Dempster received an unsecured term loan of $1,250,000. These funds, together with the funds all ready “freed-up” will enable us to have a security portfolio of about $35 per share at Dempster, or considerably more than we paid for the whole company. Thus our present valuation will involve a net of about $16 per share in the manufacturing operation and $35 in a security operation comparable to that of Buffett Partnership, Ltd. We, of course, are devoted to compounding the $16 in manufacturing at an attractive rate and believe we have some good ideas as to how to accomplish this.

While this will be easy if the business as presently conducted earns money, we have some promising ideas even if it shouldn’t. It should be pointed out that Dempster last year was 100% an asset conversion problem and therefore, completely unaffected by the stock market and tremendously affected by our success with the assets. In 1963, the manufacturing assets will still be important, but from a valuation standpoint it will behave considerably more like a general since we will have a large portion of its money invested in generals pretty much identical with those in Buffett Partnership, Ltd. For tax reasons, we will probably not put workouts in Dempster. Therefore, if the Dow should drop substantially, it would have a significant effect on the Dempster valuation. Likewise, Dempster would benefit this year from an advancing Dow which would not have been the case most of last year.

There is one final point of real significance for Buffett Partnership, Ltd. We now have a relationship with an operating man which could be of great benefit in future control situations. Harry had never thought of running an implement company six days before he took over. He is mobile, hardworking and carries out policies once they are set. He likes to get paid well for doing well, and I like dealing with someone who is not trying to figure how to get the fixtures in the executive washroom gold-plated. Harry and I like each other, and his relationship with Buffett Partnership, Ltd. should be profitable for all of us.

19. Ode to Harry Bottle

The sale announcement, delivered as a tease for the annual letter to come.

At the end of October, the overall result from the Dow for 1963 was plus 18.8%. We have had a good year in all three categories, generals, work-outs and controls. A satisfactory sale on a going concern basis of Dempster Mill Manufacturing operating assets was made about a month ago. I will give the full treatment to the Dempster story in the annual letter, perhaps climaxed by some lyrical burst such as “Ode to Harry Bottle.” While we always had a built-in profit in Dempster because of our bargain purchase price, Harry accounted for several extra servings of dessert by his extraordinary job.

Harry, incidentally, has made an advance payment toward becoming a limited partner in 1964-- we consider this the beginning, not the end. However, 1963 has not been all Dempster. While a great deal can happen the last two months and therefore interim results should not be taken too seriously, at the end of October the overall gain for the partnership was about 32%. Based on the allocation embodied in our agreement, this works out to plus 25 1/2% for the limited partners before monthly payments to those who take them. Of our approximate $3 million gain, something over $2 million came from marketable securities and a little less than $1 million from Dempster operating assets.

The combined gain from our single best general and best work-out situation approximated the gain on the Dempster operating assets. You should be aware that if our final results relative to the Dow for 1963 are as favorable as on October 31st, I will regard it as an abnormal year. I do not consider a 13.2 percentage point margin to be in the cards on a long term basis. A considerably more moderate annual edge over the Dow will be quite satisfactory.

Part Three: Sermons and Method (1964 to 1965)

20. The Mona Lisa

Compounding sermon number two, and the end of all household discussion of paintings as investments.

Now to the pulse-quickening portion of our essay. Last year, in order to drive home the point on compounding, I took a pot shot at Queen Isabella and her financial advisors. You will remember they were euchred into such an obviously low-compound situation as the discovery of a new hemisphere. Since the whole subject of compounding has such a crass ring to it, I will attempt to introduce a little class into this discussion by turning to the art world. Francis I of France paid 4,000 ecus in 1540 for Leonardo da Vinci’s Mona Lisa. On the off chance that a few of you have not kept track of the fluctuations of the ecu 4,000 converted out to about $20,000.

If Francis had kept his feet on the ground and he (and his trustees) had been able to find a 6% after-tax investment, the estate now would be worth something over $1,000,000,000,000,000.00. That’s $1 quadrillion or over 3,000 times the present national debt, all from 6%. I trust this will end all discussion in our household about any purchase or paintings qualifying as an investment. However, as I pointed out last year, there are other morals to be drawn here. One is the wisdom of living a long time. The other impressive factor is the swing produced by relatively small changes in the rate of compound.

21. Texas National Petroleum*

Really the only work-out Buffett ever dissected step by step. Month after month of phone calls to the company while waiting on an IRS ruling. This is what doing the work literally looked like. From all of his public investments, this one is the least discussed by most people referencing BPL.

This situation was a run-of-the-mill workout arising from the number one source of workouts in recent years -- the sellouts of oil and gas producing companies. TNP was a relatively small producer with which I had been vaguely familiar for years. Early in 1962 I heard rumors regarding a sellout to Union Oil of California. I never act on such information, but in this case it was correct and substantially more money would have been made if we had gone in at the rumor stage rather than the announced stage. However, that’s somebody else’s business, not mine. In early April, 1962, the general terms of the deal were announced. TNP had three classes of securities outstanding:

1. 6 1/2% debentures callable at 104 1/4 which would bear interest until the sale transpired and at that time would be called. There were $6.5 million outstanding of which we purchased $264,000 principal amount before the sale closed.

2. About 3.7 million shares of common stock of which the officers and directors owned about 40%. The proxy statement estimated the proceeds from the liquidation would produce $7.42 per share. We purchased 64,035 shares during the six months or so between announcement and closing.

3. 650,000 warrants to purchase common stock at $3.50 per share. Using the proxy statement estimate of $7.42 for the workout on the common resulted in $3.92 as a workout on the warrants.

We were able to buy 83,200 warrants or about 13% of the entire issue in six months. The risk of stockholder disapproval was nil. The deal was negotiated by the controlling stockholders, and the price was a good one. Any transaction such as this is subject to title searches, legal opinions, etc., but this risk could also be appraised at virtually nil. There were no anti-trust problems. This absence of legal or anti-trust problems is not always the case, by any means. The only fly in the ointment was the obtaining of the necessary tax ruling.

Union Oil was using a standard ABC production payment method of financing. The University of Southern California was the production payment holder and there was some delay because of their eleemosynary status. This posed a new problem for the Internal Revenue Service, but we understood USC was willing to waive this status which still left them with a satisfactory profit after they borrowed all the money from a bank. While getting this ironed out created delay, it did not threaten the deal.

When we talked with the company on April 23rd and 24th, their estimate was that the closing would take place in August or September. The proxy material was mailed May 9th and stated the sale “will be consummated during the summer of 1962 and that within a few months thereafter the greater part of the proceeds will be distributed to stockholders in liquidation.” As mentioned earlier, the estimate was $7.42 per share. Bill Scott attended the stockholders meeting in Houston on May 29th where it was stated they still expected to close on September 1st. The following are excerpts from some of the telephone conversations we had with company officials in ensuing months:

On June 18th the secretary stated “Union has been told a favorable IRS ruling has been formulated but must be passed on by additional IRS people. Still hoping for ruling in July.” On July 24th the president said that he expected the IRS ruling “early next week.” On August 13th the treasurer informed us that the TNP, Union Oil, and USC people were all in Washington attempting to thrash out a ruling. On September 18th the treasurer informed us “No news, although the IRS says the ruling could be ready by next week.” The estimate on payout was still $7.42. The ruling was received in late September, and the sale closed October 31st. Our bonds were called November 13th. We converted our warrants to common stock shortly thereafter and received payments on the common of $3.50 December 14, 1962, $3.90 February 4, 1963, and 15 cent on April 24, 1963. We will probably get another 4 cent in a year or two. On 147,235 shares (after exercise of warrants) even 4 cent per share is meaningful.

This illustrates the usual pattern: (1) the deals take longer than originally projected; and (2) the payouts tend to average a little better than estimates. With TNP it took a couple of extra months, and we received a couple of extra percent. The financial results of TNP were as follows: (1) On the bonds we invested $260,773 and had an average holding period of slightly under five months. We received 6 1/2% interest on our money and realized a capital gain of $14,446. This works out to an overall rate of return of approximately 20% per annum. (2) On the stock and warrants we have realized capital gain of $89,304, and we have stubs presently valued at $2,946. From an investment or $146,000 in April, our holdings ran to $731,000 in October. Based on the time the money was employed, the rate or return was about 22% per annum. In both cases, the return is computed on an all equity investment. I definitely feel some borrowed money is warranted against a portfolio of workouts, but feel it is a very dangerous practice against generals. We are not presenting TNP as any earth-shaking triumph.

We have had workouts which were much better and some which were poorer. It is typical of our bread-and-butter type of operation. We attempt to obtain all facts possible, continue to keep abreast of developments and evaluate all of this in terms of our experience. We certainly don’t go into all the deals that come along -- there is considerable variation in their attractiveness. When a workout falls through, the resulting market value shrink is substantial. Therefore, you cannot afford many errors, although we fully realize we are going to have them occasionally.

22. The Lessons of Dempster

He draws two lessons: patience as a structural requirement, and the open-mouth policy that can never help and can seriously hurt.

This situation started as a general in 1956. At that time the stock was selling at $18 with about $72 in book value of which $50 per share was in current assets (Cash, receivables and inventory) less all liabilities. Dempster had earned good money in the past but was only breaking even currently. The qualitative situation was on the negative side (a fairly tough industry and unimpressive management), but the figures were extremely attractive. Experience shows you can buy 100 situations like this and have perhaps 70 or 80 work out to reasonable profits in one to three years.

Just why any particular one should do so is hard to say at the time of purchase, but the group expectancy is favorable, whether the impetus is from an improved industry situation, a takeover offer, a change in investor psychology, etc. We continued to buy the stock in small quantities for five years. During most or this period I was a director and was becoming consistently less impressed with the earnings prospects under existing management. However, I also became more familiar with the assets and operations and my evaluation of the quantitative factors remained very favorable. By mid-1961 we owned about 30% or Dempster (we had made several tender offers with poor results), but in August and September 1961 made, several large purchases at $30.25 per share, which coupled with a subsequent tender offer at the same price, brought our holding to over 70%.

Our purchases over the previous five years had been in the $16-$25 range. On assuming control, we elevated the executive vice president to president to see what he would do unfettered by the previous policies. The results were unsatisfactory and on April 23, 1962 we hired Harry Bottle as president. Harry was the perfect man for the job. I have recited his triumphs before and the accompanying comparative balance sheets speak louder than any words in demonstrating the re-employment of capital.

Harry: (1) took the inventory from over $4 million (much of it slow moving) to under $1 million reducing carrying costs and obsolescence risks tremendously; (2) correspondingly freed up capital for marketable security purchases from which we gained over $400,000 (3) cut administration and selling expense from $150,000 to $75,000 per month; (4) cut factory overhead burden from $6 to $4.50 per direct labor hour; (5) closed the five branches operating unprofitably (leaving us with three good ones) and replaced them with more productive distributors; (6) cleaned up a headache at an auxiliary factory operation at Columbus, Nebraska; (7) eliminated jobbed lines tying up considerable money (which could be used profitably in securities) while producing no profits; (8) adjusted prices of repair parts, thereby producing an estimated $200,000 additional profit with virtually no loss of volume; and most important; (9) through these and many other steps, restored the earning capacity to a level commensurate with the capital employed.

In 1963, the heavy corporate taxes we were facing (Harry surprised me by the speed with which he had earned up our tax loss carry-forward) coupled with excess liquid funds within the corporation compelled us to either in some way de-incorporate or to sell the business. We set out to do either one or the other before the end of 1963. De-incorporating had many problems but would have, in effect, doubled earnings for our partners and also eliminated the problem of corporate capital gain tax on Dempster securities. At virtually the last minute, after several earlier deals had fallen through at reasonably advanced stages, a sale of assets was made. Although there were a good many wrinkles to the sale, the net effect was to bring approximately book value. This, coupled with the gain we have in our portfolio of marketable securities, gives us a realization of about $80 per share.

Dempster (now named First Beatrice Corp. - we sold the name to the new Co.) is down to almost entirely cash and marketable securities now. On BPL’s yearend audit, our First Beatrice holdings were valued at asset value (with securities at market) less a $200,000 reserve for various contingencies. I might mention that we think the buyers will do very well with Dempster. They impress us as people of ability and they have sound plans to expand the business and its profitability. We would have been quite happy to operate Dempster on an unincorporated basis, but we are also quite happy to sell it for a reasonable price. Our business is making excellent purchases -- not making extraordinary sales. Harry works the same way I do -- he likes big carrots. He is presently a limited partner of BPL, and the next belt-tightening operation we have, he’s our man.

The Dempster saga points up several morals: (1) Our business is one requiring patience. It has little in common with a portfolio of high-flying glamour stocks and during periods of popularity for the latter, we may appear quite stodgy. It is to our advantage to have securities do nothing price wise for months, or perhaps years, why we are buying them. This points up the need to measure our results over an adequate period of time. We suggest three years as a minimum. (2) We cannot talk about our current investment operations. Such an open-mouth policy could never improve our results and in some situations could seriously hurt us. For this reason, should anyone, including partners, ask us whether we are interested in any security, we must plead the “5th Amendment.”

23. Buying is 90% of the business

One paragraph on where the game is actually won, and the first appearance of the two-strings-to-our-bow image for a general that may become a control.

Buying activities during the first half were quite satisfactory. This is of particular satisfaction to me since I consider the buying end to be about 90% of this business. Our General category now includes three companies where B.P.L. is the largest single stockholder. These stocks have been bought and are continuing to be bought at prices considerably below their value to a private owner. We have been buying one of these situations for approximately eighteen months and both of the others for about a year. It would not surprise me if we continue to do nothing but patiently buy these securities week after week for at least another year, and perhaps even two years or more. What we really like to see in situations like the three mentioned above is a condition where the company is making substantial progress in terms of improving earnings, increasing asset values, etc., but where the market price of the stock is doing very little while we continue to acquire it.

This doesn’t do much for our short-term performance, particularly relative to a rising market, but it is a comfortable and logical producer of longer-term profits. Such activity should usually result in either appreciation of market prices from external factors or the acquisition by us of a controlling position in a business at a bargain price. Either alternative suits me. It is important to realize, however, that most of our holdings in the General category continue to be securities which we believe to be considerably undervalued, but where there is not the slightest possibility that we could have a controlling position. We expect the market to justify our analyses of such situations in a reasonable period of time, but we do not have the two strings to our bow mentioned in the above paragraph working for us in these securities.

24. The duck

When the pond rises the duck rises, and it should take credit only for its own paddling.

The most highly paid and respected investment management has difficulty matching the performance of an unmanaged index of blue chip stocks. The results of these companies in some ways resemble the activity of a duck sitting on a pond. When the water (the market) rises, the duck rises; when it falls, back goes the duck. SPCA or no SPCA, I think the duck can only take the credit (or blame) for his own activities. The rise and fall of the lake is hardly something for him to quack about. The water level has been of great importance to B.P.L’s performance as the table on page one indicates. However, we have also occasionally flapped our wings.

25. Why institutions can’t

The five cause diagnosis of professional mediocrity, and never improved on since.

The repetition of these tables has caused partners to ask: “Why in the world does this happen to very intelligent managements working with (1) bright, energetic staff people, (2) virtually unlimited resources, (3) the most extensive business contacts, and (4) literally centuries of aggregate investment experience?” (The latter qualification brings to mind the fellow who applied for a job and stated he had twenty years of experience - which was corrected by the former employer to read “one year’s experience -twenty times.”) This question is of enormous importance, and you would expect it to be the subject of considerable study by investment managers and substantial investors. After all, each percentage point on $30 billion is $300 million per year. Curiously enough, there is practically nothing in the literature of Wall Street attracting this problem, and discussion of it is virtually absent at security analyst society meetings, conventions, seminars, etc. My opinion is that the first job of any investment management organization is to analyze its own techniques and results before pronouncing judgment on the managerial abilities and performance of the major corporate entities of the United States. In the great majority of cases the lack of performance exceeding or even matching an unmanaged index in no way reflects lack of either intellectual capacity or integrity.

I think it is much more the product of: (1) group decisions - my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations; (3) an institutional framework whereby average is “safe” and the personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4) an adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.

26. The poll*

A public opinion poll is no substitute for thought.

We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don’t. A public opinion poll is no substitute for thought. When we really sit back with a smile on our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course of action obvious. In that case - whether other conventional or unconventional - whether others agree or disagree - we feel - we are progressing in a conservative manner. The above may seem highly subjective. It is. You should prefer an objective approach to the question. I do. My suggestion as to one rational way to evaluate the conservativeness of past policies is to study performance in declining markets. We have only three years of declining markets in our table and unfortunately (for purposes of this test only) they were all moderate declines. In all three of these years we achieved appreciably better investment results than any of the more conventional portfolios.

27. The Manhattan Indians

The twenty four dollars that beats the island.

Readers of our early annual letters registered discontent at a mere recital of contemporary investment experience, but instead hungered for the intellectual stimulation that only could be provided by a depth study of investment strategy spanning the centuries. Hence, this section. Our last two excursions into the mythology of financial expertise have revealed that purportedly shrewd investments by Isabella (backing the voyage of Columbus) and Francis I (original purchase of Mona Lisa) bordered on fiscal lunacy. Apologists for these parties have presented an array of sentimental trivia. Through it all, our compounding tables have not been dented by attack.

Nevertheless, one criticism has stung a bit. The charge has been made that this column has acquired a negative tone with only the financial incompetents of history receiving comment. We have been challenged to record on these pages a story of financial perspicacity which will be a bench mark of brilliance down through the ages. One story stands out. This, of course, is the saga of trading acumen etched into history by the Manhattan Indians when they unloaded their island to that notorious spendthrift, Peter Minuit in 1626. My understanding is that they received $24 net. For this, Minuit received 22.3 square miles which works out to about 621,688,320 square feet. While on the basis of comparable sales, it is difficult to arrive at a precise appraisal, a $20 per square foot estimate seems reasonable giving a current land value for the island of $12,433,766,400 ($12 1/2 billion). To the novice, perhaps this sounds like a decent deal. However, the Indians have only had to achieve a 6 1/2% return (The tribal mutual fund representative would have promised them this.) to obtain the last laugh on Minuit. At 6 1/2%, $24 becomes $42,105,772,800 ($42 billion) in 338 years, and if they just managed to squeeze out an extra half point to get to 7%, the present value becomes $205 billion.

28. Our Goal

The expectations contract: Dow around 7 with wild swings, a hoped-for ten-point edge with a stated range from minus ten to plus twenty-five, and every fragility of the forecast flagged by its own author.

You will note that there are no columns in the preceding table for the 27.7% average of the Partnership during its eight-year lifespan or the 22.3% average of the limited partners. Such figures are nonsensical for the long term for several reasons: (Don’t worry about me “holding back” to substantiate this prophecy.) (1) Any significant sums compounded at such rates take on national debt proportions at alarming speed. (2) During our eight-year history a general revaluation of securities has produced average annual rates of overall gain from the whole common stock field which I believe unattainable in future decades. Over a span of 20 or 30 years, I would expect something more like 6% - 7% overall annual gain from the Dow instead of the 11.1% during our brief history. This factor alone would tend to knock 4 points or so off of our annual compounding rate. It would only take a minus 20.5% year in 1965 for the Dow to bring it down to a 7% average figure for the nine years. Such years (or worse) should definitely be expected from time to time by those holding equity investments. If a 20% or 30% drop in the market value of your equity holdings (such as BPL) is going to produce emotional or financial distress, you should simply avoid common stock type investments. In the words of the poet - Harry Truman – “If you can’t stand the heat, stay out of the kitchen.” It is preferable, of course, to consider the problem before you enter the “kitchen.” (3) We do not consider it possible on an extended basis to maintain the 16.6 percentage point advantage over the Dow of the Partnership or the 11.2 percentage point edge enjoyed by the limited partners. We have had eight consecutive years in which our pool of money has out-performed the Dow, although the profit allocation arrangement left the limited partners short of Dow results in one of those years. We are certain to have years (note the plural) when the Partnership results fall short of the Dow despite considerable gnashing of teeth by the general partner (I hope not too much by the limited partners). When that happens our average margin of superiority will drop sharply. I might say that I also think we will continue to have some years of very decent margins in our favor. However, to date we have benefited by the fact that we have not had a really mediocre (or worse) year included in our average, and this obviously cannot be expected to be a permanent experience.

So what can we expect to achieve? Of course, anything I might say is largely guesswork, and my own investment philosophy has developed around the theory that prophecy reveals far more of the frailties of the prophet than it reveals of the future. Nevertheless, you, as partners, are entitled to know my expectations, tenuous as they may be. I am hopeful that our longer term experience will unfold along the following basis: (1) An overall gain from the Dow (including dividends, of course) averaging in the area of 7% per annum, exhibiting customarily wide amplitudes in achieving this average -- say, on the order or minus 40% to plus 50% at the extremes with the majority of years in the minus 10% to plus 20% range; (2) An average advantage of ten percentage points per annum for BPL before allocation to the general partner - again with large amplitudes in the margin from perhaps 10 percentage points worse than the Dow in a bad year to 25 percentage points better when everything clicks; and (3) The product of these two assumptions gives an average of 17% to BPL or about 14% to limited partners. This figure would vary enormously from year to year; the final amplitudes, of course, depending, on the interplay of the extremes hypothesized in (1) and (2). I would like to emphasize that the above is conjecture, perhaps heavily influenced by self-interest, ego, etc. Anyone with a sense of financial history knows this sort of guesswork is subject to enormous error. It might better be left out of this letter, but it is a question frequently and legitimately asked by partners. Long-range expectable return is the primary consideration of all of us belonging to BPL, and it is reasonable that I should be put on record, foolish as that may later make me appear. My rather puritanical view is that any investment manager, whether operating as broker, investment counselor, trust department, Investment Company, etc., should be willing to state unequivocally what he is going to attempt to accomplish and how he proposes to measure the extent to which he gets the job done.

29. Our Method of Operation: the four categories*

The fullest statement of method in the fourteen years, after 8 years of running the partnership. The three categories become four: Generals split into “Private Owner Basis” and a newly defined “Relatively Undervalued” class (the home of the unnamed giant position), and he announces a new technique meant to improve the expectancy and consistency of that class. If a reader takes one section of one letter, this is the one.

In past annual letters I have always utilized three categories to describe investment operations we conduct. I now feel that a four-category division is more appropriate. Partially, the addition of a new section - "Generals Relatively Undervalued" - reflects my further consideration of essential differences that have always existed to a small extent with our "Generals" group. Partially, it reflects the growing importance of what once was a very small sub-category but is now a much more significant part of our total portfolio. This increasing importance has been accompanied by excellent results to date justifying significant time and effort devoted to finding additional opportunities in this area. Finally, it partially reflects the development and implementation of a new and somewhat unique investment technique designed to improve the expectancy and consistency of operations in this category. Therefore, our four present categories are:

1. “Generals -Private Owner Basis” - a category of generally undervalued stocks, determined by quantitative standards, but with considerable attention also paid to the qualitative factor. There is often little or nothing to indicate immediate market improvement. The issues lack glamour or market sponsorship. Their main qualification is a bargain price; that is, an overall valuation of the enterprise substantially below what careful analysis indicates its value to a private owner to be. Again, let me emphasize that while the quantitative comes first and is essential, the qualitative is important. We like good management - we like a decent industry - we like a certain amount of “ferment” in a previously dormant management or stockholder group. But, we demand value. Many times in this category we have the desirable "two strings to our bow" situation where we should either achieve appreciation of market prices from external factors or from the acquisition of a controlling position in a business at a bargain price. While the former happens in the overwhelming majority of cases, the latter represents an insurance policy most investment operations don't have. We have continued to enlarge the positions in the three companies described in our 1964 midyear report where we are the largest stockholder. All three companies are increasing their fundamental value at a very satisfactory rate, and we are completely passive in two situations and active only on a very minor scale in the third. It is unlikely that we will ever take a really active part in policy-making in any of these three companies, but we stand ready if needed.

2. "Generals -Relatively Undervalued" - this category consists of securities selling at prices relatively cheap compared to securities of the same general quality. We demand substantial discrepancies from current valuation standards, but (usually because of large size) do not feel value to a private owner to be a meaningful concept. It is important in this category, of course, that apples be compared to apples - and not to oranges, and we work hard at achieving that end. In the great majority of cases we simply do not know enough about the industry or company to come to sensible judgments -in that situation we pass. As mentioned earlier, this new category has been growing and has produced very satisfactory results. We have recently begun to implement a technique, which gives promise of very substantially reducing the risk from an overall change in valuation standards; e.g. I we buy something at 12 times earnings when comparable or poorer quality companies sell at 20 times earnings, but then a major revaluation takes place so the latter only sell at 10 times. This risk has always bothered us enormously because of the helpless position in which we could be left compared to the "Generals -Private Owner" or "Workouts" types. With this risk diminished, we think this category has a promising future.

3. "Workouts" - these are the securities with a timetable. They arise from corporate activity - sell-outs, mergers, reorganizations, spin-offs, etc. In this category we are not talking about rumors or "inside information" pertaining to such developments, but to publicly announced activities of this sort. We wait until we can read it in the paper. The risk pertains not primarily to general market behavior (although that is sometimes tied in to a degree), but instead to something upsetting the applecart so that the expected development does not materialize. Such killjoys could include anti-trust or other negative government action, stockholder disapproval, withholding of tax rulings, etc. The gross profits in many workouts appear quite small. It's a little like looking for parking meters with some time left on them. However, the predictability coupled with a short holding period produces quite decent average annual rates of return after allowance for the occasional substantial loss. This category produces more steady absolute profits from year to year than generals do. In years of market decline it should usually pile up a big edge for us; during bull markets it will probably be a drag on performance. On a long-term basis, I expect the workouts to achieve the same sort of margin over the Dow attained by generals.

4. “Controls” - these are rarities, but when they occur they are likely to be of significant size. Unless we start off with the purchase of a sizable block of stock, controls develop from the general - private owner category. They result from situations where a cheap security does nothing pricewise for such an extended period of time that we are able to buy a significant percentage of the company's stock. At that point we are probably in a position to assume a degree of or perhaps complete control of the company's activities. Whether we become active or remain relatively passive at this point depends upon our assessment of the company's future and the managements capabilities.

30. Anyone for taxes?

An outspoken advocate of paying large taxes at low rates, and the swap-fund managers collecting $250,000 to $700,000 a year to compound at 1 to 3 percent.

We have had a chorus of groans this year regarding partners' tax liabilities. Of course, we also might have had a few if the tax sheet had gone out blank. More investment sins are probably committed by otherwise quite intelligent people because of "tax considerations" than from any other cause. One of my friends - a noted West Coast philosopher maintains that a majority of life's errors are caused by forgetting what one is really trying to do.

This is certainly the case when an emotionally supercharged element like taxes enters the picture (I have another friend -a noted East Coast philosopher who says it isn't the lack of representation he minds -it's the taxation). Let's get back to the West Coast. What is one really trying to do in the investment world? Not pay the least taxes, although that may be a factor to be considered in achieving the end. Means and end should not be confused, however, and the end is to come away with the largest after-tax rate of compound. Quite obviously if two courses of action promise equal rates of pre-tax compound and one involves incurring taxes and the other doesn't the latter course is superior.

However, we find this is rarely the case. It is extremely improbable that 20 stocks selected from, say, 3000 choices are going to prove to be the optimum portfolio both now and a year from now at the entirely different prices (both for the selections and the alternatives) prevailing at that later date.

If our objective is to produce the maximum after-tax compound rate, we simply have to own the most attractive securities obtainable at current prices, And, with 3,000 rather rapidly shifting variables, this must mean change (hopefully “tax-generating” change). It is obvious that the performance of a stock last year or last month is no reason, per se, to either own it or to not own it now.

It is obvious that an inability to "get even" in a security that has declined is of no importance. It is obvious that the inner warm glow that results from having held a winner last year is of no importance in making a decision as to whether it belongs in an optimum portfolio this year. If gains are involved, changing portfolios involves paying taxes.

Except in very unusual cases (I will readily admit there are some cases), the amount of the tax is of minor importance if the difference in expectable performance is significant. I have never been able to understand why the tax comes as such a body blow to many people since the rate on long-term capital gain is lower than on most lines of endeavor (tax policy indicates digging ditches is regarded as socially less desirable than shuffling stock certificates). I have a large percentage of pragmatists in the audience so I had better get off that idealistic kick.

There are only three ways to avoid ultimately paying the tax: (1) die with the asset - and that's a little too ultimate for me even the zealots would have to view this "cure" with mixed emotions; (2) give the asset away - you certainly don't pay any taxes this way, but of course you don't pay for any groceries, rent, etc., either; and (3) lose back the gain if your mouth waters at this tax-saver, I have to admire you -you certainly have the courage of your convictions. So it is going to continue to be the policy of BPL to try to maximize investment gains, not minimize taxes. We will do our level best to create the maximum revenue for the Treasury -at the lowest rates the rules will allow.

An interesting sidelight on this whole business of taxes, vis-à-vis investment management, has appeared in the last few years. This has arisen through the creation of so-called "swap funds" which are investment companies created by the exchange of the investment company's shares for general market securities held by potential investors.

The dominant sales argument has been the deferment (deferment, when pronounced by an enthusiastic salesman, sometimes comes very close phonetically to elimination) of capital gains taxes while trading a single security for a diversified portfolio. The tax will only finally be paid when the swap fund's shares are redeemed. For the lucky ones, it will be avoided entirely when any of those delightful alternatives mentioned two paragraphs earlier eventuates.

The reasoning implicit in the swapee's action is rather interesting. He obviously doesn't really want to hold what he is holding or he wouldn't jump at the chance to swap it (and pay a fairly healthy commission - usually up to $100,000) for a grab-bag of similar hot potatoes held by other tax-numbed investors. In all fairness, I should point out that after all offerees have submitted their securities for exchange and had a chance to review the proposed portfolio they have a chance to back out but I understand a relatively small proportion do so.

There have been twelve such funds (that I know of) established since origination of the idea in 1960, and several more are currently in the works. The idea is not without appeal since sales totaled well over $600 million. All of the funds retain an investment manager to whom they usually pay 1/2 of 1% of asset value. This investment manager faces an interesting problem; he is paid to manage the fund intelligently (in each of the five largest funds this fee currently ranges from $250,000 to $700,000 per year), but because of the low tax basis inherited from the contributors of securities, virtually his every move creates capital gains tax liabilities. And, of course, he knows that if he incurs such liabilities, he is doing so for people who are probably quite sensitive to taxes or they wouldn't own shares in the swap fund in the first place.

I am putting all of this a bit strongly, and I am sure there are some cases where a swap fund may be the best answer to an individual's combined tax and investment problems. Nevertheless, I feel they offer a very interesting test-tube to measure the ability of some of the most respected investment advisors when they are trying to manage money without paying (significant) taxes.

The three largest swap funds were all organized in 1961, and combined have assets now of about $300 million. One of these, Diversification Fund, reports on a fiscal year basis which makes extraction of relevant data quite difficult for calendar year comparisons. The other two, Federal Street Fund and Westminster Fund (respectively first and third largest in the group) are managed by investment advisors who oversee at least $2 billion of institutional money.

Here's how they shape up for all full years of existence:

This is strictly the management record. No allowance has been made for the commission in entering and any taxes paid by the fund on behalf of the shareholders have been added back to performance.

Anyone for taxes?

Part Four: Concentration and Berkshire (1965 to 1966)

31. Ground Rule 7*

The 40% rule, announced as a decided departure. Concentration authorized when an extremely high probability of being right on facts and reasoning meets a very low probability of drastic change in underlying value.

Last year in commenting on the inability of the overwhelming majority of investment managers to achieve performance superior to that of pure chance, I ascribed it primarily to the product of: "(1) group decisions - my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations; (3) an institutional framework whereby average is "safe" and the personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4) an adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.”

This year in the material which went out in November, I specifically called your attention to a new Ground Rule reading, "7. We diversify substantially less than most investment operations. We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could drastically change the underlying value of the investment."

We are obviously following a policy regarding diversification which differs markedly from that of practically all public investment operations. Frankly, there is nothing I would like better than to have 50 different investment opportunities, all of which have a mathematical expectation (this term reflects the range of all possible relative performances, including negative ones, adjusted for the probability of each - no yawning, please) of achieving performance surpassing the Dow by, say, fifteen percentage points per annum. If the fifty individual expectations were not intercorelated (what happens to one is associated with what happens to the other) I could put 2% of our capital into each one and sit back with a very high degree of certainty that our overall results would be very close to such a fifteen percentage point advantage.

It doesn't work that way.

We have to work extremely hard to find just a very few attractive investment situations. Such a situation by definition is one where my expectation (defined as above) of performance is at least ten percentage points per annum superior to the Dow. Among the few we do find, the expectations vary substantially. The question always is, “How much do I put in number one (ranked by expectation of relative performance) and how much do I put in number eight?" This depends to a great degree on the wideness of the spread between the mathematical expectation of number one versus number eight.” It also depends upon the probability that number one could turn in a really poor relative performance. Two securities could have equal mathematical expectations, but one might have .05 chance of performing fifteen percentage points or more worse than the Dow, and the second might have only .01 chance of such performance. The wider range of expectation in the first case reduces the desirability of heavy concentration in it.

The above may make the whole operation sound very precise. It isn't. Nevertheless, our business is that of ascertaining facts and then applying experience and reason to such facts to reach expectations. Imprecise and emotionally influenced as our attempts may be, that is what the business is all about. The results of many years of decision-making in securities will demonstrate how well you are doing on making such calculations - whether you consciously realize you are making the calculations or not. I believe the investor operates at a distinct advantage when he is aware of what path his thought process is following.

There is one thing of which I can assure you. If good performance of the fund is even a minor objective, any portfolio encompassing one hundred stocks (whether the manager is handling one thousand dollars or one billion dollars) is not being operated logically. The addition of the one hundredth stock simply can't reduce the potential variance in portfolio performance sufficiently to compensate for the negative effect its inclusion has on the overall portfolio expectation.

Anyone owning such numbers of securities after presumably studying their investment merit (and I don't care how prestigious their labels) is following what I call the Noah School of Investing - two of everything. Such investors should be piloting arks. While Noah may have been acting in accord with certain time-tested biological principles, the investors have left the track regarding mathematical principles. (I only made it through plane geometry, but with one exception, I have carefully screened out the mathematicians from our Partnership.)

Of course, the fact that someone else is behaving illogically in owning one hundred securities doesn't prove our case. While they may be wrong in overdiversifying, we have to affirmatively reason through a proper diversification policy in terms of our objectives.

The optimum portfolio depends on the various expectations of choices available and the degree of variance in performance which is tolerable. The greater the number of selections, the less will be the average year-to-year variation in actual versus expected results. Also, the lower will be the expected results, assuming different choices have different expectations of performance.

I am willing to give up quite a bit in terms of leveling of year-to-year results (remember when I talk of “results,” I am talking of performance relative to the Dow) in order to achieve better overall long-term performance. Simply stated, this means I am willing to concentrate quite heavily in what I believe to be the best investment opportunities recognizing very well that this may cause an occasional very sour year - one somewhat more sour, probably, than if I had diversified more. While this means our results will bounce around more, I think it also means that our long-term margin of superiority should be greater.

You have already seen some examples of this. Our margin versus the Dow has ranged from 2.4 percentage points in 1958 to 33.0 points in 1965. If you check this against the deviations of the funds listed on page three, you will find our variations have a much wider amplitude. I could have operated in such a manner as to reduce our amplitude, but I would also have reduced our overall performance somewhat although it still would have substantially exceeded that of the investment companies. Looking back, and continuing to think this problem through, I feel that if anything, I should have concentrated slightly more than I have in the past. Hence, the new Ground Rule and this long-winded explanation.

Again let me state that this is somewhat unconventional reasoning (this doesn't make it right or wrong - it does mean you have to do your own thinking on it), and you may well have a different opinion - if you do, the Partnership is not the place for you. We are obviously only going to go to 40% in very rare situations - this rarity, of course, is what makes it necessary that we concentrate so heavily, when we see such an opportunity. We probably have had only five or six situations in the nine-year history of the Partnership where we have exceeded 25%. Any such situations are going to have to promise very significantly superior performance relative to the Dow compared to other opportunities available at the time. They are also going to have to possess such superior qualitative and/or quantitative factors that the chance of serious permanent loss is minimal (anything can happen on a short-term quotational basis which partially explains the greater risk of widened yearto-year variation in results). In selecting the limit to which I will go in anyone investment, I attempt to reduce to a tiny figure the probability that the single investment (or group, if there is intercorrelation) can produce a result for our total portfolio that would be more than ten percentage points poorer than the Dow.

We presently have two situations in the over 25% category - one a controlled company, and the other a large company where we will never take an active part. It is worth pointing out that our performance in 1965 was overwhelmingly the product of five investment situations. The 1965 gains (in some cases there were also gains applicable to the same holding in prior years) from these situations ranged from about $800,000 to about $3 1/2 million. If you should take the overall performance of our five smallest general investments in 1965, the results are lackluster (I chose a very charitable adjective).

Interestingly enough, the literature of investment management is virtually devoid of material relative to deductive calculation of optimal diversification. All texts counsel "adequate" diversification, but the ones who quantify "adequate" virtually never explain how they arrive at their conclusion. Hence, for our summation on overdiversification, we turn to that eminent academician Billy Rose, who says, "You've got a harem of seventy girls; you don't get to know any of them very well.”

32. The beginning of Berkshire

The first mention of Berkshire Hathaway, disclosed in a housekeeping letter.

The partnership owns a controlling interest in Berkshire Hathaway Inc., a publicly-traded security. As mentioned in my midyear letter, asset values and earning power are the dominant factors affecting the valuation of a controlling interest in a business. Market price, which governs valuation of minority interest positions, is of little or no importance in valuing a controlling interest. We will value our position in Berkshire Hathaway at yearend at a price halfway between net current asset value and book value. Because of the nature of our receivables and inventory this, in effect, amounts to valuation of our current assets at 100 cents on the dollar and our fixed assets at 50 cents on the dollar. Such a value in my opinion is fair to both adding and withdrawing partners. It may be either of lower than market value at the time.

As I write this, we are orbiting in quite satisfactory fashion. Our margin over the Dow is well above average, and even those Neanderthal partners who utilize such crude yardsticks as net profit would find performance satisfactory. This is all, of course, subject to substantial change by yearend.

33. The War on Poverty

His best year ever, reported as a joke and an apology!

Our War on Poverty was successful in 1965.

Specially, we were $12,304,060 less poor at the end of the year.

Last year under a section in the annual letter entitled “Our Goal” (please particularly note it was not headed "Our Promise"), I stated we were trying to achieve “… An average advantage (relative to the Dow) of ten percentage points per annum for BPL before allocation to the general partner again with large amplitudes in the margin from perhaps 10 percentage points worse than the Dow in a bad year to 25 percentage points better when everything clicks.”

My fallibility as a forecaster was quickly demonstrated when the first year fell outside my parameters. We achieved our widest margin over the Dow in the history of BPL with an overall gain of 47.2% compared to an overall gain (including dividends which would have been received through ownership of the Dow) of 14.2% for the Dow. Naturally, no writer likes to be publicly humiliated by such a mistake. It is unlikely to be repeated.

34. The Berkshire story*

Berkshire’s first real appearance in the letters. Purchased at $7.60 in 1962, $14.86 average, about $19 of net working capital per share, and Ken Chace running things first-class.

I’d also like to add Berkshire’s price today is exactly 100,000x higher than when it was first purchased! So, a 100,000x investment is equivalent to a 9,999,900% return (just under ten million percent!).

Our purchases of Berkshire started at a price of $7.60 per share in 1962. This price partially reflected large losses incurred by the prior management in closing some of the mills made obsolete by changing conditions within the textile business (which the old management had been quite slow to recognize). In the postwar period the company had slid downhill a considerable distance, having hit a peak in 1948 when about $29 1/2 million was earned before tax and about 11,000 workers were employed. This reflected output from 11 mills.

At the time we acquired control in spring of 1965, Berkshire was down to two mills and about 2,300 employees. It was a very pleasant surprise to find that the remaining units had excellent management personnel, and we have not had to bring a single man from the outside into the operation. In relation to our beginning acquisition cost of $7.60 per share (the average cost, however, was $14.86 per share, reflecting very heavy purchases in early 1965), the company on December 31, 1965, had net working capital alone (before placing any value on the plants and equipment) of about $19 per share.

Berkshire is a delight to own. There is no question that the state of the textile industry is the dominant factor in determining the earning power of the business, but we are most fortunate to have Ken Chace running the business in a first-class manner, and we also have several of the best sales people in the business heading up this end of their respective divisions.

While a Berkshire is hardly going to be as profitable as a Xerox, Fairchild Camera or National Video in a hypertensed market, it is a very comfort able sort of thing to own. As my West Coast philosopher says, “It is well to have a diet consisting of oatmeal as well as cream puffs.”

Because of our controlling interest, our investment in Berkshire is valued for our audit as a business, not as a marketable security. If Berkshire advances $5 per share in the market, it does BPL no good - our holdings are not going to be sold. Similarly, if it goes down $5 per share, it is not meaningful to us. The value of our holding is determined directly by the value of the business. I received no divine inspiration in that valuation of our holdings. (Maybe the owners of the three wonder stocks mentioned above do receive such a message in respect to their holdings -I feel I would need something at least that reliable to sleep well at present prices.) I attempt to apply a conservative valuation based upon my knowledge of assets, earning power, industry conditions, competitive position, etc. We would not be a seller of our holdings at such a figure, but neither would we be a seller of the other items in our portfolio at yearend valuations –otherwise, we would already have sold them.

35. The Sorrows of Compounding

Why size is actually the enemy of returns...

Usually, at this point in my letter, I have paused to modestly attempt to set straight the historical errors of the last four or five hundred years. While it might seem difficult to accomplish this in only a few paragraphs a year, I feel I have done my share to reshape world opinion on Columbus, Isabella, Francis I, Peter Minuit and the Manhattan Indians. A by-product of this endeavor has been to demonstrate the overwhelming power of compound interest. To insure reader attention I have entitled these essays "The Joys of Compounding. " The sharp-eyed may notice a slight change this year.

A decent rate (better we have an indecent rate) of compound -plus the addition of substantial new money has brought our beginning capital this year to $43,645,000. Several times in the past I have raised the question whether increasing amounts of capital would harm our investment performance. Each time I have answered negatively and promised you that if my opinion changed, I would promptly report it.

I do not feel that increased capital has hurt our operation to date. As a matter of fact, I believe that we have done somewhat better during the past few years with the capital we have had in the Partnership than we would have done if we had been working with a substantially smaller amount. This was due to the partly fortuitous development of several investments that were just the right size for us -big enough to be significant and small enough to handle.

I now feel that we are much closer to the point where increased size may prove disadvantageous. I don't want to ascribe too much precision to that statement since there are many variables involved. What may be the optimum size under some market and business circumstances can be substantially more or less than optimum under other circumstances. There have been a few times in the past when on a very short-term basis I have felt it would have been advantageous to be smaller but substantially more times when the converse was true.

Nevertheless, as circumstances presently appear, I feel substantially greater size is more likely to harm future results than to help them. This might not be true for my own personal results, but it is likely to be true for your results.

Therefore, unless it appears that circumstances have changed (under some conditions added capital would improve results) or unless new partners can bring some asset to the Partnership other than simply capital, I intend to admit no additional partners to BPL.

The only way to make this effective is to apply it across-the-board and I have notified Susie that if we have any more children, it is up to her to find some other partnership for them.

Because I anticipate that withdrawals (for taxes, among other reasons) may well approach additions by present partners and also because I visualize the curve of expectable performance sloping only very mildly as capital increases, I presently see no reason why we should restrict capital additions by existing partners.

The medically oriented probably will interpret this entire section as conclusive evidence that an effective antithyroid pill has been developed.

36. The diversification essay*

Probably the most rigorous thinking in the collection of letters. It includes a mathematical expectation defined mid sentence, the Noah School of Investing, and portfolio limits set by the width of each idea’s bad tail.

Last year in commenting on the inability of the overwhelming majority of investment managers to achieve performance superior to that of pure chance, I ascribed it primarily to the product of: "(1) group decisions - my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations; (3) an institutional framework whereby average is "safe" and the personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4) an adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.”

This year in the material which went out in November, I specifically called your attention to a new Ground Rule reading, "7. We diversify substantially less than most investment operations. We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could drastically change the underlying value of the investment."

We are obviously following a policy regarding diversification which differs markedly from that of practically all public investment operations. Frankly, there is nothing I would like better than to have 50 different investment opportunities, all of which have a mathematical expectation (this term reflects the range of all possible relative performances, including negative ones, adjusted for the probability of each - no yawning, please) of achieving performance surpassing the Dow by, say, fifteen percentage points per annum. If the fifty individual expectations were not intercorelated (what happens to one is associated with what happens to the other) I could put 2% of our capital into each one and sit back with a very high degree of certainty that our overall results would be very close to such a fifteen percentage point advantage.

It doesn't work that way.

We have to work extremely hard to find just a very few attractive investment situations. Such a situation by definition is one where my expectation (defined as above) of performance is at least ten percentage points per annum superior to the Dow. Among the few we do find, the expectations vary substantially. The question always is, “How much do I put in number one (ranked by expectation of relative performance) and how much do I put in number eight?" This depends to a great degree on the wideness of the spread between the mathematical expectation of number one versus number eight.” It also depends upon the probability that number one could turn in a really poor relative performance. Two securities could have equal mathematical expectations, but one might have .05 chance of performing fifteen percentage points or more worse than the Dow, and the second might have only .01 chance of such performance. The wider range of expectation in the first case reduces the desirability of heavy concentration in it.

The above may make the whole operation sound very precise. It isn't. Nevertheless, our business is that of ascertaining facts and then applying experience and reason to such facts to reach expectations. Imprecise and emotionally influenced as our attempts may be, that is what the business is all about. The results of many years of decision-making in securities will demonstrate how well you are doing on making such calculations - whether you consciously realize you are making the calculations or not. I believe the investor operates at a distinct advantage when he is aware of what path his thought process is following.

There is one thing of which I can assure you. If good performance of the fund is even a minor objective, any portfolio encompassing one hundred stocks (whether the manager is handling one thousand dollars or one billion dollars) is not being operated logically. The addition of the one hundredth stock simply can't reduce the potential variance in portfolio performance sufficiently to compensate for the negative effect its inclusion has on the overall portfolio expectation.

Anyone owning such numbers of securities after presumably studying their investment merit (and I don't care how prestigious their labels) is following what I call the Noah School of Investing - two of everything. Such investors should be piloting arks. While Noah may have been acting in accord with certain time-tested biological principles, the investors have left the track regarding mathematical principles. (I only made it through plane geometry, but with one exception, I have carefully screened out the mathematicians from our Partnership.)

Of course, the fact that someone else is behaving illogically in owning one hundred securities doesn't prove our case. While they may be wrong in overdiversifying, we have to affirmatively reason through a proper diversification policy in terms of our objectives.

The optimum portfolio depends on the various expectations of choices available and the degree of variance in performance which is tolerable. The greater the number of selections, the less will be the average year-to-year variation in actual versus expected results. Also, the lower will be the expected results, assuming different choices have different expectations of performance.

I am willing to give up quite a bit in terms of leveling of year-to-year results (remember when I talk of “results,” I am talking of performance relative to the Dow) in order to achieve better overall long-term performance. Simply stated, this means I am willing to concentrate quite heavily in what I believe to be the best investment opportunities recognizing very well that this may cause an occasional very sour year - one somewhat more sour, probably, than if I had diversified more. While this means our results will bounce around more, I think it also means that our long-term margin of superiority should be greater.

You have already seen some examples of this. Our margin versus the Dow has ranged from 2.4 percentage points in 1958 to 33.0 points in 1965. If you check this against the deviations of the funds listed on page three, you will find our variations have a much wider amplitude. I could have operated in such a manner as to reduce our amplitude, but I would also have reduced our overall performance somewhat although it still would have substantially exceeded that of the investment companies. Looking back, and continuing to think this problem through, I feel that if anything, I should have concentrated slightly more than I have in the past. Hence, the new Ground Rule and this long-winded explanation.

Again let me state that this is somewhat unconventional reasoning (this doesn't make it right or wrong - it does mean you have to do your own thinking on it), and you may well have a different opinion - if you do, the Partnership is not the place for you. We are obviously only going to go to 40% in very rare situations - this rarity, of course, is what makes it necessary that we concentrate so heavily, when we see such an opportunity. We probably have had only five or six situations in the nine-year history of the Partnership where we have exceeded 25%. Any such situations are going to have to promise very significantly superior performance relative to the Dow compared to other opportunities available at the time. They are also going to have to possess such superior qualitative and/or quantitative factors that the chance of serious permanent loss is minimal (anything can happen on a short-term quotational basis which partially explains the greater risk of widened yearto-year variation in results). In selecting the limit to which I will go in anyone investment, I attempt to reduce to a tiny figure the probability that the single investment (or group, if there is intercorrelation) can produce a result for our total portfolio that would be more than ten percentage points poorer than the Dow.

We presently have two situations in the over 25% category - one a controlled company, and the other a large company where we will never take an active part. It is worth pointing out that our performance in 1965 was overwhelmingly the product of five investment situations. The 1965 gains (in some cases there were also gains applicable to the same holding in prior years) from these situations ranged from about $800,000 to about $3 1/2 million. If you should take the overall performance of our five smallest general investments in 1965, the results are lackluster (I chose a very charitable adjective).

Interestingly enough, the literature of investment management is virtually devoid of material relative to deductive calculation of optimal diversification. All texts counsel "adequate" diversification, but the ones who quantify "adequate" virtually never explain how they arrive at their conclusion. Hence, for our summation on overdiversification, we turn to that eminent academician Billy Rose, who says, "You've got a harem of seventy girls; you don't get to know any of them very well.”

37. The eight giants

$100,000 split among the bluest chips on earth on January 1, 1966; $83,370 six months later.

During the first half of 1966, the Dow-Jones Industrial Average (hereinafter called the "Dow") declined from 969.26 to 870.10. If one had owned the Dow during this period, dividends of approximately 14.70 would have been received, reducing the overall loss of the Dow to about 8.7%.

It is my objective and my hope (but not my prediction!) that we achieve over a long period of time, an average yearly advantage of ten percentage points relative to the Dow. During the first half we did considerably better than expected with an overall gain of approximately 8.2%. Such results should be regarded as decidedly abnormal. I have previously complimented partners on the good-natured tolerance they display in shrugging off such unexpected positive variances. The nature of our business is such that over the years, we will not disappoint the many of you who must also desire a test of your capacity for tolerance of negative variances.

Even Samson gets clipped occasionally. If you had invested $100.000 on January 1 equally among:

• the world's largest auto company (General Motors);

• the world's largest oil company (Standard of New Jersey);

• the world's largest retailing company (Sears Roebuck);

• the world's largest chemical company (Dupont);

• the world's largest steel company (U.S. Steel);

• the world's largest stockholder-owned insurance company (Aetna);

• the world’s largest public utility (American Telephone & Telegraph);

• the world's largest bank (Bank of America);

your total portfolio (including dividends received) would have been worth $83,370 on June 30 for a loss of 16.6%. The total market value on January 1 of these eight giants was well over $100 billion. Everyone of them was selling lower on June 30.

38. Hochschild Kohn and the iceberg

His first negotiated purchase of an entire business, and an important disclosure: newsworthiness is not financial significance.

During the first half we, and two 10% partners, purchased all of the stock of Hochschild, Kohn & Co., a privately owned Baltimore department store. This is the first time in the history of the Partnership that an entire business has been purchased by negotiation, although we have, from time to time, negotiated purchase of specific important blocks of marketable securities. However, no new principles are involved. The quantitative and qualitative aspects of the business are evaluated and weighed against price, both on an absolute basis and relative to other investment opportunities. HK (learn to call it that - I didn't find out how to pronounce it until the deal was concluded) stacks up fine in all respects.

We have topnotch people (both from a personal and business standpoint) handling the operation. Despite the edge that my extensive 75 cents an hour experience at the Penney's store in Omaha some years back gives us (I became an authority on the Minimum Wage Act), they will continue to run the business as in the past. Even if the price had been cheaper but the management had been run-of-the-mill, we would not have bought the business.

It is impossible to avoid some public notice when a business with several thousand employees is acquired. However, it is important that you do not infer the degree of financial importance to BPL from its news value to the public. We have something over $50 million invested, primarily in marketable securities, of which only about 10% is represented by our net investment in HK. We have an investment of over three times this much in a marketable security where our ownership will never come to public attention. This is not to say an HK is not important - a 10% holding definitely is. However, it is not as significant relative to our total operation as it would be easy to think. I still prefer the iceberg approach toward investment disclosure.

It is my intention to value HK at yearend at cost plus our share of retained earnings since purchase. This policy will be followed in future years unless there is a demonstrable change in our position relative to other department stores or in other objective standards of value. Naturally we wouldn't have purchased HK unless we felt the price was quite attractive. Therefore, a valuation policy based upon cost may somewhat undervalue our holdings. Nevertheless, it seems the most objective figure to apply. All of our investments usually appear undervalued to me - otherwise we wouldn't own them.

39. The sermon on market forecasting*

Written because partners phoned after a 100-point slide to say the market was going lower. If they knew in February, why didn’t they call then; if they didn’t know in February, how do they know in May. “What should happen, not when it should happen.”

Ground Rule No.6 (from our November packet) says: “I am not in the business of predicting general stock market or business fluctuations. If you think I can do this, or think it is essential to an investment program, you should not be in the partnership.”

Of course, this rule can be attacked as fuzzy, complex, ambiguous, vague, etc. Nevertheless, I think the point is well understood by the great majority of our partners. We don't buy and sell stocks based upon what other people think the stock market is going to do (I never have an opinion) but rather upon what we think the company is going to do. The course of the stock market will determine, to a great degree, when we will be right, but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen, not when it should happen.

In our department store business I can say with considerable assurance that December will be better than July. (Notice how sophisticated I have already become about retailing.) What really counts is whether December is better than last December by a margin greater than our competitors' and what we are doing to set the stage for future Decembers. However, in our partnership business I not only can't say whether December will be better than July, but I can't even say that December won't produce a very large loss. It sometimes does. Our investments are simply not aware that it takes 365-1/4 days for the earth to make it around the sun. Even worse, they are not aware that your celestial orientation (and that of the IRS) requires that I report to you upon the conclusion of each orbit (the earth's - not ours). Therefore, we have to use a standard other than the calendar to measure our progress. This yardstick is obviously the general experience in securities as measured by the Dow. We have a strong feeling that this competitor will do quite decently over a period of years (Christmas will come even if it's in July) and if we keep beating our competitor we will have to do something better than "quite decently". It's something like a retailer measuring his sales gains and profit margins against Sears' - beat them every year and somehow you'll see daylight.

I resurrect this "market-guessing" section only because after the Dow declined from 995 at the peak in February to about 865 in May, I received a few calls from partners suggesting that they thought stocks were going a lot lower. This always raises two questions in my mind: (1) if they knew in February that the Dow was going to 865 in May, why didn't they let me in on it then; and, (2) if they didn't know what was going to happen during the ensuing three months back in February, how do they know in May? There is also a voice or two after any hundred point or so decline suggesting we sell and wait until the future is clearer. Let me again suggest two points: (1) the future has never been clear to me (give us a call when the next few months are obvious to you – or, for that matter the next few hours); and, (2) no one ever seems to call after the market has gone up one hundred points to focus my attention on how unclear everything is, even though the view back in February doesn't look so clear in retrospect.

If we start deciding, based on guesses or emotions, whether we will or won't participate in a business where we should have some long run edge, we're in trouble. We will not sell our interests in businesses (stocks) when they are attractively priced just because some astrologer thinks the quotations may go lower even though such forecasts are obviously going to be right some of the time. Similarly, we will not buy fully priced securities because "experts" think prices are going higher. Who would think of buying or selling a private business because of someone's guess on the stock market? The availability of a question for your business interest (stock) should always be an asset to be utilized if desired. If it gets silly enough in either direction, you take advantage of it. Its availability should never be turned into a liability whereby its periodic aberrations in turn formulate your judgments. A marvelous articulation of this idea is contained in chapter two (The Investor and Stock Market Fluctuations) of Benjamin Graham's "The Intelligent Investor". In my opinion, this chapter has more investment importance than anything else that has been written.

Part Five: The Hinge (1967 to 1968)

40. The first decade, and the trickle*

The tenth-anniversary self-audit: a hardy little band on the west banks of the Missouri, $105,100, and now a confession that real ideas arrive two or three times a year. He discusses the circle of competence (he knows as much about semiconductors as about the mating habits of the chrząszcz!) and the refusal of fashion investing on grounds of intellect and temperament.

A keen mind working diligently at interpreting the figures on page one could come to a lot of wrong conclusions.

The results of the first ten years have absolutely no chance of being duplicated or even remotely approximated during the next decade. They may well be achieved by some hungry twenty-five year old working with $105,100 initial partnership capital and operating during a ten year business and market environment which is frequently conducive to successful implementation of his investment philosophy.

They will not be achieved by a better fed thirty-six year old working with our $54,065,345 current partnership capital who presently finds perhaps one-fifth to one-tenth as many really good ideas as previously to implement his investment philosophy.

Buffett Associates. Ltd. (predecessor to Buffett Partnership. Ltd.) was founded on the west banks of the Missouri. May 5. 1956 by a hardy little band consisting of four family members, three close friends and $105,100. (I tried to find some brilliant flash of insight regarding our future or present conditions from my first page and a half annual letter of January, 1957 to insert as a quote here. However, someone evidently doctored my file copy so as to remove the perceptive remarks I must have made.)

At that time, and for some years subsequently, there were substantial numbers of securities selling at well below the "value to a private owner" criterion we utilized for selection of general market investments. We also experienced a flow of “workout” opportunities where the percentages were very much to our liking. The problem was always which, not what. Accordingly, we were able to own fifteen to twenty-five issues and be enthusiastic about the probabilities inherent in all holdings.

In the last few years this situation has changed dramatically. We now find very few securities that are understandable to me, available in decent size, and which offer the expectation of investment performance meeting our yardstick of ten percentage points per annum superior to the Dow. In the last three years we have come up with only two or three new ideas a year that have had such an expectancy of superior performance. Fortunately, in some cases, we have made the most of them. However, in earlier years, a lesser effort produced literally dozens of comparable opportunities. It is difficult to be objective about the causes for such diminution of one's own productivity. Three factors that seem apparent are: (1) a somewhat changed market environment; (2) our increased size; and (3) substantially more competition.

It is obvious that a business based upon only a trickle of fine ideas has poorer prospects than one based upon a steady flow of such ideas. To date the trickle has provided as much financial nourishment as the flow. This is true because there is only so much one can digest (million dollar ideas are of no great benefit to thousand dollar bank accounts - this was impressed on me in my early days) and because a limited number of ideas causes one to utilize those available more intensively. The latter factor has definitely been operative with us in recent years. However, a trickle has considerably more chance of drying up completely than a flow.

These conditions will not cause me to attempt investment decisions outside my sphere of understanding (I don't go for the "If you can't lick 'em, join 'em” philosophy - my own leaning is toward "If you can't join ‘em, lick 'em”). We will not go into businesses where technology which is away over my head is crucial to the investment decision. I know about as much about semi-conductors or integrated circuits as I do of the mating habits of the chrzaszcz. (That's a Polish May bug, students - if you have trouble pronouncing it, rhyme it with thrzaszcz.)

Furthermore, we will not follow the frequently prevalent approach of investing in securities where an attempt to anticipate market action overrides business valuations. Such so-called "fashion" investing has frequently produced very substantial and quick profits in recent years (and currently as I write this in January). It represents an investment technique whose soundness I can neither affirm nor deny. It does not completely satisfy my intellect (or perhaps my prejudices), and most definitely does not fit my temperament. I will not invest my own money based upon such an approach hence, I will most certainly not do so with your money.

Finally, we will not seek out activity in investment operations, even if offering splendid profit expectations, where major human problems appear to have a substantial chance of developing.

What I do promise you, as partners, is that I will work hard to maintain the trickle of ideas and try to get the most out of it that is possible – but if it should dry up completely, you will be informed honestly and promptly so that we may all take alternative action.

41. October 9, 1967*

The investing environment has fundamentally changed. Obvious, statistically cheap stocks have become scarce, markets react faster, and managing more capital makes outperforming much harder. The most important change in his career starts here.

Over the past eleven years, I have consistently set forth as the BPL investment goal an average advantage in our performance of ten percentage points per annum in comparison with the Dow Jones Industrial Average. Under the environment that existed during that period. I have considered such an objective difficult but obtainable.

The following conditions now make a change in yardsticks appropriate:

1. The market environment has changed progressively over the past decade, resulting in a sharp diminution in the number of obvious quantitatively based investment bargains available;

2. Mushrooming interest in investment performance (which has its ironical aspects since I was among a lonely few preaching the importance of this some years ago) has created a hyper-reactive pattern of market behavior against which my analytical techniques have limited value;

3. The enlargement of our capital base to about $65 million when applied against a diminishing trickle of good investment ideas has continued to present the problems mentioned in the January, 1967 letter; and

4. My own personal interests dictate a less compulsive approach to superior investment results than when I was younger and leaner.

Let's look at each of these factors in more detail.

The evaluation of securities and businesses for investment purposes has always involved a mixture of qualitative and quantitative factors. At the one extreme, the analyst exclusively oriented to qualitative factors would say. "Buy the right company (with the right prospects, inherent industry conditions, management, etc.) and the price will take care of itself.” On the other hand, the quantitative spokesman would say, “Buy at the right price and the company (and stock) will take care of itself.” As is so often the pleasant result in the securities world, money can be made with either approach. And, of course, any analyst combines the two to some extent - his classification in either school would depend on the relative weight he assigns to the various factors and not to his consideration of one group of factors to the exclusion of the other group.

Interestingly enough, although I consider myself to be primarily in the quantitative school (and as I write this no one has come back from recess - I may be the only one left in the class), the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a "high-probability insight". This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side - the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.

Such statistical bargains have tended to disappear over the years. This may be due to the constant combing and recombing of investments that has occurred during the past twenty years, without an economic convulsion such as that of the ‘30s to create a negative bias toward equities and spawn hundreds of new bargain securities. It may be due to the new growing social acceptance, and therefore usage (or maybe it's vice versa - I'll let the behaviorists figure it out) of takeover bids which have a natural tendency to focus on bargain issues. It may be due to the exploding ranks of security analysts bringing forth an intensified scrutiny of issues far beyond what existed some years ago. Whatever the cause, the result has been the virtual disappearance of the bargain issue as determined quantitatively - and thereby of our bread and butter. There still may be a few from time to time. There will also be the occasional security where I am really competent to make an important qualitative judgment. This will offer our best chance for large profits. Such instances will. however, be rare. Much of our good performance during the past three years has been due to a single idea of this sort.

The next point of difficulty is the intensified interest in investment performance. For years I have preached the importance of measurement. Consistently I have told partners that unless our performance was better than average, the money should go elsewhere. In recent years this idea has gained momentum throughout the investment (or more importantly, the investing) community. In the last year or two it has started to look a bit like a tidal wave. I think we are witnessing the distortion of a sound idea.

I have always cautioned partners that I considered three years a minimum in determining whether we were "performing". Naturally, as the investment public has taken the bit in its teeth, the time span of expectations has been consistently reduced to the point where investment performance by large aggregates of money is being measured yearly, quarterly, monthly, and perhaps sometimes even more frequently (leading to what is known as "instant research"). The payoff for superior short term performance has become enormous, not only in compensation for results actually achieved, but in the attraction of new money for the next round. Thus a self-generating type of activity has set in which leads to larger and larger amounts of money participating on a shorter and shorter time span. A disturbing corollary is that the vehicle for participation (the particular companies or stocks) becomes progressively less important - at times virtually incidental - as the activity accelerates.

In my opinion what is resulting is speculation on an increasing scale. This is hardly a new phenomenon; however, a dimension has been added by the growing ranks of professional (in many cases formerly quite docile) investors who feel they must “get aboard”. The game is dignified, of course, by appropriate ceremonies, personages and lexicon. To date it has been highly profitable. It may also be that this is going to be the standard nature of the market in the future. Nevertheless, it is an activity at which I am sure I would not do particularly well. As I said on page five of my last annual letter,

"Furthermore, we will not follow the frequently prevalent approach of investing in securities where an attempt to anticipate market action overrides business valuations. Such so-called 'fashion' investing has frequently produced very substantial and quick profits in recent years (and currently as I write this in January). It represents an investment technique whose soundness I can neither affirm nor deny. It does not completely satisfy my intellect (or perhaps my prejudices), and most definitely does not fit my temperament. I will not invest my own money based upon such an approach – hence, I will most certainly not do so with your money.”

Any form of hyper-activity with large amounts of money in securities markets can create problems for all participants. I make no attempt to guess the action of the stock market and haven't the foggiest notion as to whether the Dow will be at 600, 900 or 1200 a year from now. Even if there are serious consequences resulting from present and future speculative activity, experience suggests estimates of timing are meaningless. However, I do believe certain conditions that now exist are likely to make activity in markets more difficult for us for the intermediate future.

The above may simply be "old-fogeyism" (after all, I am 37). When the game is no longer being played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, etc. I have been scornful of such behavior by others in the past. I have also seen the penalties incurred by those who evaluate conditions as they were - not as they are. Essentially I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand (although I find it difficult to apply) even though it may mean foregoing large and apparently easy, profits to embrace an approach which I don’t fully understand, have not practiced successfully and which, possibly, could lead to substantial permanent loss of capital.

The third point of difficulty involves our much greater base of capital. For years my investment ideas were anywhere from 110% to 1000% of our capital. It was difficult for me to conceive that a different condition could ever exist. I promised to tell partners when it did and in my January, 1967 letter had to make good on that promise. Largely because of the two conditions previously mentioned, our greater capital is now something of a drag on performance. I believe it is the least significant factor of the four mentioned, and that if we were operating with one-tenth of our present capital our performance would be little better. However, increased funds are presently a moderately negative factor.

The final, and most important, consideration concerns personal motivation. When I started the partnership I set the motor that regulated the treadmill at "ten points better than the DOW". I was younger, poorer and probably more competitive. Even without the three previously discussed external factors making for poorer performance. I would still feel that changed personal conditions make it advisable to reduce the speed of the treadmill. I have observed many cases of habit patterns in all activities of life, particularly business, continuing (and becoming accentuated as years pass) long after they ceased making sense. Bertrand Russell has related the story of two Lithuanian girls who lived at his manor subsequent to World War I. Regularly each evening after the house was dark, they would sneak out and steal vegetables from the neighbors for hoarding in their rooms; this despite the fact that food was bountiful at the Russell table. Lord Russell explained to the girls that while such behavior may have made a great deal of sense in Lithuania during the war, it was somewhat out of place in the English countryside. He received assenting nods and continued stealing.

He finally contented himself with the observation that their behavior, strange as it might seem to the neighbors, was really not so different from that of the elder Rockefeller.

Elementary self-analysis tells me that I will not be capable of less than all-out effort to achieve a publicly proclaimed goal to people who have entrusted their capital to me. All-out effort makes progressively less sense. I would like to have an economic goal which allows for considerable non-economic activity. This may mean activity outside the field of investments or it simply may mean pursuing lines within the investment field that do not promise the greatest economic reward. An example of the latter might be the continued investment in a satisfactory (but far from spectacular) controlled business where I liked the people and the nature of the business even though alternative investments offered an expectable higher rate of return. More money would be made buying businesses at attractive prices, then reselling them. However, it may be more enjoyable (particularly when the personal value of incremental capital is less) to continue to own them and hopefully improve their performance, usually in a minor way, through some decisions involving financial strategy.

Thus, I am likely to limit myself to things which are reasonably easy, safe, profitable and pleasant. This will not make our operation more conservative than in the past since I believe, undoubtedly with some bias, that we have always operated with considerable conservatism. The long-term downside risk will not be less; the upside potential will merely be less.

Specifically, our longer term goal will be to achieve the lesser of 9% per annum or a five percentage point advantage over the Dow. Thus, if the Dow averages -2% over the next five years, I would hope to average +3% but if the Dow averages +12%, I will hope to achieve an average of only +9%. These may be limited objectives, but I consider it no more likely that we will achieve even these more modest results under present conditions than I formerly did that we would achieve our previous goal of a ten percentage point average annual edge over the Dow. Furthermore, I hope limited objectives will make for more limited effort (I'm quite sure the converse is true).

I will incorporate this new goal into the Ground Rules to be mailed you about November 1, along with the 1968 Commitment Letter. I wanted to get this letter off to you prior to that mailing so you would have ample time to consider your personal situation, and if necessary get in touch with me to clear up some of the enclosed, before making a decision on 1968. As always, I intend to continue to leave virtually all of my capital (excluding Data Documents stock), along with that of my family, in BPL. What I consider satisfactory and achievable may well be different from what you consider so. Partners with attractive alternative investment opportunities may logically decide that their funds can be better employed elsewhere, and you can be sure I will be wholly in sympathy with such a decision.

I have always found behavior most distasteful which publicly announces one set of goals and motivations when actually an entirely different set of factors prevails. Therefore, I have always tried to be l00% candid with you about my goals and personal feelings so you aren't making important decisions pursuant to phony proclamations (I've run into a few of these in our investment experience). Obviously all the conditions enumerated in this letter haven't appeared overnight. I have been thinking about some of the points involved for a long period of time. You can understand, I am sure, that I wanted to pick a time when past goals had been achieved to set forth a reduction in future goals. I would not want to reduce the speed of the treadmill unless I had fulfilled my objectives to this point.

42. Rained gold

A year when gold rained and the bass tuba was the wrong instrument. Buffett also includes Ben Graham’s line that speculation is “neither illegal, immoral nor fattening”.

By most standards, we had a good year in 1967. Our overall performance was plus 35.9% compared to plus 19.0% for the Dow, thus surpassing our previous objective of performance ten points superior to the Dow. Our overall gain was $19,384,250 which, even under accelerating inflation, will buy a lot of Pepsi. And, due to the sale of some longstanding large positions in marketable securities, we had realized taxable income of $27,376,667 which has nothing to do with 1967 performance but should give all of you a feeling of vigorous participation in The Great Society on April 15th.

The minor thrills described above are tempered by any close observation of what really took place in the stock market during 1967. Probably a greater percentage of participants in the securities markets did substantially better than the Dow last year than in virtually any year in history. In 1967, for many, it rained gold and it paid to be out playing the bass tuba. I don't have a final tabulation at this time but my guess is that at least 95% of investment companies following a common stock program achieved better results than the Dow - in many cases by very substantial amounts. It was a year when profits achieved were in inverse proportion to age - and I am in the geriatric ward, philosophically.

My mentor, Ben Graham, used to say. “Speculation is neither illegal, immoral nor fattening (financially).” During the past year, it was possible to become fiscally flabby through a steady diet of speculative bonbons. We continue to eat oatmeal but if indigestion should set in generally, it is unrealistic to expect that we won’t have some discomfort.

43. The pleasant-business confession*

The paragraph where Berkshire’s future is decided. He will not trade known pleasant relationships with highgrade people, at a satisfactory return, for possible irritation and aggravation at higher ones.

Our investment in controlled companies was a similar drag on relative performance in 1967, but this is to be expected in strong markets. On an average investment of $20,192,776 we had an overall gain of $2,894,571. I am pleased with this sort of performance, even though this category will continue to underperform if the market continues strong during 1968. Through our two controlled companies (Diversified Retailing and Berkshire Hathaway), we acquired two new enterprises in 1967. Associated Cotton Shops and National Indemnity (along with National Fire & Marine, an affiliated company). These acquisitions couldn't be more gratifying. Everything was as advertised or better. The principal selling executives, Ben Rosner and Jack Ringwalt, have continued to do a superb job (the only kind they know), and in every respect have far more than lived up to their end of the bargain.

The satisfying nature of our activity in controlled companies is a minor reason for the moderated investment objectives discussed in the October 9th letter. When I am dealing with people I like, in businesses I find stimulating (what business isn't ?), and achieving worthwhile overall returns on capital employed (say, 10 -12%), it seems foolish to rush from situation to situation to earn a few more percentage points. It also does not seem sensible to me to trade known pleasant personal relationships with high grade people, at a decent rate of return, for possible irritation, aggravation or worse at potentially higher returns. Hence, we will continue to keep a portion of our capital (but not over 40% because of the possible liquidity requirements arising from the nature of our partnership agreement) invested in controlled operating businesses at an expected rate of return below that inherent in an aggressive stock market operation.

44. Worst category, and “Definitely, no”

Work-outs at this size just aren't “working-out” anymore.

We had our worst performance in history in the “Workout” section. In the 1965 letter, this category was defined as, “...securities with a timetable. They arise from corporate activity -- sell-outs, mergers, reorganizations, spin-offs, etc. In this category, we are not talking about rumors or inside information pertaining to such developments, but to publicly announced activities of this sort. We wait until we can read it in the paper. The risk does not pertain primarily to general market behavior (although that is sometimes tied in. to a degree). but instead to something upsetting the applecart so that the expected corporate development does not materialize.”

The streets were filled with upset applecarts - our applecarts - during 1967. Thus, on an average investment of $17,246,879, our overall gain was $153,273. For those of you whose slide rule does not go to such insulting depths, this represents a return of .89 of 1%. While I don't have complete figures. I doubt that we have been below 10% in any past year. As in other categories, we tend to concentrate our investments in the workout category in just a few situations per year. This technique gives more variation in yearly results than would be the case if we used an across-the-board approach. I believe our approach will result in as great (or greater) profitability on a long-term basis, but you can't prove it by 1967.

45. Chain letters

The entrepreneur who believed in “bold, imaginative accounting.”

I make no effort to predict the course of general business or the stock market. Period. However, currently there are practices snowballing in the security markets and business world which, while devoid of short term predictive value, bother me as to possible long term consequences.

I know that some of you are not particularly interested (and shouldn't be) in what is taking place on the financial stage. For those who are, I am enclosing a reprint of an unusually clear and simple article which lays bare just what is occurring on a mushrooming scale. Spectacular amounts of money are being made by those participating (whether as originators, top employees. professional advisors, investment bankers, stock speculators, etc… ) in the chain-letter type stock-promotion vogue. The game is being played by the gullible, the self-hypnotized, and the cynical. To create the proper illusions, it frequently requires accounting distortions (one particularly progressive entrepreneur told me he believed in "bold, imaginative accounting"), tricks of capitalization and camouflage of the true nature of the operating businesses involved. The end product is popular, respectable and immensely profitable (I'll let the philosophers figure in which order those adjectives should be placed).

Quite candidly, our own performance has been substantially improved on an indirect basis because of the fallout from such activities. To create an ever widening circle of chain letters requires increasing amounts of corporate raw material and this has caused many intrinsically cheap (and not so cheap) stocks to come to life. When we have been the owners of such stocks, we have reaped market rewards much more promptly than might otherwise have been the case. The appetite for such companies, however, tends to substantially diminish the number of fundamentally attractive investments which remain.

I believe the odds are good that, when the stock market and business history of this period is being written, the phenomenon described in Mr. May's article will be regarded as of major importance, and perhaps characterized as a mania. You should realize, however, that his "The Emperor Has No Clothes" approach is at odds (or dismissed with a “SO What?” or an "Enjoy, Enjoy”) with the views of most investment banking houses and currently successful investment managers. We live in an investment world, populated not by those who must be logically persuaded to believe, but by the hopeful, credulous and greedy, grasping for an excuse to believe.

Finally, for a magnificent account of the current financial scene, you should hurry out and get a copy of “The Money Game” by Adam Smith. It is loaded with insights and supreme wit. (Note: Despite my current “Support Your Local Postmaster” drive, I am not enclosing the book with this letter - it retails for $6.95.)

Part Six: The Exit (1969 to 1970)

46. Thirteen spades

The best year in partnership history, plus 58.8 against 7.7, reported as a freak hand of bridge; with the money manager who must study securities minute-by-minute.

At the beginning of 1968, I felt prospects for BPL performance looked poorer than at any time in our history. However, due in considerable measure to one simple but sound idea whose time had come (investment ideas, like women are often more exciting than punctual), we recorded an overall gain of $40,032,691.

Naturally, you all possess sufficient intellectual purity to dismiss the dollar result and demand an accounting of performance relative to the Dow-Jones Industrial Average. We established a new mark at plus 58.8% versus an overall plus 7.7 % for the Dow, including dividends which would have been received through ownership of the Average throughout the year. This result should be treated as a freak like picking up thirteen spades in a bridge game. You bid the slam, make it look modest, pocket the money and then get back to work on the part scores. We will also have our share of hands when we go set.

The following summarizes the year-by-year performance of the Dow, the Partnership before allocation (one quarter of the excess over 6%) to the General Partner and the results for limited partners:

It is interesting that after twelve years these four funds (which presently aggregate well over $5 billion and account for over 10% of the investment company industry) have averaged only a fraction of one percentage point annually better than the Dow.

Some of the so-called “go-go” funds have recently been re-christened “no-go” funds. For example, Gerald Tsai's Manhattan Fund, perhaps the world's best-known aggressive investment vehicle, came in at minus 6.9% for 1968. Many smaller investment entities continued to substantially outperform the general market in 1968, but in nothing like the quantities of 1966 and 1967.

The investment management business, which I used to severely chastise in this section for excessive lethargy, has now swung in many quarters to acute hypertension. One investment manager, representing an organization (with an old established name you would recognize) handling mutual funds aggregating well over $1 billion, said upon launching a new advisory service in 1968:

“The complexities of national and international economics make money management a full-time job. A good money manager cannot maintain a study of securities on a week-by-week or even a day-by-day basis. Securities must be studied in a minute-by-minute program.”

Wow!

This sort of stuff makes me feel guilty when I go out for a Pepsi. When practiced by large and increasing numbers of highly motivated people with huge amounts of money on a limited quantity of suitable securities, the result becomes highly unpredictable. In some ways it is fascinating to watch and in other ways it is appalling.

47. Floods, faucets, and the plaque

The Johnstown flood of 1968 becoming a leaky faucet in Altoona; the plaque at Texas Instruments about relying on miracles; the old ballplayer whose pinch-hit homer changes nothing about the lineup. Nearby sits the first appearance of the most famous ten words he ever wrote, “Price is what you pay. Value is what you get.”

Over the years this (generals, private owner) has been our best category, measured by average return, and has also maintained by far the best percentage of profitable transactions. This approach was the way I was taught the business, and it formerly accounted for a large proportion of all our investment ideas. Our total individual profits in this category during the twelve year BPL history are probably fifty times or more our total losses. The cash register really rang on one simple industry idea (implemented in several ways) in this area in 1968. We even received a substantial fee (included in Other Income in the audit) for some work in this field.

Our total investment in this category (which is where I feel by far the greatest certainty regarding consistently decent results) is presently under $2 million and I have nothing at all in the hopper to bolster this. What came through like the Johnstown flood in 1968 looks more like a leaky faucet in Altoona for 1969.

******************************

I can't emphasize too strongly that the quality and quantity of ideas is presently at an all time low - the product of the factors mentioned in my October 9th, 1967 letter, which have largely been intensified since then.

Sometimes I feel we should have a plaque in our office like the one at the headquarters of Texas Instruments in Dallas which reads: “We don't believe in miracles, we rely on them.” It is possible for an old, overweight ball player, whose legs and batting eye are gone, to tag a fast ball on the nose for a pinch-hit home run, but you don't change your line-up because of it.

We have a number of important negatives operating on our future and, while they shouldn't add up to futility, they certainly don't add up to more than an average of quite moderate profitability.

48. Memorabilia*

Looking back with nostalgia…

As one of my older friends says, “Nostalgia just isn't what it used to be.” Let's take a stab at it, anyway.

Buffett Associates, Ltd., the initial predecessor partnership, was formed May 5, 1956 with seven limited partners (four family, three close friends), contributing $105,000, and the General Partner putting his money where his mouth was by investing $100. Two additional single-family limited partnerships were formed during 1956, so that on January 1, 1957 combined net assets were $303,726. During 1957, we had a gain of $31,615.97, leading to the 10.4% figure shown on page one. During 1968 I would guess that the New York Stock Exchange was open around 1,200 hours, giving us a gain of about $33,000 per hour (sort of makes you wish they had stayed with the 5-1/2 hour, 5 day week, doesn't it), or roughly the same as the full year gain in 1957.

On January 1, 1962 we consolidated the predecessor limited partnerships moved out of the bedroom and hired our first full-time employees. Net assets at that time were $7,178,500. From that point to our present net assets of $104,429,431 we have added one person to the payroll. Since 1963 (Assets $9,405,400) rent has gone from $3,947 to $5,823 (Ben Rosner would never have forgiven me if I had signed a percentage lease) travel from $3,206 to $3,603, and dues and subscriptions from $900 to $994. If one of Parkinson's Laws is operating, at least the situation hasn't gotten completely out of control.

In making our retrospective survey of our financial assets, our conclusion need not parallel that of Gypsy Rose Lee who opined, when reviewing her physical assets on her fifty-fifth birthday: “I have everything I had twenty years ago - it's just that it's all lower.”

49. May 29, 1969*

The resignation of the century, four pages long.

About eighteen months ago I wrote to you regarding changed environmental and personal factors causing me to modify our future performance objectives.

The investing environment I discussed at that time (and on which I have commented in various other letters has generally become more negative and frustrating as time has passed. Maybe I am merely suffering from a lack of mental flexibility. (One observer commenting on security analysts over forty stated: “They know too many things that are no longer true.”)

However, it seems to me that: (1) opportunities for investment that are open to the analyst who stresses quantitative factors have virtually disappeared, after rather steadily drying up over the past twenty years; (2) our $100 million of assets further eliminates a large portion of this seemingly barren investment world, since commitments of less than about $3 million cannot have a real impact on our overall performance, and this virtually rules out companies with less than about $100 million of common stock at market value; and (3) a swelling interest in investment performance has created an increasingly short-term oriented and (in my opinion) more speculative market.

The October 9th, 1967 letter stated that personal considerations were the most important factor among those causing me to modify our objectives. I expressed a desire to be relieved of the (self-imposed) necessity of focusing 100% on BPL. I have flunked this test completely during the last eighteen months. The letter said: I hope limited objectives will make for more limited effort. It hasn't worked out that way. As long as I am “on stage”, publishing a regular record and assuming responsibility for management of what amounts to virtually 100% of the net worth of many partners, I will never be able to put sustained effort into any non-BPL activity. If I am going to participate publicly. I can't help being competitive. I know I don't want to be totally occupied with out-pacing an investment rabbit all my life. The only way to slow down is to stop.

Therefore, before yearend. I intend to give all limited partners the required formal notice of my intention to retire. There are, of course, a number of tax and legal problems in connection with liquidating the Partnership, but overall, I am concerned with working out a plan that attains the following objectives:

1. The most important item is that I have an alternative regarding money management to suggest to the many partners who do not want to handle this themselves. Some partners of course, have alternatives of their own in which they have confidence and find quite acceptable. To the others, however, I will not hand over their money with a "good luck". I intend to suggest an alternative money manager to whom I will entrust funds of my relatives and others for whom I have lifetime financial responsibility. This manager has integrity and ability and will probably perform as well or better than I would in the future (although nowhere close to what he or I have achieved in the past). He will be available to any partner, so that no minimum size for accounts will cause any of you a problem. I intend, in the future, to keep in general touch with what he is doing, but only on an infrequent basis with any advice on my part largely limited to a negative type.

2. I want all partners to have the option of receiving cash and possibly readily marketable securities (there will probably be only one where this will apply) where I like both the prospects and price but which partners will be able to freely convert to cash if they wish.

3. However, I also want all partners to have the option of maintaining their proportional interests in our two controlled companies (Diversified Retailing Company Inc. and Berkshire Hathaway Inc.) and one other small "restricted" holding. Because these securities will be valued unilaterally by me at fair value, I feel it is essential that, if you wish, you can maintain your proportionate interest at such valuation. However, these securities are not freely marketable (various SEC restrictions apply to “control” stock and non-registered stock) and they will probably be both non-transferable and non-income -producing for a considerable period of time. Therefore, I want you to be able to go either way in our liquidation - either stick with the restricted securities or take cash equivalent. I strongly like all of the people running our controlled businesses (joined now by the Illinois National Bank and Trust Company of Rockford, Illinois, a $100 million plus, extremely well-run bank, purchased by Berkshire Hathaway earlier this year), and want the relationship to be life long. I certainly have no desire to sell a good controlled business run by people I like and admire, merely to obtain a fancy price. However, specific conditions may cause the sale of one operating unit at some point.

I believe we will have a liquidation program which will accomplish the above objectives. Our activities in this regard should cause no change in your tax planning for 1969.

One final objective, I would like very much to achieve (but which just isn't going to happen) is to go out with a bang. I hate to end with a poor year, but we are going to have one in 1969. My best guess is that at yearend, allowing for a substantial increase in value of controlled companies (against which all partners except me will have the option of taking cash), we will show a breakeven result for 1969 before any monthly payments to partners. This will be true even if the market should advance substantially between now and yearend, since we will not be in any important position which will expose us to much upside potential.

Our experience in workouts this year has been atrocious - during this period I have felt like the bird that inadvertently flew into the middle of a badminton game. We are not alone in such experience, but it came at a time when we were toward the upper limit of what has been our historical range of percentage commitment in this category.

Documenting one's boners is unpleasant business. I find "selective reporting" even more distasteful. Our poor experience this year is 100% my fault. It did not reflect bad luck, but rather an improper assessment of a very fast-developing governmental trend. Paradoxically, I have long believed the government should have been doing (in terms of the problem attacked – not necessarily the means utilized) what it finally did - in other words, on an overall basis, I believe the general goal of the activity which has cost us substantial money is socially desirable and have so preached for some time. Nevertheless, I didn't think it would happen. I never believe in mixing what I think should happen (socially) with what I think will happen in making decisions - in this case, we would be some millions better off if I had.

Quite frankly, in spite of any factors set forth on the earlier pages. I would continue to operate the Partnership in 1970, or even 1971, if I had some really first class ideas. Not because I want to, but simply because I would so much rather end with a good year than a poor one. However. I just don't see anything available that gives any reasonable hope of delivering such a good year and I have no desire to grope around, hoping to "get lucky" with other people's money. I am not attuned to this market environment and I don't want to spoil a decent record by trying to play a game I don't understand just so I can go out a hero.

Therefore, we will be liquidating holdings throughout the year, working toward a residual of the controlled companies, the one "investment letter" security, the one marketable security with favorable long-term prospects, and the miscellaneous "stubs", etc. of small total value which will take several years to clean up in the Workout category.

I have written this letter a little early in lieu of the mid-year letter. Once I made a decision, I wanted you to know. I also wanted to be available in Omaha for a period after you received this letter to clear up anything that may be confusing in it. In July, I expect to be in California.

Some of you are going to ask, "What do you plan to do?" I don't have an answer to that question. I do know that when I am 60, I should be attempting to achieve different personal goals than those which had priority at age 20. Therefore, unless I now divorce myself from the activity that has consumed virtually all of my time and energies during the first eighteen years of my adult life, I am unlikely to develop activities that will be appropriate to new circumstances in subsequent years.

50. Recommending Bill Ruane

Recommending a manager: character first, the record including the catastrophe, three negatives volunteered, and the incentive disclosure that he is making a decision with “nothing to gain (personally) and considerable to lose.”

Bill Ruane - we met in Ben Graham's class at Columbia University in 1951 and I have had considerable opportunity to observe his qualities of character, temperament and intellect since that time. If Susie and I were to die while our children are minors, he is one of three trustees who have carte blanche on investment matters - the other two are not available for continuous investment management for all partners, large or small.

There is no way to eliminate the possibility of error when judging humans particularly in regard to future behavior in an unknown environment. However, decisions have to be made - whether actively or passively - and I consider Bill to be an exceptionally high probability decision on character and a high probability one on investment performance. I also consider it likely that Bill will continue as a money manager for many years to come.

Bill has recently formed a New York Stock Exchange firm, Ruane, Cunniff & Stires, Inc., 85 Broad Street, New York, N.Y. 10004, telephone number (212) 344-6700. John Harding presently plans to establish an office for the firm in Omaha about March 1st, 1970. Bill manages accounts individually on a fee basis and also executes brokerage for the accounts - presently with some portion of the brokerage commissions used to offset a portion of the investment advisory fee. His method of operation allows monthly withdrawals on a basis similar to BPL - as a percentage of capital and unrelated to realized or unrealized gain or loss. It is possible he may form some sort of pooled account but such determinations will be made between him and those of you who elect to go with him. I, of course, will not be involved with his operation. I am making my list of partners available to him and he will be writing you fairly soon regarding a trip he plans to make before yearend to Omaha, Los Angeles and Chicago, so that those of you who wish to meet him may do so. Any of you who are going to be in New York during the next few months can contact him directly.

Bill's overall record has been very good-averaging fairly close to BPL's, but with considerably greater variation. From 1956-1961 and from 1964-1968, a composite of his individual accounts averaged over 40% per annum. However, in 1962, undoubtedly somewhat as a product of the euphoric experience of the earlier years, he was down about 50%. As he re-oriented his thinking, 1963 was about breakeven.

While two years may sound like a short time when included in a table of performance, it may feel like a long time when your net worth is down 50%. I think you run this sort of short-term risk with virtually any money manager operating in stocks and it is a factor to consider in deciding the portion of your capital to commit to equities. To date in 1969, Bill is down about 15%, which I believe to be fairly typical of most money managers. Bill, of course, has not been in control situations or workouts, which have usually tended to moderate the swings in BPL year-to-year performance. Even excluding these factors, I believe his performance would have been somewhat more volatile (but not necessarily poorer by any means) than mine - his style is different, and while his typical portfolio (under most conditions) would tend to have a mild overlap with mine, there would always be very significant differences.

Bill has achieved his results working with an average of $5 to $10 million. I consider the three most likely negative factors in his future to be: (1) the probability of managing significantly larger sums - this is a problem you are going to have rather quickly with any successful money manager, and it will tend to moderate performance; I believe Bill's firm is now managing $20 -$30 million and, of course, they will continue to add accounts; (2) the possibility of Bill's becoming too involved in the detail of his operation rather than spending all of his time simply thinking about money management. The problems of being the principal factor in a NYSE firm as well as handling many individual accounts can mean that he, like most investment advisors, will be subject to pressures to spend much of his time in activities that do nothing to lead to superior investment performance. In this connection, I have asked Bill to make his services available to all BPL partners - large or small and he will, but I have also told him he is completely a free agent if he finds particular clients diverting him from his main job; (3) the high probability that even excellent investment management during the next decade will only produce limited advantages over passive management. I will comment on this below.

The final point regarding the negatives listed above is that they are not the sort of drawbacks leading to horrible performance, but more likely the sort of things that lead to average performance. I think this is the main risk you run with Bill - and average performance is just not that terrible a risk.

In recommending Bill, I am engaging in the sort of activity I have tried to avoid in BPL portfolio activities - a decision where there is nothing to gain (personally) and considerable to lose. Some of my friends who are not in the Partnership have suggested that I make no recommendation since, if results were excellent it would do me no good and, if something went wrong, I might well get a portion of the blame. If you and I had just had a normal commercial relationship, such reasoning might be sound. However, the degree of trust partners have extended to me and the cooperation manifested in various ways precludes such a "hands off" policy. Many of you are professional investors or close thereto and need no advice from me on managers - you may well do better yourself. For those partners who are financially inexperienced. I feel it would be totally unfair for me to assume a passive position and deliver you to the most persuasive salesman who happened to contact you early in 1970.

51. Bonds versus Stocks*

The only place he ever priced an entire asset class from first principles, in seven numbered steps, ending at what he himself calls a rather startling conclusion: tax-free bonds at 6.5 percent were the full equivalent of professionally managed stock money for the coming decade. He was, for that decade, right.

Finally, a word about expectations. A decade or so ago was quite willing to set a target of ten percentage points per annum better than the Dow, with the expectation that the Dow would average about 7%. This meant an expectancy for us of around 17%, with wide variations and no guarantees, of course - but, nevertheless, an expectancy. Tax-free bonds at the time yielded about 3%. While stocks had the disadvantage of irregular performance, overall they seemed much the more desirable option. I also stressed this preference for stocks in teaching classes, participating in panel discussions, etc…

For the first time in my investment lifetime. I now believe there is little choice for the average investor between professionally managed money in stocks and passive investment in bonds. If correct. this view has important implications. Let me briefly (and in somewhat oversimplified form) set out the situation as I see it:

1. I am talking about the situation for, say, a taxpayer in a 40% Federal Income Tax bracket who also has some State Income Tax to pay. Various changes are being proposed in the tax laws, which may adversely affect net results from presently tax-exempt income, capital gains, and perhaps other types of investment income. More proposals will probably come in the future. Overall, I feel such changes over the years will not negate my relative expectations about after-tax income from presently tax-free bonds versus common stocks, and may well even mildly reinforce them.

2. I am talking about expectations over the next ten years - not the next weeks or months. I find it much easier to think about what should develop over a relatively long period of time than what is likely in any short period. As Ben Graham said: “In the long run, the market is a weighing machine - in the short run, a voting machine.” I have always found it easier to evaluate weights dictated by fundamentals than votes dictated by psychology.

3. Purely passive investment in tax-free bonds will now bring about 6-1/2%. This yield can be achieved with excellent quality and locked up for just about any period for which the investor wishes to contract. Such conditions may not exist in March when Bill and I will be available to assist you in bond purchases, but they exist today.

4. The ten year expectation for corporate stocks as a group is probably not better than 9% overall. say 3% dividends and 6% gain in value. I would doubt that Gross National Product grows more than 6% per annum - I don’t believe corporate profits are likely to grow significantly as a percentage of GNP - and if earnings multipliers don’t change (and with these assumptions and present interest rates they shouldn’t) the aggregate valuation of American corporate enterprise should not grow at a long-term compounded rate above 6% per annum. This typical experience in stocks might produce (for the taxpayer described earlier) 1-3/4% after tax from dividends and 4-3/4% after tax from capital gain, for a total after-tax return of about 6-1/2%. The pre-tax mix between dividends and capital gains might be more like 4% and 5%, giving a slightly lower aftertax result. This is not far from historical experience and overall, I believe future tax rules on capital gains are likely to be stiffer than in the past.

5. Finally, probably half the money invested in stocks over the next decade will be professionally managed. Thus, by definition virtually, the total investor experience with professionally managed money will be average results (or 6-1/2% after tax if my assumptions above are correct). My judgment would be that less than 10% of professionally managed money (which might imply an average of $40 billion just for this superior segment) handled consistently for the decade would average 2 points per annum over group expectancy. So-called “aggressively run” money is unlikely to do significantly better than the general run of professionally managed money. There is probably $50 billion in various gradations of this “aggressive” category now - maybe 100 times that of a decade ago - and $50 billion just can’t “perform”. If you are extremely fortunate and select advisors who achieve results in the top 1% to 2% of the country (but who will be working with material sums of money because they are that good), I think it is unlikely you will do much more than 4 points per annum better than the group expectancy. I think the odds are good that Bill Ruane is in this select category. My estimate . therefore, is that over the next decade the results of really excellent management for our “typical taxpayer” after tax might be 1-3/4% from dividends and 7-3/4% from capital gain. or 9 –1.2% overall.

6. The rather startling conclusion is that under today’s historically unusual conditions, passive investment in tax-free bonds is likely to be fully the equivalent of expectations from professionally managed money in stocks, and only modestly inferior to extremely well-managed equity money.

7. A word about inflation - it has very little to do with the above calculation except that it enters into the 6% assumed growth rate in GNP and contributes to the causes producing 6-1/2% on tax-free bonds. If stocks should produce 8% after tax and bonds 4%, stocks are better to own than bonds, regardless of whether prices go up, down or sidewise. The converse is true if bonds produce 6-1/2% after tax. and stocks 6%. The simple truth, of course, is that the best expectable after-tax rate of return makes the most sense - given a rising, declining or stable dollar.

All of the above should be viewed with all the suspicion properly accorded to assessments of the future. It does seem to me to be the most realistic evaluation of what is always an uncertain future - I present it with no great feeling regarding its approximate accuracy, but only so you will know what I think at this time.

You will have to make your own decision as between bonds and stocks and, if the latter, who advises you on such stocks. In many cases, I think the decision should largely reflect your tangible and intangible (temperamental) needs for regularity of income and absence of large principal fluctuation, perhaps balanced against psychic needs for some excitement and the fun associated with contemplating and perhaps enjoying really juicy results.

52. Businesses, not stocks*

“I think about them as businesses, not ‘stocks’”.

At yearend, BPL will own 800,000 of 1,000,000 shares outstanding of Diversified Retailing Company. First Manhattan Company and Wheeler, Munger & Company will each own 100,000 shares. DRC previously owned 100% of Hochschild, Kohn & Company of Baltimore, and currently owns 100% of Associated Retail Stores (formerly named Associated Cotton Shops). On December 1st, DRC sold its entire interest in H-K to Supermarkets General Corp. for $5,045,205 of cash plus non-interest bearing SGC notes for $2 million due 2-1- 70, and $4,540,000 due 2-1-71. The present value of these notes approximates $6.0 million so, effectively, DRC received about $11 million on the sale. Various warranties were made by DRC in connection with the sale, and, while we expect no claims pursuant to the contract, a remote contingent liability always exists while warranties are in force.

Associated Retail Stores has a net worth of about $7.5 million. It is an excellent business with a strong financial position, good operating margins and a record of increasing sales and earnings in recent years. Last year, sales were about $37.5 million and net income about $1 million. This year should see new records in sales and earnings, with my guess on the latter to be in the area of $1.1 million after full taxes.

DRC has $6.6 million in debentures outstanding (prospectus with full description of the business as of December 18th, 1967 and the debenture terms will be sent you upon request) which have one unusual feature in that if I, or an entity controlled by me, is not the largest shareholder of DRC, the debentureholders have the right to present their debentures for payment by the company at par.

Thus, DRC has tangible net assets of about $11.50 - $12.00 per share, an excellent operating business and substantial funds available for reinvestment in other operating businesses. On an interim basis, such funds will be employed in marketable securities.

Berkshire Hathaway Inc. has 983,582 shares outstanding, of which BPL owns 691,441. B-H has three main operating businesses, the textile operation, the insurance operation (conducted by National Indemnity Company and National Fire & Marine Insurance Company, which will be collectively called the insurance company) and the Illinois National Bank and Trust Company of Rockford, Illinois. It also owns Sun Newspapers Inc, Blacker Printing Company and 70% of Gateway Underwriters, but these operations are not financially significant relative to the total.

The textile operation presently employs about $16 per share in capital and, while I think it has made some progress relative to the textile industry generally, cannot be judged a satisfactory business. Its return on capital has not been sufficient to support the assets employed in the business and, realistically, an adequate return has less than an even chance of being averaged in the future. It represents the best segments of the business that existed when we purchased control four and one-half years ago. Capital from the other segments has been successfully redeployed - first, on an interim basis into marketable securities and, now on a permanent basis into insurance and banking. I like the textile operating people - they have worked hard to improve the business under difficult conditions - and, despite the poor return, we expect to continue the textile operation as long as it produces near current levels.

The insurance operation (of which B-H owns virtually 100%) and the bank (where B-H owns 97.7%) present a much happier picture. Both are first-class businesses, earning good returns on capital and stacking up well on any absolute or comparative analysis of operating statistics. The bank has about $17 per share of net tangible assets applicable to B-H, and the insurance company approximately $15. I would estimate their normal current earning power to be about $4 per share (compared to about $3.40 from operations pro-forma in 1968), with good prospects for future growth on the combined $32 of tangible net assets in the bank and insurance company. Adding in the textile business and miscellaneous assets, and subtracting parent company bank debt of about $7 million, gives a tangible net asset value of about $43 per share for B-H, or about $45 stated book value, allowing for the premium over tangible assets paid for the bank.

One caveat - when I talk above of tangible net assets. I am valuing the $75 million of bonds held by the insurance company and bank at amortized cost. This is in accord with standard accounting procedures used in those industries and also in accord with the realities of their business operations where it is quite unlikely that bonds will have to be sold before maturity. At today's historically low bond prices, however, our bonds have a market value substantially below carrying value, probably on the order of $10 per share of B-H stock.

Between DRC and B-H, we have four main operating businesses with three of them in my opinion, definitely first class by any of the usual standards of evaluation. The three excellent businesses are all run by men over sixty who are largely responsible for building each operation from scratch. These men are hard working, wealthy, and good – extraordinarily good. Their age is a negative, but it is the only negative applicable to them. One of the reasons I am happy to have a large segment of my capital in B-H and DRC is because we have such excellent men in charge of the operating businesses.

We have various annual reports, audits, interim reports, proxy materials prospectuses, etc… applicable to our control holdings and we will be glad to supply you with any item you request. I also solicit your written questions and will send to all partners the questions and answers shortly before yearend. Don't hesitate to ask any question at all that comes to mind - if it isn't clear to you, it probably isn't clear to others - and there is no reason for any of you to be wondering about something that I might clear up.

DRC and B-H presently pay no dividends and will probably pay either no dividends or very modest dividends for some years to come. There are a number of reasons for this. Both parent companies have borrowed money - we want to maintain a good level of protection for depositors at the bank and policyholders at the insurance company - some of the operating companies have very satisfactory ways to utilize additional capital - and we are hopeful of finding new businesses to both diversify and augment our earning power.

My personal opinion is that the intrinsic value of DRC and B-H will grow substantially over the years. While no one knows the future, I would be disappointed if such growth wasn't at a rate of approximately 10% per annum. Market prices for stocks fluctuate at great amplitudes around intrinsic value but, over the long term, intrinsic value is virtually always reflected at some point in market price. Thus, I think both securities should be very decent long-term holdings and I am happy to have a substantial portion of my net worth invested in them. You should be unconcerned about short-term price action when you own the securities directly, just as you were unconcerned when you owned them indirectly through BPL. I think about them as businesses, not “stocks”, and if the business does all right over the long term, so will the stock.

53. The textile answer*

Asked why Berkshire keeps running a substandard mill, he answers with the sentence that separates him forever from the liquidator he had been at Dempster: he will not trade “severe human dislocations” for a few percentage points of additional return, and he states exactly the conditions under which he would decide otherwise.

Various questions have been asked pursuant to the last letter:

1. If we are not getting a good return on the textile business of Berkshire Hathaway Inc., why do we continue to operate it?

   Pretty much for the reasons outlined in my letter. I don't want to liquidate a business employing 1100 people when the Management has worked hard to improve their relative industry position, with reasonable results, and as long as the business does not require substantial additional capital investment. I have no desire to trade severe human dislocations for a few percentage points additional return per annum. Obviously, if we faced material compulsory additional investment or sustained operating losses, the decision might have to be different, but I don't anticipate such alternatives.

54. Should I hold?

Question 11, answered with position, size, and intent: holding, buying more, expecting significantly higher value in five or ten years, promising no promotion of any kind.

11. Should I hold my BH or DRC stock?

    I can’t give you the answer on this one. All I can say is that I’m going to do so and I plan to buy more. I am very happy to have a material portion of my net worth invested in these companies on a long term basis. Obviously, I think they will be worth significantly more money five or ten years hence. Compared to most stocks, I think there is a low risk of loss. I hope their price patterns follow a rather moderate range related to business results rather than behaving in a volatile manner related to speculative enthusiasm or depression. Obviously, I cannot control the latter phenomena, but there is no intent to "promote" the stocks a la much of the distasteful general financial market activity of recent years.

55. The Free Bond Course

The man dissolving a hundred-million-dollar fund spends his final letter teaching departing partners to buy municipal bonds, at no fee, with no interest in the transactions.

The underlying investment principles are still valuable, but much of the mechanics are obsolete because the municipal bond market has changed dramatically. Anything obsolete has been excluded in its entirety.

Marketability

Tax-free bonds are materially different from common stocks or corporate bonds in that there are literally hundreds of thousands of issues, with the great majority having very few holders. This substantially inhibits the development of close, active markets. Whenever the City of New York or Philadelphia wants to raise money it sells perhaps twenty, thirty or forty non-identical securities, since it will offer an issue with that many different maturities. A 6% bond of New York coming due in 1980 is a different animal from a 6% bond of New York coming due in 1981. One cannot be exchanged for the other, and a seller has to find a buyer for the specific item he holds. When you consider that New York may offer bonds several times a year, it is easy to see why just this one city may have somewhere in the neighborhood of 1,000 issues outstanding. Grand Island, Nebraska may have 75 issues outstanding. The average amount of each issue might be $100,000 and the average number of holders may be six or eight per issue. Thus, it is absolutely impossible to have quoted markets at all times for all issues and spreads between bids and offers may be very wide. You can't set forth in the morning to buy a specific Grand Island issue of your choosing. It may not be offered at any price, anywhere, and if you do find one seller, there is no reason why he has to be realistic compared to other offerings of similar quality. On the other hand, there are single issues such as those of the Ohio Turnpike, Illinois Turnpike, etc. that amount to $200 million or more and have thousands of bondholders owning a single entirely homogeneous and interchangeable issue. Obviously, here you get a high degree of marketability.

My impression is that marketability is generally a function of the following three items, in descending order of importance: (1) the size of the particular issue; (2) the size of the issuer (a $100,000 issue of the State of Ohio will be more marketable than a $100,000 issue of Podunk, Ohio); and (3) the quality of the issuer. By far the most sales effort goes into the selling of new issues of bonds. An average of over $200 million per week of new issues comes up for sale, and the machinery of bond distribution is geared to get them sold, large or small. In my opinion, there is frequently insufficient differential in yield at time of issue for the marketability differences that will exist once the initial sales push is terminated. We have frequently run into markets in bonds where the spread between bid and asked prices may get to 15%. There is no need to buy bonds with the potential for such grotesque markets (although the profit spread to the dealer who originally offers them is frequently wider than on more marketable bonds) and we will not be buying them for you. The bonds we expect to buy will usually tend to have spreads (reflecting the difference between what you would pay net for such bonds on purchase and receive net on sale at the same point in time) of from 2% to 5%. Such a spread would be devastating if you attempted to trade in such bonds, but I don't believe it should be a deterrent for a long-term investor. The real necessity is to stay away from bonds of very limited marketability - which frequently are the type local bond dealers have the greatest monetary incentive to push.

Specific Areas of Purchase

We will probably concentrate our purchases in the following general areas:

1. Large revenue-producing public entities such as toll roads, electric power districts, water districts, etc. Many of these issues possess high marketability, are subject to quantitative analysis, and sometimes have favorable sinking fund or other factors which tend not to receive full valuation in the market place.

2. Industrial Development Authority bonds which arise when a public entity holds title to property leased to a private corporation. For example, Lorain, Ohio holds title to an $80 million project for U.S. Steel Corp. The Development Authority Board issued bonds to pay for the project and has executed a net and absolute lease with U.S. Steel to cover the bond payments. The credit of the city or state is not behind the bonds and they are only as good as the company that is on the lease. Many top-grade corporations stand behind an aggregate of several billion dollars of these obligations, although new ones are being issued only in small amounts ($5 million per project or less) because of changes in the tax laws. For a period of time there was a very substantial prejudice against such issues, causing them to sell at yields considerably higher than those commensurate with their inherent credit standing. This prejudice has tended to diminish, reducing the premium yields available, but I still consider it a most attractive field. Our insurance company owns a majority of its bonds in this category.

3. Public Housing Authority Issues for those of you who wish the very highest grade of tax-free bonds. In effect, these bonds bear the guarantee of the U.S. Government, so they are all rated AAA. In states where local taxes put a premium on buying in-state issues, and I can’t fill your needs from (1) and (2) , my tendency would be to put you into Housing Authority issues rather than try to select from among credits that I don't understand. If you direct me to buy obligations of your home state, you should expect substantial quantities of Housing Authority issues. There is no need to diversify among such issues, as they all represent the top credit available.

4. State obligations of a direct or indirect nature.

Callable Bonds

We will not buy bonds where the issuer of the bonds has a right to call (retire) the bonds on a basis which substantially loads the contract in his favor. It is amazing to me to see people buy bonds which are due in forty years, but where the issuer has the right to call the bonds at a tiny premium in five or ten years. Such a contract essentially means that you have made a forty year deal if it is advantageous to the issuer (and disadvantageous to you) and a five year deal if the initial contract turns out to be advantageous to you (and disadvantageous to the issuer). Such contracts are really outrageous and exist because bond investors can't think through the implications of such a contract form and bond dealers don't insist on better terms for their customers. One extremely interesting fact is that bonds with very unattractive call features sell at virtually the same yield as otherwise identical bonds which are noncallable.

One way to avoid this problem is to buy bonds which are totally noncallable. Another way is to buy discount bonds where the right of the issuer to call the bond is at a price so far above your cost as to render the possible call inconsequential. If you buy a bond at 60 which is callable at 103, the effective cost to you of granting the issuer the right to prematurely terminate the contract (which is a right you never have) is insignificant. But to buy a bond of the Los Angeles Department of Water and Power at 100 to come due at 100 in 1999 or to come due at 104 in 1974, depending on which is to the advantage of the issuer and to your disadvantage, is the height of foolishness when comparable yields are available on similar credits without such an unfair contract. Nevertheless, just such a bond was issued in October, 1969 and similar bonds continue to be issued every day. I only write at such length about an obvious point, since it is apparent from the continual sale of such bonds that many investors haven't the faintest notion how this loads the dice against them and many bond salesmen aren't about to tell them.

Maturity and the Mathematics of Bonds

Many people, in buying bonds, select maturities based on how long they think they are going to want to hold bonds, how long they are going to live, etc. While this is not a silly approach, it is not necessarily the most logical. The primary determinants in selection of maturity should probably be (1) the shape of the yield curve; (2) your expectations regarding future levels of interest rates and (3) the degree of quotational fluctuation you are willing to endure or hope to possibly profit from. Of course, (2) is the most important but by far the most difficult upon which to comment intelligently.

Let's tackle the yield curve first. When other aspects of quality are identical, there will be a difference in interest rates paid based upon the length of the bond being offered. For example, a top grade bond being offered now might have a yield of 4.75% if it came due in six or nine months, 5.00% in two years, 5.25% in five years, 5.50% in ten years and 6.25% in twenty years. When long rates are substantially higher than short rates, the curve is said to be strongly positive. In the U. S. Government bond market, rates recently have tended to produce a negative yield curve; that is, a long term Government bond over the last year or so has consistently yielded less than a short term one. Sometimes the yield curve has been very flat, and sometimes it is positive out to a given point, such as ten years, and then flattens out. What you should understand is that it varies, often very substantially, and that on an historical basis the present slope tends to be in the high positive range. This doesn't mean that long bonds are going to be worth more but it does mean that you are being paid more to extend maturity than in many periods. If yields remained constant for several years, you would do better with longer bonds than shorter bonds, regardless of how long you intended to hold them.

The second factor in determining maturity selection is expectations regarding future rate levels. Anyone who has done much predicting in this field has tended to look very foolish very fast. I did not regard rates as unattractive one year ago, and I was proved very wrong almost immediately. I believe present rates are not unattractive and I may look foolish again. Nevertheless, a decision has to be made and you can make just as great a mistake if you buy short term securities now and rates available on reinvestment in a few years are much lower.

The final factor involves your tolerance for quotational fluctuation. This involves the mathematics of bond investment and may be a little difficult for you to understand. Nevertheless, it is important that you get a general grasp of the principles. Let's assume for the moment a perfectly flat yield curve and a non-callable bond. Further assume present rates are 5% and that you buy two bonds, one due in two years and one due in twenty years. Now assume one year later that yields on new issues have gone to 3% and that you wish to sell your bonds. Forgetting about market spreads, commissions, etc. , you will receive $1,019.60 for the original two year $1,000 bond (now with one year to run) and $1,288.10 for the nineteen year bond (originally twenty years). At these prices, a purchaser will get exactly 3% on his money after amortizing the premium he has paid and cashing the stream of 5% coupons attached to each bond. It is a matter of indifference to him whether to buy your nineteen year 5% bond at $1,288.10 or a new 3% bond (which we have assumed is the rate current - one year later) at $1,000.00. On the other hand, let's assume rates went to 7%. Again we will ignore commissions, capital gains taxes on the discount, etc. Now the buyer will only pay $981.00 for the bond with one year remaining until maturity and $791.60 for the bond with nineteen years left. Since he can get 7% on new issues, he is only willing to buy your bond at a discount sufficient so that accrual of this discount will give him the same economic benefits from your 5% coupon that a 7% coupon at $1,000.00 would give him.

The principle is simple. The wider the swings in interest rates and the longer the bond, the more the value of a bond can go up or down on an interim basis before maturity. It should be pointed out in the first example where rates went to 3%, our long term bond would only have appreciated to about $1,070.00 if it had been callable in five years at par, although it would have gone down just as much if 7% rates had occurred. This just illustrates the inherent unfairness of call provisions.

For over two decades, interest rates on tax-free bonds have almost continuously gone higher and buyers of long term bonds have continuously suffered. This does not mean it is bad now to buy long term bonds - it simply means that the illustration in the above paragraph has worked in only one direction for a long period of time and people are much more conscious of the downside risks from higher rates than the upside potential from lower ones.

If it is a 50-50 chance as to the future general level of interest rates and the yield curve is substantially positive, then the odds are better in buying long term non-callable bonds than shorter term ones. This reflects my current conclusion and, therefore, I intend to buy bonds within the ten to twenty-five year range. If you have any preferences within that range, we will try to select bonds reflecting such preferences, but if you are interested in shorter term bonds, we will not be able to help you as we are not searching out bonds in this area.

Before you decide to buy a twenty year bond, go back and read the paragraph showing how prices change based upon changes in interest rates. Of course, if you hold the bond straight through, you are going to get the contracted rate of interest, but if you sell earlier, you are going to be subject to the mathematical forces described in that paragraph, for better or for worse. Bond prices also change because of changes in quality over the years but, in the tax-free area, this has tended to be - and probably will continue to be - a relatively minor factor compared to the impact of changes in the general structure of interest rates.

Discount Versus Full Coupon Bonds

You will have noticed in the above discussion that if you now wanted to buy a 7% return on a nineteen year bond, you had a choice between buying a new nineteen year bond with a 7% coupon rate or buying a bond with a 5% coupon at $791.60, which would pay you $1,000.00 in nineteen years. Either purchase would have yielded exactly 7% compounded semi-annually to you. Mathematically, they are the same. In the case of tax-free bonds the equation is complicated, however, by the fact that the $70.00 coupon is entirely tax-free to you, whereas the bond purchased at a discount gives you tax-free income of $50.00 per year but a capital gain at the end of the nineteenth year of $208.40. Under the present tax law, you would owe anything from a nominal tax, if the gain from realization of the discount was your only taxable income in the nineteenth year, up to a tax of over $70.00 if it came on top of very large amounts of capital gain at that time (the new tax law provides for capital gain rates of 35%, and even slightly higher on an indirect basis in 1972 and thereafter for those realizing very large gains.) In addition to this, you might have some state taxes to pay on the capital gain.

Obviously, under these circumstances you are not going to pay the $791.60 for the 5% coupon and feel you are equally as well off as with the 7% coupon at $1,000.00. Neither is anyone else. Therefore, identical quality securities with identical maturities sell at considerably higher gross yields when they have low coupons and are priced at discounts than if they bear current high coupons.

Interestingly enough, for most taxpayers, such higher gross yields over-compensate for the probable tax to be paid. This is due to several factors. First, no one knows what the tax law will be when the bonds mature and it is both natural and probably correct to assume the tax rate will be stiffer at that time than now. Second, even though a 5% coupon on a $1,000.00 bond purchased at $791.60 due in nineteen years is the equivalent of a 7% coupon on a $1,000.00 bond purchased at par with the same maturity, people prefer to get the higher current return in their pocket. The owner of the 5% coupon bond is only getting around 6.3% current yield on his $791.60 with the balance necessary to get him up to 7% coming from the extra $208.40 he picks up at the end. Finally, the most important factor affecting prices currently on discount bonds (and which will keep affecting them) is that banks have been taken out of the market as buyers of discount tax-free bonds by changes brought about in bank tax treatment through the 1969 Tax Reform Act. Banks have historically been the largest purchasers and owners of tax-free bonds and anything that precludes them from one segment of the market has dramatic effects on the supply-demand situation in that segment. This may tend to give some edge to individuals in the discount tax-free market, particularly those who are not likely to be in a high tax bracket when the bonds mature or are sold.

If I can get a significantly higher effective after-tax yield (allowing for sensible estimates of your particular future tax rate possibilities), I intend to purchase discount bonds for you. I know some partners prefer full coupon bonds, even though their effective yield is less, since they prefer to maximize the current cash yield and if they will so advise me, we will stick to full coupon issues (or very close thereto) in their cases.

*This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk. Conduct your own due diligence!

The enterprise value is negative. It is a Graham net-net of the sort the early Buffett partnership was built on, except this one earns 20% operating margins, pays a dividend every single year, and grew its cash pile again last quarter.

Sewoon Medical makes the most unglamorous products in healthcare. Almost everything it sells is single-use, so demand recurs with surgical volumes rather than the economic cycle.

The founding family owns 53%, pays itself modestly, and the filings are cleaner and more honest than I expected going in.

There are also multiple paths to rerating, even if undated.

And meanwhile the waiting itself is paid: a three percent yield, interest on the cash, and retained earnings raising the floor every year.

The downside, executed perfectly, is dead money with a coupon on top of a liquidation value.

The upside is the entire earnings power of a 55-year-old business, currently thrown in for nothing.

Business Summary

Sewoon Medical is the kind of company that gets overlooked precisely because it has been doing the same dull thing for more than half a century.

The lineage runs back to 1969, with the company being incorporated in 1982. It listed on KOSDAQ in September 2008 at ₩5,600 a share. The factory and main office are in Cheonan, and the business is about as unglamorous as healthcare gets: disposable medical devices.

They make the vacuum bulb that sits at a patient’s bedside after surgery, pulling fluid and blood plasma out of the wound so it heals faster and needs fewer antibiotics.

Around that core the company makes catheters and tubes of every description, plus IV and infusion sets and a line of stents.

Almost everything they sell is single-use, disposable devices.

Domestically it sells into general hospitals through a network of dealers and distributors. Abroad it carries the full alphabet of approvals you need to ship regulated devices into developed markets.

Manufacturing is split in two: the Cheonan plant in Korea, and a Vietnamese subsidiary, Sewoon Medical LLC, which produces IV sets and catheter-type products since 2015.

A separate domestic subsidiary, Standard Sci Tech, runs the stent sales and distribution. Two earlier affiliates have dropped away: a Chinese plant in Qingdao was divested in 2020, and an innovation vision subsidiary that was merged in 2019.

Competitive Advantages

Disposable drains, catheters and IV sets are high volume, price competitive products, so we could say the business operates in a somewhat commoditized corner of medical devices.

The filings present Sewoon as a leader in its suction drainage niche, but this isn’t a business with pricing power such as Coca-Cola.

The only edge there is comes from three places:

1. The regulatory state is a genuine barrier, as getting and keeping those certifications across multiple jurisdictions is slow and expensive, and it’s why a 55 year business doesn’t get casually displaced.

2. When your drains and catheters are already specified in a hospital, there are challenges to swapping out a cheap consumable for an unproven alternative.

3. The Vietnam plant gives a labour cost advantage on products that are about manufacturing cheaply at scale.

Of course, as common sense would tell you, none of this is a fortress in the sense of competitive advantages.

However, all of it together is enough to keep a profitable niche profitable.

Future Reliability

On the demand side: surgeries happen, drains and catheters get used, and that volume doesn’t swing with the economic cycle the way discretionary goods do.

The company has been consistently profitable, as we’ll see in the financial statements: highlights section. But a reliable revenue base is not the same as a growing one. So the fair characterisation is a stable and cash generative niche that isn’t growing.

Analysing Management

I haven’t spoken to management. But what the filings do support is a fairly precise picture of who controls the company, how, and what they’ve done with the cash.

Skin In The Game

This is a family company. The controlling shareholders hold 23,119,180 shares, or 52.78%:

• Lee Gil-hwan, the largest holder, sits at 31.70% (13,884,400 shares)

• Lee Jae-hee, the representative director, at 17.35% (7,600,000 shares)

• Lee Jae-yeon at 3.15%

• Seon Yun-woo and Seon Jun-seo at 0.23% each

• Heo Mong-do at 0.13%.

They're also paid like owners, not like managers. Total remuneration for all seven directors and auditors was only ₩1.26 bn, against an approved ₩2.5 bn.

Though there is one caveat. 52.78% is majority control, so this is a controlled company. Minorities cannot outvote the family on anything, and the inside directors have been reappointed seven times (roughly 21 years).

So alignment is real, but there is also controlled company risk that the family's preferences is different from the minority interests.

Integrity and honesty

I'm assessing what’s observable, such as audit history, restatements, related party transparency, pay discipline, and whether they do what they say. And it looks good.

My findings include:

• restrained and transparent pay;

• the MD&A flaging that the FY2025 statements were preAGM and commits to filing a correction if shareholders rejected them;

• they also said they run “shareholder-centred management” and “consider balancing future growth with returning profits to shareholders,” and they actually initiated a ₩3B buyback and raised the payout;

• and the audit committee is all outside, with a CPA, a lawyer, and a former tax-office head, which is reasonable financial expertise for a company this size.

So generally, management is more transparent and honest than I thought they’d be. But with one caveat, as we’ll see in the following section:

Capital Allocation and Shareholder Value

The business itself is very capital-light. 37% gross margin, 20% operating margin, zero interest-bearing debt, and strong cash conversion. Maintenance capital expenditures and required incremental working capital are minimal compared to size.

If you strip the cash off the balance sheet, the operating business earns a very high return on the capital it actually uses.

But the balance sheet is drowning in idle cash. Cash and equivalents are ₩100B, earning 2.2% interest. That pulls ROE down to 7.9%, far below what the underlying operating business returns. The cash is the problem, not the business.

However, management has started to take some sort of action. The 2025 buyback (₩3B and the first in fifteen years) was cash returned beyond the dividend.

But the pace which they are doing it doesn't really move the needle compared to their excess cash. Total capital returns ran about ₩5.6B, roughly a third of free cash flow, so net cash still grew ₩10.6B over the year.

The pile is compounding on the balance sheet faster than it's being handed back. At this rate the over-capitalization will continue to widen.

The buyback itself was still well executed. Bought at around ₩2,680, every won spent below intrinsic value transferred value to the shareholders.

But it was small, and the shares sit in treasury rather than cancelled.

Retiring them would convert it into real commitment, and if they continued to do that, rerating would be rather probable.

Important Risks

Korea has no “Risk Factors” chapter, so these are pulled from the risk-management section and the notes.

Financial and market:

• FX risk

• Liquidity risk: ₩3.7B of liabilities, nearly all <1 year, well covered by ₩100B cash, no debt. So really the risk of needed liquidity is close to null.

• Capital risk: managed through debt/equity (6.1%).

Accounting estimates:

• Inventory impairment: valuation and disposal losses jumped to ₩698M, ₩1.2B allowance.

• Fair value of unlisted financial asset is valued by technique, so it requires significant estimation.

• Non-financial-asset impairment, deferred-tax recoverability, capitalized development costs are all dependent on assumptions.

Business, industry and operational:

• Macro: high interest rates or weak domestic demand.

• Competition: low-priced Chinese products in export markets.

• Channel dependence: sales run through regional exclusive distributors, not an owned salesforce.

• No order backlog.

• Geographic concentration: Korea ~73% of revenue, though no single customer is >10%.

Governance and structural

• Controlled company: Lee family holds 52.78%; us minorities can’t outvote.

• Related-party dealings: SMC (warehouse rental) and Life Medical (~₩1.2B purchases/yr).

Financial Statements: Highlights

Historical Margins (20y):

Revenue & Growth (20y):

Free Cash Flow vs Dividends (20y):

Total Equity & Cash (20y):

Valuation

At the time of this writing, the enterprise value of the business is negative, meaning net cash is above its marketcap.

So this security is being priced in such a way where 2 things must be true to justify the current price:

1. The operating business has no value whatsoever, and therefore is expected to deteriorate in the coming years, or

2. The cash balance will never be returned back to shareholders (or at an incredibly slow pace).

Before evaluating the cause of such mispricing, I believe it’s appropriate to first value the business.

The intrinsic value of a business can be estimated in many ways within many ranges. However, simplified, the value of a business to equity holders can be divided into two:

Value of the Operating Business

Operating value consists of the present value of all operating owner earnings, which uses Buffett’s definition of owner earnings excluding financing effects, so that it represents the actual cash operations produce.

In practise, I use the following:

Of course, this is not mechanical. Each item is adjusted to roughly reflect a “normal” business year.

This normalisation requires judgement on what mid-cycle operating income is, the average tax rate, what non-cash charges are actually recurring, what capital expenditures are required to maintain current business operations, and if there’s any additional working capital requirements to maintain current competitive position and operations.

All of this is assumption heavy. They are all rough estimations. So the margin of safety must be adequate.

I may also recommend that, when in doubt about which figure to use, choose the least flattering one.

In recent years, Sewoon has experienced some volatility in operating income, even if the core business is generally predictable to some extent over an entire cycle.

After careful review, a normalised figure for operating income is around ₩13B, tax rate 20%, and recurring non-cash charges (which in this case is depreciation) ₩3B.

Maintenance CapEx is a different story. Historically, the business had heavily invested into growth and capital expenditures was notably higher than depreciation.

However, over the past 5 years this trend has reversed. Capital expenditures are half of depreciation, and it’s due to the material cut in these.

I believe they might be underinvesting, and this trend will eventually revert in the long-run. So actual maintenance CapEx should be roughly in line with depreciation.

Moreover, there in no meaningful additional working capital required to maintain its current competitive position and unit volume.

So the actual Operating Owner Earnings is roughly ₩10.4B.

By now we can estimate the operating value of the business.

Most people use DCF models, but for such a business that’s not really a compounder with predictable growth, applying a capitalisation rate to the normalized operating owner earnings is the more sensible approach.

Now, what should be the capitalisation rate?

It’s a profitable, established business; operates in medical devices, which tends to be more stable than highly cyclical industries; and has almost neglectable interest bearing debt and a gigant net cash balance.

However, it’s a smallcap Korean company with limited liquidity; has limited scale; and has a less diversified revenue base than larger medtech companies.

So a fair risk premium is around 6%. Adding the 10 year Korean bond yield brings us to a rough capitalisation rate of 10%, with a reasonable range between 9% to 12%.

That implies an estimated operating value of approximately ₩87B-₩116B.

Value of Net Non-Operating Assets

Sewoon’s net non-operating assets consist of their total excess cash + short-term investments + long-term investments - interest-bearing debt.

Of course, almost everything here can be directly found in the balance sheet:

• Total cash & equivalents are ₩100B

• Long-term investments are ₩516M

• Current portion of leases are ₩136M

• Long-term leases are ₩680M

However, excess cash is not typically disclosed as a standalone metric by management, including in Sewoon’s case. So we require judgement to estimate it.

The minimum cash required to preserve normal business operations must be subtracted, as it is not surplus. This operating liquidity buffer is distinct from the working capital requirements in operating owner earnings, which reflect the capital needed to maintain its competitive position and unit volume.

It’s also important to keep in mind that estimating the required operating cash buffer is a very subjective practice, where analysts use different approaches and some don’t even bother to estimate it.

A reasonable estimate for this operating cash buffer is 2-4 months of operating expenses, with 3 months as a fair central assumption.

The 12 month normal operating expense is ₩48B, so the deduction for operating cash needs is ₩12B (3 months of operating expenses).

Deducting the operating buffer from the cash balance gives us an approximated excess cash of ₩88B.

Adding ₩0.5B of long-term investments yields total non-operating assets of approximately ₩88.5B

After subtracting lease liabilities of approximately ₩0.8B, net non-operating assets amount to roughly ₩87.7B

Intrinsic Value

By now we have both halves, and the equity value is simply their sum.

The operating business is worth roughly ₩87B to ₩116B, and net non-operating assets come to roughly ₩87.7B. Adding them gives a total intrinsic value of approximately ₩175B to ₩204B.

Converting it to a per-share figure, intrinsic value is approximately ₩4,042 to ₩4,138 per share, as for the base case. This implies a base case margin of safety between 45% and 53%.

The margin of safety here is not a matter of one or two favourable assumptions. It’s the entire earnings power of a profitable business, thrown in for nothing.

There is no reasonable combination within the ranges above that justifies the current price on fundamentals alone.

The Case for Pessimism

It’s worth returning now to where I began.

I started by noting that the enterprise value is negative, and that this means one of two things has to be true:

• Either the operating business is worth nothing and is expected to deteriorate from here,

• or the cash is never coming back to shareholders, or comes back so slowly that it amounts to the same thing.

The second condition is the most concerning one, and a common theme around Koran smallcaps.

This is not a company that hoards everything. It has paid a cash dividend every single year.

A payout ratio in the low twenties, a yield of two and a half to three percent, 70 won a share. Cash does come back.

The problem is the pace, and the pace is the whole argument.

Look at what actually left the building in 2025.

A dividend of roughly ₩2.6B and a buyback of ₩3.0B, so ₩5.6B of total return, against net income of ₩12.2B and free cash flow well above that.

In the same twelve months the cash balance grew from ₩86.1B to ₩97.0B. They returned about a third of what the business produced and the pile still swelled by nearly eleven billion.

Then, in case there were any doubt about direction, the first quarter of 2026 shows cash at ₩99.8B - higher again, and after the buyback.

This is the main argument of the bear case: the cash compounds faster than it is handed back, and it has kept doing so into the most recent quarter on file. A dividend that grows the pile is not, in any sense that matters to a minority holder, the pile being returned.

And the buyback was one contract of ₩3B against ₩100B cash balance, the second repurchase in the company’s history, the first since 2010.

The succession dynamic also belongs here. The founder, Lee Gil-hwan, is eighty-four and holds 31.69%. The chief executive, Lee Jae-hee, is thirty years younger and holds 17.35%.

If the family is holding for a transfer under Korea’s inheritance regime, and an eighty-four-year-old founder is precisely the profile that forces the question, then a low share price is not their problem to solve.

It is their objective, as every additional won of market value is a won of tax the family pays to the state.

Then there is the business. It isn’t really growing.

Additionally, chinese low price competition is named in the filings as an export risk, and in a category defined by manufacturing cheaply at scale, that is exactly the sort of competitor that compresses margins slowly rather than all at once.

They’ve also had very low reinvestment opportunities, so the business is currently hard to scale.

So value is destroyed every year it sits, because capital earning a fraction of its opportunity cost is worth less each year that passes.

The pile is not merely failing to be returned. It is also slowly being wasted in place.

Which brings me to the floor: if the earnings deteriorate and the discount never closes, what is actually underneath you?

Conservative Liquidation Value

Unlike my first pass, these are the audited book values, not estimates. However, the amount I deem recoverable is a subjective practice driven by judgement.

Therefore I prefer to be overly punitive than overly optimistic.

• Cash is cash, slightly discounted only for friction on whatever sits in Vietnam

• Receivables get haircuted by 30%, as customers pay a dying supplier last

• Inventory of these disposables recovers perhaps 25% in a liquidation

• Medical and manufacturing equipment is close to scrap, with only the Cheonan real estate and the investment property holding value, so PP&E takes a 70% cut.

• Intangibles and deferred tax are worth nothing in a liquidation, as always.

That leaves roughly ₩110.8B, or about ₩2,626 per share as a conservative liquidation value floor. A Graham net-net, counting only current assets and subtracting all liabilities, lands at about ₩2,865.

At the current price of ₩2,240 per share, we get a P/NCAV ratio of 0.78 and price-to-liquidation value of 0.85.

So at ₩2,240 you are paying less than what I’d expect to recover in a wind-down, for a company that is profitable, unlevered, and added cash again last quarter.

The market has priced this business as worth more dead than it currently trades alive, and it is very much alive.

That’s the floor. Now for the reasons the gap might actually close.

The Case for Optimism

The operating business only has to keep doing what it has done for fifty years.

Every argument for optimism is an argument about pace: the pace at which cash comes back, and the pace at which someone forces the issue.

Start with what has already changed. For fifteen years the answer to “will they return more?” was no.

In 2025 it changed slightly. The first buyback since 2010, a raised payout, and “shareholder-centred management” written into the filings.

I’ve said myself that the amounts are trivial against a ₩100B pile. But controlled Korean companies do can change their behaviour (in terms of capital allocation) under pressure.

The 2025 amendments to the Commercial Act gave directors a fiduciary duty to shareholders, not merely to the company.

Then in February 2026 the National Assembly passed a third amendment making the cancellation of treasury shares mandatory: new buybacks must be retired within a year, existing treasury holdings within eighteen months of the law taking effect, and keeping any of it beyond that requires a retention plan approved by shareholders every single year.

I wrote earlier that retiring the treasury shares would convert the buyback into real commitment. As it turns out, the legislature has since removed the optionality.

Every won Sewoon now spends on repurchases shrinks the share count by law, at 0.85 times my liquidation value.

Around that there is the Value-Up disclosures, tax incentives for companies that raise shareholder returns, activists hunting exactly this profile of balance sheet, and even talk in the Assembly of a law aimed specifically at families suppressing share prices ahead of succession.

Which brings me back to the succession.

Before the transfer, a low share price is what’s favorable for a family owned company.

After the transfer, the estate is shares and the bill is cash. The founder’s 31.7% is worth about ₩31B at today’s price.

Korean inheritance tax runs to 50% for the biggest shareholder.

And the family’s share of the entire annual dividend is about ₩1.4B.

In this position, historically management does some combination of three things:

• increase the dividend

• sell shares

• sell the company

And, most importantly, every one of them delivers value for us minorities.

Additionally, the state has been trying to get rid of this structure for years.

The attempt to cut the top rate failed in 2024, but the government is pushing a shift to taxing each successor’s share, aimed at 2028.

If the penalty falls, the reason to keep the price down weakens.

Finally, the waiting itself is paid.

A three percent yield at ₩70, interest on the cash, and seven billion won of retained earnings landing every year on a pile that already covers the marketcap.

The floor rises. So the bear case isn’t really a loss.

It is dead money with a coupon, standing on a liquidation value, while the share count quietly shrinks by statute.

That is about the most comfortable way I know of to be wrong.

The Verdict & Thesis

This is not a compounder. There is no reinvestment engine, and no reason to believe the operating business will be worth much more in ten years than it is today.

This is a very Graham and Buffett partnership style purchase: a collection of assets, mostly cash, bought at a large discount to a conservatively counted value, with a profitable business thrown in for nothing and several independent forces pushing toward realisation, even if outdated.

If the price merely reaches the bottom of my range, ₩4,042, within five years, that is around 16% annual return once dividends are counted. Within three years, closer to 25%.

And if it never gets there, I collect the yield while book value grows.

So the downside is mainly opportunity cost. The rerating never happens, and no (undated) catalyst ever appears.

What Would Break the Thesis

• Operating income sliding below the normalised range for consecutive years, with export gross margins confirming Chinese competition.

• The cash moving sideways: a bad acquisition, an affiliate stake, etc.

• A tender offer or take-private attempt near the current price.

• And the good one: the price entering my estimated fair value range. At that point it stops being mispriced, and I stop owning it.

What I’m Watching

• Total capital returned against free cash flow. When that ratio crosses one, the cash pile shrinks and capital is actually being returned at a larger scale.

• The treasury account as the cancellation deadline approaches: retired, or a retention plan.

• A Value-Up disclosure, or its continued absence.

• Any movement in the family’s shares.

• Export gross margins.

The business will keep making drains, the cash will keep compounding, and sooner or later somebody will have to answer what a hundred billion won of idle cash is actually for.

At ₩2,240 I am being paid about three percent a year to wait for the answer, standing on a floor I priced as a pessimist.

I can think of worse places to stand.

*This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk. Conduct your own due diligence!

The portfolio’s return since inception on April 2026 is 3.9%, vs the S&P 500’s 4.1%. I expect returns may lag the general market in short periods of time. The long run objective is to perform roughly in line with the general market in periods of substantial advance, and outperform in periods of decline or stagnation, though this outcome is inherently uncertain and cannot be guaranteed.

Since inception my efforts were devoted to researching North American and European securities. However, over the past month I have spent countless hours researching other markets, mainly Korea and Japan. I have found equities trading at prices no private owner would ever offer, at discounts materially more extreme than those in the US. These two markets stand out for the lack of coverage and attention given to mature, family-owned businesses, creating discounts far larger than the typical small security trading in more followed countries. Of course, such discounts exist for a reason. Corporate governance in both countries has historically favored insiders and management over minority shareholders, with cross shareholdings, cash hoarding, and a reluctance to return capital to the shareholders.

That said, Japan’s corporate governance reforms and the Tokyo Stock Exchange’s pressure on companies trading below book value have begun to force change, and Korea’s Value-Up program is pushing in a similar direction, however unevenly.

All of this is directly applicable to the generally undervalued securities bucket (generals). While these don’t rely on a corporate event, I do require at least the knowledge that management intends to return the excess cash on the balance sheet or the cash the business generates to shareholders at some point. Without that, value can compound inside the business for years and never find its way to me. A large cash balance only matters to a minority shareholder if it is eventually paid out, and a discount only closes if there is some credible path, however undated, to that capital coming back. The governance shifts above do not change my requirement, but they raise the odds that managements which already intend to return capital will actually do so, and sooner.

I expect the portfolio to become increasingly more concentrated in these two markets, at least for the foreseeable future.

Holdings as of June 2026:

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Many small investors, especially those new to investing, don’t know what to buy.

Furthermore, it’s getting inherently easier to looks like a genius, making it even harder to distinguish analysis from speculation.

Yet there exists a niche corner of the market where returns are often driven less by forecasting a company’s future and more by understanding the mechanics of corporate actions.

So, if you’re a small investor managing less than $100k, I introduce to you: Odd-Lot Investing (or odd-lot arbitrage).

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Tender Offers

A regular tender offer is when a company offers to buy back shares at a premium to market price, so shareholders can tender their shares to make a profit.

Companies do tenders instead of open market purchases as a tender offer is basically a controlled purchase, while buying in the market is usually too slow or moves the price against them.

That means it’s almost free cash, right?

Well, of course, there’s a catch.

Suppose a company offers to buy back 10 million shares, but shareholders tender 15 million shares. The offer is oversubscribed, so the company can't buy every share tendered.

In this particular case, it would mean that everyone who tendered might have only 66.7% of their shares accepted.

That is called proration1.

However, in some tender offers, small shareholders purchasing less than 100 shares receive special treatment.

Odd-Lot Provision

A round lot refers to a position of 100 shares. An odd lot is any position smaller than that.

Sometimes tender offers include an odd-lot provision, meaning shareholders who own fewer than 100 shares have those purchased before any proration is applied.

But why would a company do this?

Small shareholders (odd-lot holders) create more administrative work and cost, so companies often want to eliminate or reduce tiny holdings after a tender.

As the maximum pay is a fixed number, and usually a small one, institutions don’t bother to care.

This is where the edge lives.

Short Example:

Imagine a company trading at $40 a share announces a tender offer to repurchase stock at $50. If you buy 99 shares at $40 and tender them as an odd-lot holder, you capture the full $10 spread per share, regardless of how oversubscribed the offer becomes.

The math isn’t going to make you rich. Tendering all 99 shares make $990 before fees and taxes.

But that’s the point of being a small investor in this corner of the market.

How To Find Odd-Lots

This is more straightforward than it seems.

For US securities, you want to look for filings named SC-TO, which are the tender offer statements. Most odd-lot tender offers are from the US, some Canadian, mostly due to corporate laws and securities regulations.

Afterwards, filter for files containing “Odd lot”, “in cash” and “(a)(1)”. Legally tender offer documents must be filed as an (a)(1) exhibit.

When looking for qualifying companies, you’ll probably see various different filings from the same company. You want to focus on “exhibit (a)(1)(A)” or “exhibit (a)(1)(i)”, which are the offer to purchase filings containing the details of the offer.

Documents filed in the past 30 days or less are normally not expired. Anything above 60 days is unusual and a red flag.

Sometimes, the offer to purchase is based on NAV instead of cash. I would disregard any NAV purchase, as these carry additional risks which defeat the purpose of the odd-lot tender being almost free cash.

Obviously the most important step is paying below the minimum purchase price, if not you’d probably be losing money!

You can check out odd-lot tender offers in the US here.

Following this I’ll share an incredibly profitable opportunity.

Interested?

Then let me introduce you to…

Optimum Communications - The Unusual Odd-Lot

Searching for odd-lots I found Optimum Communications, and it is quite an unusual setup.

CSC Investments II LLC, a wholly owned subsidiary of Optimum, is offering to buy up to 120,000,000 shares of Class A common stock at $2.50/share cash, expiring on June 30, 2026.

The stock closed at $0.66 the last trading day before the announcement, and currently trades around $1.09. The offer is funded by a $300M private placement of 13% to 15% Series A Preferred Units in CSC Investments II.

So the headline is a tender at $2.50 against a $1.09 market price. A spread of roughly 130%.

The Real Risk and Why Odd-Lot Holders Are the Exception

Almost every risk is a risk to the spread, not a risk to an odd-lot tender. Once you separate the two, the odd-lot case becomes unusually clean.

For anyone tendering >100 shares, the main risk isn’t that the deal collapses, it’s proration.

You’re promised $2.50 on only a fraction of your shares, and the unaccepted remainder drops back into a $1.09 stub in a 90.5% Drahi controlled debt distressed equity. Your outcome gets dragged down toward the stub, and you can’t know the acceptance ratio at tender time.

That is why the spread is so wide and that is why it stays like that. The 130% is compensation for proration, stub risk and tax characterization, not a free lunch.

So the single risk that destroys the trade for everyone else (proration) does not apply to odd-lot holders, as mentioned before. That’s why odd-lot investing is one of the best risk reward setups in the market.

The filing states:

• If you own, beneficially or of record, fewer than 100 shares in aggregate, tender all of them, and complete the “Odd Lots” section of the Letter of Transmittal, your shares are accepted for payment before any proration of other tenders.

• Odd lots get first priority in the purchase waterfall, ahead of all pro-rata purchasing.

• You get the full $2.50 per share on 100% of your shares.

The rest of the risk list, for the odd-lot holder

• Stub, liquidity, going-concern and Drahi control: mostly irrelevant, as you keep zero residual shares if you tender in full.

• Termination risk: this is the real risk. If the deal is pulled, you simply keep your shares. You’re back where you started near $1.09, out only opportunity cost and the time your shares were tied up. Something I’ve found important in the filing is withdrawal rights run through the expiration, so if conditions deteriorate you can still pull your tender.

• Tax: for an odd-lot holder who tenders all of the shares, you have the strongest case for complete termination under Section 302. You still must watch constructive ownership, and US holders should return the W-9 to avoid 24% backup withholding (W-8 for anyone outside the US, like me, holders, who face the 30% default withholding and a refund process). But the odd-lot holder is still the best positioned person in the offer.

Bottom Line

For a large holder, the spread is compensation for proration, a worthless stub, and tax uncertainty.

For an odd-lot holder, the one risk that justifies practically the entire spread (proration) doesn’t exist, and a full position tender subsequently gives you the cleanest capital gain tax.

You collect $2.50 on every share against a $1.09 market price, with first priority acceptance, and the only meaningful downside is that the deal breaks and you keep stock you could’ve sold anyway.

That asymmetry is exactly what makes odd-lot investing attractive, and it’s why this offer is a good situation specifically and only for odd-lot holders.

*This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk. Conduct your own due diligence!

Arcontech is a financial middleware provider deeply embedded in clients’ data base, with extremely high recurring revenue (94-99%), a net cash position that covers 80% of marketcap, and a credible pipeline driven by platform replacement opportunities. Their customer base is exceptional, securing multi year contracts with top tier institutions globally and a very low churn rate.

The market is mispricing temporary customer churn and slow sales cycles, while ignoring the optionality of acquisitions and long‑term contracts. Downside is protected by cash; upside comes from waiting just 2 years to get your investment back in owner earnings + new Tier 1 contracts to grow their revenue + the high probability of an acquisition or a cash return to shareholders.

And yes, I’ve talked to management.

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Business Summary

Founded in 1979 and renamed after the acquisition of Knowledge Technology Solutions PLC in 2009, the firm has transitioned from a software consultancy to selling a product that addresses the most complex challenges in real time data distribution. Unlike bigger firms such as Bloomberg or the London Stock Exchange Group, Arcontech does not own market data itself, rather it provides the middleware that allows its clients to manage the data from other sources.

Strategy and Purpose

Their main purpose is to establish a strategy and business model which promotes long-term value for shareholders. Their main advantages involve, but are not limited to:

• Reductions in costs

• Providing something that does things faster and more efficiently for clients

• A solution that provides more functionality and/or flexibility.

They can achieve this by providing software solutions that enable clients to manage their real-time market data, independent of any of the market data vendors.

Arcontech’s strategy is to provide solutions (both server-side functions and to meet desktop requirements) in areas where they add significant value. The value and functionality provided together with content from multiple vendors makes their solutions difficult to displace.

This strategy will deliver growth from a solid base within existing clients as well as from establishing business with new clients.

To ensure the success of this strategy, the group prioritises research and development for business growth.

The CityVision Ecosystem

The group’s product portfolio is centered on the CityVision Market Data Platform, an extensible suite of components that can be deployed individually or as a comprehensive enterprise solution .

The flagship CityVision platform acts as a high-speed, real-time data distribution engine. It is engineered to support multiprotocol environments, facilitating the translation between disparate data standards, and legacy proprietary formats. This interoperability is particularly critical for Tier 1 banks that often operate complex systems.

Beyond the distribution engine, the product suite includes several specialized modules. I won’t elaborate further as I believe the exact details on modules are highly irrelevant for an investor.

The CityVision Multi-Vendor Contribution System is particularly dominant in the contribution market. It allows price-making desks at banks to broadcast their indicative rates, such as gold fixes or foreign exchange quotes, to multiple external platforms like Bloomberg, Refinitiv, and ICE simultaneously. This reduces bandwidth costs, ensures pricing consistency across venues, and simplifies the compliance and audit trail required by regulations.

Industry Background

The financial market data industry is a wide and growing sector, with global spending exceeding $40B. This industry serves as the fundamental base of the global financial markets.

Lower Costs

Despite the increasing necessity of market data, financial institutions are under pressure to reduce their market data spend. Major exchanges and data vendors have consistently raised their fees for data usage and redistribution, leading firms to look for ways to optimize their consumption.

This cost optimization has created a market for vendor neutral tools that provide transparency into how data is being used within an organization. Arcontech’s “Data Shaper” tools and Symbol Mappers are increasingly used by market data managers to audit consumption and identify unnecessary data fees. By allowing firms to decouple their applications from specific vendors, Arcontech lets them cancel expensive terminal packages and move toward more affordable data feeds.

Pricing

The success and stability of Arcontech is mainly thanks to its recurring subscription revenue model. This is designed for high visibility and predictable cash flows, which lets us investors value the business which much higher certainty.

Subscription Revenue Model

Normally, 99% of Arcontech’s turnover is derived from recurring annual license fees (however, this number can sometimes drop in the low 90%). This is standard for software but particularly resilient in the market data industry. Once a firm has integrated CityVision, the costs and risks of switching to a competitor are substantial, leading to very low churn rates.

In the fiscal year ended June 30, 2025, recurring revenues accounted for 94% of total turnover, maintaining the high levels seen in previous years. In the interim result for the six months ended 31 December, 2025, recurring revenues accounted for 99% of total revenues. This percentage can fluctuate slightly when the company undertakes significant non-recurring development work for major clients, as what happened in year ended 2025, but the core business remains firm in long-term subscriptions.

Consulting and Bespoke Development Fees

While the group is a product led organization, it also generates revenue through consultancy and bespoke development. In FY 2025, the company reported a “return of consulting revenue”, which contributed to the 6.8% turnover growth.

Arcontech frequently undertakes Proof of Concept work or develops custom integration solutions for Tier 1 banks. Although these are accounted as non-recurring revenues, they are designed to act as a catalyst for future recurring license fees. By solving a specific, complex integration challenge for a bank, Arcontech gets itself into that institution’s infrastructure.

Total Cost of Ownership Positioning

Arcontech positions itself as a cost effective alternative to both terminal packages and expensive internal builds.

• Unbundling the Big Vendors: Large data providers often bundle their software with data feeds, making it difficult for firms to reduce their spend. Arcontech’s independent middleware allows firms to “unbundle” these services, often saving significantly more in data fees than the cost of the Arcontech license itself.

• The Build vs Buy: For large banks, the cost of building and maintaining an internal market data distribution platform is material, requiring specialized development teams and constant support. Arcontech offers an “off-the-shelf” solution that provides the same level of performance and reliability but at a significantly lower TCO.

Product Sales Overview

Their financial performance reflects a company that has been successfully positioned for long term growth, regardless of adverse macroeconomic changes. For the fiscal year ended June 30, 2025, Arcontech reported total turnover of £3.1M, representing a 6.8% increase over the previous year (£2.9M).

Geographical Revenue

Arcontech is a global company, with its software deployed across multiple continents. Its revenue is very diverse world wide, which helps mitigate risks associated with specific regional economic downturns or regulatory shifts.

The United Kingdom remains the primary market, accounting for approximately 68% of total revenue in 2025. However, the increase in revenue from Australasia and the steady growth in North America indicate the company’s success in expanding internationally. In North America, the company has been focused on a long-term build-out to displace an alternative solution at a global investment bank in New York. More on that later.

Interim Results for H1 2026

The interim results for the six months ended December 31, 2025 (reported as H1 2026), showed a temporary decline in revenue. Turnover decreased by 4.7% to £1,439,382 (for the 6 month period) compared to the same period in the previous year. This was attributed to a net reduction in annual contracted revenue following the loss of one long-standing customer and some downsizing within another client’s user base. One-off revenues also dropped significantly (by 69%) after being exceptionally high in the previous period. Despite this, recurring revenue as a percentage of total turnover rose to 99%, and cash balances continued to grow, reaching £7,774,037 by December 31, 2025.

Customers

Arcontech serves a blue chip customer base that includes some of the world’s most significant financial institutions. These include Bank of England, JP Morgan, Goldman Sachs, Morgan Stanley, Barclays, Citi, Deutsche Bank, and more. The “mission-critical” nature of the software means that Arcontech’s clients view the relationship more as a partnership than a simple vendor and customer arrangement.

Client Profile and Tiering

The Group’s clients primarily fall into three categories:

1. Tier 1 Investment Banks: These large institutions use CityVision to handle the volumes of data through their trading desks. Arcontech’s software often serves as the last distribution layer within these banks, connecting external feeds to internal pricing engines and risk systems.

2. Central Banks and National Institutions: Arcontech’s heritage includes providing high-reliability contribution systems for central banks. These institutions use the Multi-Vendor Contribution System to publish official interest rate fixes, auction results, and other market-moving data to the global vendor community.

3. Hedge Funds and Trading Venues: For smaller firms, Arcontech provides a cost-effective way to access high-performance data infrastructure without the need for a big internal IT department.

Customer Concentration and Strategic Risk

Due to the specialized nature of its products, Arcontech has a high customer concentration base. In 2025, four major customers each accounted for more than 10% of total revenue, collectively contributing 67% (£2,094,680) of total turnover. This is a decrease from 2024, when five customers represented 78% of revenue.

The loss of a major customer can have a material impact on short-term financial performance, as seen in the H1 2026 interim results. However, the company mitigates this risk through high engagement with clients and by diversifying its pipeline. The current client list is described by management as “the strongest it has been for many years”, with interest coming from firms looking for alternatives to their existing market data platforms.

Retention and Stickiness

Arcontech’s software is deeply embedded in its clients operations. The difficulty and risk associated with getting rid of an incredibly important market data distribution layer create a high stickiness factor, which subsequently creates low churn. This is reflected in the Group’s net staff retention rate of 94%.

To further strengthen these relationships, the company has expanded its support and customer service teams. The goal is to move beyond reactive support and toward proactive partnership, where Arcontech engineers work closely with client IT departments to identify growth opportunities and solve emerging challenges in real-time. This strategy was successful at one specific client where Arcontech was able to renew a multiyear agreement shortly after by demonstrating its value, despite competition.

Competition

Arcontech operates in a highly competitive and consolidating market. Its competitors range from global data giants with multi-billion dollar budgets to smaller, nimble FinTech startups and internal bank IT departments.

The “Mega-Vendor” Challenge

The primary competition comes from the “Mega-Vendors” such as Bloomberg and Refinitiv. These firms own the data feeds and provide the terminals used by the vast majority of financial professionals. Their competitive advantage lies mainly in their massive scale.

However, these vendors also represent a significant problem for clients due to high costs and “vendor lock-in”. Arcontech’s competitive strategy is to act as the independent bridge between these vendors. For example, while a bank might continue to subscribe to Bloomberg for its data, it can use Arcontech’s middleware to route that data more efficiently and avoid being forced into using Bloomberg’s software.

Competitive Threats and Market Churn

The market remains challenging, with Arcontech noting that its “two main competitors” are currently offering “enhanced packages”. This has forced many customers to stringently review their costs and has led to a slight reduction in Arcontech’s user base at some institutions. The company’s response to this is continued investment in R&D to ensure its products remain technically superior and more flexible than those of its rivals.

Growth Strategy

The growth strategy of Arcontech is characterized by a balance of organic investment in product innovation and a formalized search for strategic acquisitions.

Platform Replacement Strategy

Probably the most fundamental strategy Arcontech has for future growth is the development of an extension to its product range that will allow customers to completely replace their existing market data platforms. Historically, Arcontech’s components often complemented existing infrastructure like Refinitiv’s RTDS. By evolving into a full platform replacement, Arcontech can capture a much larger share of a bank’s infrastructure budget.

This strategy has already generated significant interest from both existing clients and new prospects, leading to the strongest pipeline of potential business the company has seen in years.

Expanding their Team

To capture the opportunities in its pipeline, the Group has intentionally widened its sales operations and enlarged its support teams. The increase in staffing costs that impacted profit in 2025 was a direct result of this investment. By having a larger presence in the market, the company aims to reduce lead times for converting prospects which remain slow.

Acquisitions

With their cash balance exceeding £8 million and no debt, Arcontech is in a strong position to grow through acquisitions. The board has formalized its search for relevant acquisitions, prioritizing companies that offer growth potential and a strong fit with Arcontech’s existing software.

If an acquisition occurs and is done correctly, three things would happen:

1. Unlock value for shareholders

2. Prove cash isn’t trapped

3. Create the potential for future growth

All leading to a meaningful rerating in price.

The downside thesis in this entire investment lies in the acquisition (if done) resulting to be value destructive. If this occurs, no additional revenue will be created, the cash balance will shrink, returns on capital will decrease, and shareholders will be less protected by liquid assets.

Transition to Longer Contracts

A fundamental goal is the continued transition of the client base onto longer contracts. This strategy improves financial visibility and provides a more stable foundation for R&D. By securing multiyear agreements with Tier 1 banks, Arcontech reduces the risk of annual churn and ensures that it remains the best choice for the client.

Analysing Management

Skin In The Game

One of the strongest indicators of management’s integrity and commitment to shareholder value is the concentration of insider ownership. Over 56% of shares are held my insiders, including the CEO, CFO, and Chairman. This amount of “skin in the game” materially mitigates dilution risk and value destructive decisions, as the executives personal net worth is directly tied to the share price and the safety of the dividend.

The behavior of management during the stock’s drawdown in January provides a further insight into their shareholder orientation. In February 2026, following the release of the 2026 interim results that reported a client loss and a decline in profit, both the CEO and CFO bought shares. Matthew Jeffs, the CEO, purchased 20,000 shares at 76.46p, bringing his ownership to 7.72% of the company. Ben Hodges, the CFO, purchased 6,472 shares at 77.25p. These purchases were made when the stock was trading near 52-week lows. So, management is willing to risk their own capital knowing what they stated - viewing the recent downturn as temporary and believing in the strong pipeline to return to growth - is likely to happen.

Integrity and Honesty

Management’s wording in both the filings and their reply to an email I sent them demonstrate a clear pattern. No PR fluff, no promotional language, but a lot of transparency regarding business headwinds and opportunities.

In their last annual report, under goodwill, management specified when goodwill would be impaired and they value the business to determine which circumstances should occur for it to happen. Reading it answers what I believe are several of the most important questions regarding integrity and honesty of management, as well as what to reasonably expect the future to look like and the value of the enterprise.

I will just let you, the reader, arrive to your own conclusion. Nevertheless, you can already picture it based on previous comments:

The group tests goodwill annually for impairment or more frequently if there are indications that goodwill might be impaired. The key assumptions for the value in use calculations are those regarding the discount rates, growth rates and expected changes to selling prices and direct costs during the period. The discount rate is estimated using pretax rates that reflect current market assessments of the time value of money and the risks specific to the CGUs. Long-term growth rates are based on industry growth forecasts. Changes in selling prices are based on past practices and expectations of future changes in the market. Changes in direct costs are based on expected cost of inflation of 6.0% and 1.8% after year 5.

Cashflow forecasts are based on the latest financial budgets and extrapolate the cashflows for the next five years based on an estimated growth in revenue representing an average rate of 3.3% per annum, after which the UK long-term growth rate of 1.8% is applied for a further eight years. The Directors consider a timeline of fourteen years appropriate given the historical consistency of revenue to date, and that the rate of 3.3% for the first five years is appropriate given the current sales pipeline. Fluctuation in revenue is the most sensitive of assumptions. Should revenue fall by more than an average of 5% per annum then this could result in the value of goodwill being impaired. As the Group does not have any borrowings, the rate used to discount all the forecast cash flows is 8.8%, which represents the Group’s cost of capital.

Capital Allocation and Dividend Policy - The Email

I sent management an email on the 2nd of April, 2025. After 2 weeks and a follow-up, management never reached out to me, so I decided to call the shareholder enquiries number to confirm whether they had received it. To my surprise, the CEO Matthew Jeffs picked up. I was not expecting that at all. After giving him my details he told me he’d personally write back.

As it turned out my emails never reached their end. He had to personally email me through his company email after not being able to find my email. Here is how the exchange played out:

From Matthew’s response a few things stand out:

1. The board actively discusses capital allocation at every meeting

2. They are actually comparing acquisitions against returning cash, rather than just sitting on it indefinitely

3. They are aware of shareholder frustration around the cash pile and are not dismissive of it

4. The progressive dividend is a real objective, but it's dependent on performance

Additionally, the first line of response is telling. The preference of treating every shareholder equally and not just giving one investor an informational edge does show integrity rather than evasiveness.

Management willing to hold cash until the right opportunity arrives has 2 sides. At a first glance it would seem as they are just holding cash with no willingness to act, especially as it’s been a very long time since their last acquisition. Of course, after digging deeper, the picture seems much clearer. Cash is not only a buffer against macroeconomic headwinds but to deploy in an acquisition to create value for the company, as well as a high possibility of returning a portion of the cash to shareholders. Either way, the cash is not trapped - and management knows it.

Risks

Principal Risks and Uncertainties

The Group’s performance is affected by a number of risks and uncertainties, which the Board monitor on an ongoing basis in order to identify, manage and minimise their possible impact. General risks and uncertainties include changes in economic conditions, interest rate fluctuations and the impact of competition. The Group’s principal risk areas and the action taken to mitigate their outcome are shown below:

Other Risks

Upon closer inspection, there are some other material risks management doesn’t include explicitly. These include:

• High Customer Concentration: Arcontech’s revenue is heavily concentrated among a small number of financial institutions, even if they are considered elite.

  • In 2025, just four customers accounted for 67% of total turnover.

  • The loss of even a single long-standing customer can lead to material contractions in revenue and profit.

• Acquisition and Capital Allocation Risk: With a cash pile covering roughly 80% of its marketcap, the biggest risk to the downside protection is poor capital allocation.

  • If management does a poor acquisition, i.e. overvalued or not suitable, it could erode the firm's primary safety net and reduce returns on capital.

Interpretation of Financial Statements

In order, from most relevant financial statement to least relevant.

Overview

Results for the six months ended 31 December 2025:

• Revenue decreased by 4.7% to £1,439,382 (H1 2024: £1,511,346) with recurring revenues down by 3% and one-off revenues down by 69%

• Recurring revenues represented 99% of total revenues for the period (H1 2024: 97%)

• Adjusted EBITDA* decreased by 23.6% to £341,239 (H1 2024: £446,513) as the result of the revenue decrease noted above and continuing investment in staff (* adjusted ebitda is defined as operating profit before depreciation, amortisation, share based payments and releases of historic accruals relating to administrative expenses)

• Profit before tax decreased by 23.8% to £394,622 (H1 2024: £518,166 )

• Net cash of £7,774,037 at 31 December 2025, up 8.4% (H1 2024: £7,166,839)

Key Metrics

• Cash Return on Operating Capital, defined as Owner Earnings / (Invested Capital - Cash) is approximately 90%.

• Gross margin is 100%, as the business reports no cost of goods sold.

• FCF margin is 35%, with a 5 year average of 32%.

• Net cash to Market Cap is approximately 80%.

• Owner Earnings to Enterprise is 43%, and on a normalised basis (calculated in the following section) is of 30%.

• Cash Flow Conversion, defined as OCF to Net Income, is roughly 2x. This is using the most recent filing, and it can fluctuate widely. However, on average, OCF is usually higher than reported earnings, meaning accounting earnings understate actual cash generation.

• Price to book is 1.1x.

• 10 year revenue CAGR is approximately 4%.

Balance Sheet

Financial Safety

As observable, their balance sheet stands out mainly due to the extreme level of liquidity and an absence of financial risk. This fortress of a balance sheet is the primary source of safety for shareholders and a fundamental differentiator in the smallcap technology sector, as many of these companies are highly leveraged and dilute shareholders.

Cash and Liquidity

As of the latest filing, the group held cash and cash equivalents of roughly £7.8M .To put this in perspective, the current marketcap is approximately £9.9M. This means that roughly 80% of the company’s equity value is backed by cash on hand. The growth in cash from £7.2M in June 2024 to over £7.7M by the end of 2025 gives a clear picture on how cash generative the business is.

The liquidity position is even better once we look at the current ratio. At the end of December 2025, current assets (£8.24 million) outweighed current liabilities (£1.86 million) by 4.4x.

Debt Obligations

Arcontech has no debt, having no bank loans or revolving credit. The only non-current financial liabilities are related to lease obligations under IFRS 16 and small provisions for office maintenance. These lease liabilities, which total £368,748, represent the present value of future rent payments for the office.

There is a nuance in software accounting. Deferred income, while technically a liability, as it represents cash received in advance for licenses and support services, it is a good liability because it represents cash already in the bank without any interest cost or repayment obligation. Meaning this liability will most definitely be added next year to their cash balance.

Intangible and Fixed Assets

The balance sheet includes £1,715,153 in goodwill, which has remained the same for more than 10 years. This goodwill was from a historical acquisition of a software business. The company does annual impairment reviews, which consistently demonstrate that the value in use of the cash generating units (CGU) exceeds the carrying value. Property, plant, and equipment is minimal (£7,588), do to the business being capital light, where the primary investments are expensed through the income statement as research and development staff costs.

Cash Flow Statement

Cash generated from operations:

Operating Cash Flow

Net cash from operating activities was £860,247, a significant increase from £432,237 in 2024. This occurred despite the decrease in PBT and was largely driven by the timing of annual billing cycles. Arcontech typically bills its larger clients annually in advance. This leads to large cash inflows at the start of contract cycles.

Dividend Policy

Arcontech has maintained a consistent and growing dividend, which is again something rare for a microcap company. The company has a 9 year growth streak, with the most recent dividend increased to 4.00p per share. The consistency is extraordinary.

Even as the payout ratio has increased from 14% in 2018 to over 50% in 2025, the company’s cash generation remains sufficient to fund both the dividend and the ongoing reinvestment in staff and R&D.

Income Statement

Revenue

Arcontech’s revenue was lower in the first half of this financial year with a net reduction in annual contracted revenue due to the loss of a long-standing customer and some downsizing coupled with a drop in one-off revenues. Churn is inevitable but management has have been very successful maintaining their customer base with a material proportion on multi-year contracts.

They noted in the last full year’s statement that one-off revenue was exceptionally high and not expected to continue at the previous year’s levels. Overall, given the strong pipeline they expect the recurring revenue run rate to recover around the end of the financial year.

20 Year revenue graph:

Operating Costs

The main cost of goods sold is basically the capital required to develop, maintain, and support CityVision. Because the company expenses its research and development R&D directly through the income statement rather than capitalizing it, the administrative expenses line provides a look at the firm’s true reinvestment rate, which I find quite interesting.

While revenue fell by 4.7%, their adjusted EBITDA decreased by 23.6%. The reason for this margin compression was continuing investment in staff. Management intentionally used the company's £7.8 million cash position to fund this expansion.

Valuation

Relative Valuation

This is slightly tricky. Publicly traded peers offering similar solutions aren’t valued merely for these. Most of them offer different, more general services which are secondary to their primary business model.

Of course, this makes multiple peer comparison more difficult. Either way, there are 3 publicly traded companies which also offer similar packages inside their business:

• ICE - Intercontinental Exchange

• LSEG - London Stock Exchange Group

• NASDAQ - Nasdaq

ICE currently trades at 22x earnings, EV/FCF of 23x, and a PB ratio of 2.9x; LSEG trades at 39x earnings, EV/FCF of 16x, and a PB ratio of 2x; and NASDAQ trades at 27x earnings, EV/FCF of 30x, and PB ratio of 4.25x

To put into perspective, Arcontech trades at just 12x earnings, 2.4x EV/FCF, and 1.1x book. At first glance, this does seem cheap relative to “peers”.

However, as stated previously, this comparison should not be used to define the relative valuation and conclude it’s undervalued or cheap (even if it really is). An absolute valuation would really put into perspective the true value and margin of safety of this security.

Absolute Valuation

I would undoubtedly classify this business as capital light. Its value is driven almost exclusively by the present value of future cash flows, independent of asset value.

Nevertheless, there is a very important asset in the balance sheet: cash.

Most of the investment thesis is compelling thanks to the sheer amount of cash they have in the balance sheet, and how this could make or break the entire investment.

It creates a meaningful downside buffer, while also amplifying upside optionality if deployed correctly.

Normalised Owner Earnings

Before building a full valuation model, I first derive a normalised level of owner earnings to understand the current earning power of the business.

Starting point is revenue of approximately £2.9M, adjusted to reflect the recurring base of the business rather than headline revenue, which can be distorted by one-off or consulting-driven work.

Operating expenses are taken at approximately £2.33M, which reflects the current cost base after management’s investment in headcount and capability. I do not average this with historical periods because management has clearly indicated that these costs are structural rather than temporary.

To this I add net finance income of approximately £220k, which is a direct function of the company’s net cash position and therefore a recurring component of earnings.

Tax is applied at a normalised 19% rate, which is what management has mentioned to use in their adjusted earnings, stating it’s a much more appropriate rate than the artificially low effective tax rates seen historically due to credits and timing effects.

To finally arrive at owner earnings, I adjust for non-cash items and maintenance capex:

• Depreciation is added back (£110k)

• Maintenance capex is deducted (£10k)

This results in normalised owner earnings of roughly £750k per year, which is the base earning power of the business before any growth assumptions are applied.

At the current market capitalisation, this already implies a very high owner earnings yield, particularly given the quality and stickiness of the business.

We arrive at a 7% normalised owner earnings yield, which does seem rather fair.

Of course, accounting for net cash changes the picture significantly, and it should be the metric to look at. Under these assumptions, we arrive at a near 30% Normalised Owner Earnings / EV yield.

Intrinsic Value - Base Case

To arrive at a somewhat realistic intrinsic value, I’ll build a 10 year explicit projection of owner earnings, based on conservative assumptions:

• Revenue growth:

  • Years 1-5: 3.0%

  • Years 6-10: 1.5%

• Operating expenses grow at about 0.5% annually (reflecting gradual inflation and continued investment in the business)

• Net finance income remains flat at £220k (no benefit from higher rates or additional cash deployment)

• Tax remains at 19%

• Depreciation and maintenance capex remain constant

Obviously this is slightly unrealistic. The company has existed for decades, operates with highly recurring revenue, and serves some of the largest financial institutions in the world. However, I would rather be conservative with an understated margin of safety than assume heroic assumptions and get an overstated margin of safety. One gives protection and optionality, the other risks overpaying.

Management uses an 8.8% discount rate when valuing the business, which they describe as the Group’s cost of capital. Given the debt free balance sheet, recurring revenue base, and overall quality of the business, I strongly agree with this figure.

For simplicity, I use a 9% discount rate, which was also what I first thought the business should be capitalised at before reading management’s note.

The present value of 10 years of explicit owner earnings is approximately £6.5M.

Adding cash (£7.8M) less any debt/lease obligations (£0.3M) results in an intrinsic value of approximately £14M, or 105p per share.

Margin of Safety and Interpretation

Quick reminder: intrinsic value is just a range, useful when the discrepancy between price and value is wide enough, and if the assumptions used are reasonable or conservative.

At the current share price of 74.5p, this implies a margin of safety of roughly 30%.

Again, the more important point is not the precise output of the model, but the assumptions embedded within it:

• No terminal value beyond year 10

• No potential acquisitions

• Flat finance income despite large and growing net cash balance

• Conservative growth below management guidance

• No optionality value assigned to platform replacement strategy

The entire base case revolves around stabilisation. The company continues to operate the same way, no new customers, no downsizing, no exponential growth. The same thing it has done for 2 decades.

Intrinsic Value - Bear Cases

Bear Case 1 - Loss of Largest Customer

The first and most obvious risk is customer concentration.

Arcontech’s largest customer represents 22% of total revenue, equivalent to approximately £668k of sales annually. Here I assume the company loses this customer entirely and never recovers the revenue.

Additionally, I assume:

• No new customer is found

• No one offs that increase total revenue

• Operating expenses remain unchanged

• Management doesn’t reduce costs

• The goodwill impairment occurs

This is intentionally harsh. It assumes revenue falls materially while the cost base remains largely fixed.

Under these assumptions:

After adjusting for non-cash items and maintenance capex, normalized owner earnings total approximately £197k.

Importantly, the goodwill impairment does not affect owner earnings. It would reduce reported accounting equity, but it is not a cash expense, leading to an artificially low price even if actual cash generation still exists.

Capitalising these owner earnings at 9% and adding net cash results in an intrinsic value of approximately £9.7M. Which, I may add, is remarkably close to the market’s current valuation.

The margin of safety is roughly -4%. So, even if Arcontech permanently loses its largest customer and never recovers, shareholders today are still paying something close to fair value primarily due to the strength of the balance sheet.

Bear Case 2 - Value Destructive Acquisition

The second major risk is capital allocation.

A large part of the investment thesis relies on management deploying cash intelligently.

In this scenario, I assume the base operating business performs normally and revenue and owner earnings remain practically the same as with the base case.

However, management deploys half the cash balance into an acquisition that ultimately destroys value.

This means roughly £4M of cash disappears, the acquisition contributes no earnings, and returns on capital deteriorate.

Importantly, even under this scenario, the core operating business itself remains intact and continues generating owner earnings.

The result would likely be a lower quality investment and a reduced margin of safety, but not necessarily a permanently impaired business.

This is probably the most realistic downside scenario in my view, because poor capital allocation is often the biggest risk in net cash microcaps, given they are looking to deploy the cash in an acquisition.

The margin of safety is roughly 2%, practically implying paying fair value. A very similar result is obtained compared to the previous bear case.

Catastrophic Case Scenario

The catastrophic case combines both bear scenarios simultaneously.

Arcontech loses its largest customer permanently, revenue never recovers, costs remain the same, management destroys roughly half the cash balance through a poor acquisition, no operational recovery occurs, and no additional customers are won.

This would represent permanent destruction of both earnings power and balance sheet strength at the same time.

Capitalising owner earnings at 9% and adjusting for the reduced cash balance results in an intrinsic value of £5.8M, at a per share value of 43p.

Compared to the current share price of 74.5p, this would imply downside of approximately 42%.

This is clearly unrealistic. The probability of this happening, at least in the foreseeable future, is extremely low. It’s a combination of revenue deterioration, burnt cash, and no management response.

This scenario assumes a permanent loss of the largest customer, no replacement revenue whatsoever, no cost flexibility, no operational recovery, the destruction of half the company’s cash, no benefit from future contracts…

In other words, it assumes almost everything that can go wrong does go wrong simultaneously.

That asymmetry is what makes the opportunity interesting to me.

The base case does not require exceptional execution for the investment to work, while the worst case requires multiple independent failures occurring simultaneously, something highly improbable.

Intrinsic Value - Bull Case

The bull case mainly requires the replacement of lost revenue and the continuation of the company’s historical recurring revenue growth profile.

Management already stated that the newly secured client is expected to replace the lost revenue. Given the size of the previously lost customer, I think it is reasonable to model this new customer similarly to their current 4th largest customer, which accounts for approximately 10% of revenue, or £330k annually.

I therefore assume this revenue is effectively added back the following year.

I do not attempt to model or estimate how a potential acquisition would affect future revenue.

There is simply no reasonable or educated estimate I can arrive at which would not, in my opinion, become speculative judgment. Arcontech has no recent acquisition history to properly analyse capital allocation outcomes or estimate returns on invested capital. As a result, acquisitions are entirely excluded from the upside case.

This is important because it means the bull case is driven purely by the existing business.

Once the replacement revenue is added back, I model growth broadly in line with management’s own assumptions disclosed in the annual report.

Management stated:

“Cashflow forecasts are based on the latest financial budgets and extrapolate the cashflows for the next five years based on an estimated growth in revenue representing an average rate of 3.3% per annum, after which the UK long-term growth rate of 1.8% is applied for a further eight years.”

Given the current pipeline and the replacement customer already secured, I slightly increase these assumptions while still remaining, in my view, within a realistic range.

Assuming:

• Revenue growth:

  • Years 1-5: 4%

  • Years 6-14: 2%

• Operating expenses grow at 0.5% annually

• Net finance income grows at 3% annually as the company continues accumulating cash and earning interest income on its balance sheet

• Tax remains at 19%

• Depreciation and maintenance capex remain constant

Under these assumptions, owner earnings evolve as follows:

This is simply the existing business compounding over time with the lost revenue restored, for 14 more years.

Discounting these owner earnings at a 9% capitalization rate results in a present value of owner earnings of approximately £12.1M.

Adding back net cash results in a total intrinsic value of £19.6M, or 147p intrinsic value per share.

Compared to the current share price of 74.5p, this implies a margin of safety of approximately 50%.

The asymmetry becomes particularly attractive when comparing this scenario to the bear cases.

The downside cases require multiple operational or capital allocation failures occurring simultaneously, while the upside case mainly requires the business to continue behaving similarly to how it historically has.

If there’s a successful acquisition, the margin of safety will be extremely wide at current prices.

This bull case seems more realistic than the bear cases, and even these would mostly mean you paid a fair price for the business (unless it’s the catastrophic case).

Catalysts & Why The Market Is Wrong

There are multiple paths for re-rating.

However, it’s worth noting that Arcontech does not require a catalyst to deliver satisfactory returns. At current prices, the business generates a 9.4% owner earnings yield on market cap (or 7% if normalised conservatively), a 43% earnings yield on enterprise value (or 30% if normalised conservatively), and pays a 5.5% growing dividend, all while sitting on cash that represents 80% of its market cap.

That said, there are several catalysts which would cause the market to recognize the value discrepancy.

The most immediate is the recovery of recurring revenue following the loss of the already mentioned long standing client that happened at the end of 2025.

Management has already signed a contract with what they describe as a prestigious new customer, with a second in the final stages of negotiation. Lead times in this market are long, so the recovery will be gradual, but a return to revenue growth would confirm that the 2025 decline was indeed a one off.

If it does go through, which seems highly probable, the market could rerate and recognise the value of the business relatively quickly.

Apart from the near term recovery, management has formalised its search for acquisitions of smaller competitors. It is also worth noting that the last acquisition was completed in 2009, meaning the cash has compounded on the balance sheet for over 15 years without being deployed.

This could be a failure to execute cash, but given that the business has continued to grow and management has been explicit about not deploying capital poorly, the more likely explanation is simply a high bar for quality.

Of course a well executed acquisition could meaningfully expand the revenue base. In the event of a poor acquisition, the value of Arcontech could meaningfully decline, obviously depending on the magnitude of the acquisition.

However given the patience and discipline they've demonstrated in and the acknowledgement on direct shareholder returns, this possibility seems relatively low.

At 56% insider ownership, management's interests are directly aligned with deploying that cash wisely.

If the acquisition results in the creation of new opportunities and expansion, not only would intrinsic value increase, but the re-rating would be material and would unlock a lot of future potential.

After everything, we can conclude the following: The stock market isn't blind, it's one eyed. The market is pricing a temporary revenue decline as if it were permanent impairment. Based on all of the above, this clearly isn't the case.

Final Thesis

Arcontech is no ordinary business. It operates in an incredibly niche industry, is very small, ignored by most investors, and has no analyst coverage whatsoever. 

Situations like this are unusual.

The business itself is extremely high quality, with the obvious exception being customer concentration. 

However, the customers themselves are also exceptionally high quality institutions. The software is deeply embedded into client infrastructure, recurring revenue ranges in the high 90%, margins are extremely high, and the business requires almost no capital to operate.

Management is another major part of the thesis. They own more than half the company, continue buying shares in the open market, communicate transparently, and appear highly rational regarding capital allocation.

Their comments throughout filings and the email I sent suggest they understand both the value of the business and the importance of protecting shareholder capital.

The market appears to be mispricing the business for several reasons, such as obscurity and lack of coverage, the temporary revenue decline, slow sales cycles, the fear of customer concentration, and possible skepticism around the cash balance.

A long standing customer was lost, but management has already stated the revenue is expected to be replaced and that the pipeline is the strongest it has been in years.

Lead times in this industry are long, which delays recognition by the market, but does not necessarily impair intrinsic value. This is actually a core reason to why the mispricing exists, making it a sort of benefit.

The base case valuation is intentionally conservative, and arguably too punitive.

It assumes no meaningful margin expansion, modest growth, no benefit from acquisitions, no additional customer wins, and effectively assumes the business disappears after 10 years.

Even under those assumptions, intrinsic value still implies roughly a 30% margin of safety.

The bear cases require either the destruction of the cash balance, or permanent loss of the largest customer. Even then, we would be paying fair value.

Meanwhile the bull case does not require extraordinary assumptions. It's just the replacement of lost revenue, continuation of historical recurring revenue growth, and time. This alone rises intrinsic value materially and implies roughly a 50% margin of safety.

If not enough, we are being paid to wait through a growing dividend yield of roughly 5.5%. Time itself is arguably the primary catalyst.

Additionally there are multiple realistic paths to rerating, all included in the previous section.

As observed, the current valuation already prices in substantial pessimism, while the business itself remains profitable, cash generative, debt free, and deeply embedded within some of the world’s largest financial institutions.

In my mind, that asymmetry is what makes the opportunity extremely compelling.

*This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk. Conduct your own due diligence!

Author Notes:

The portfolio’s return since inception on April 2026 is roughly 3%, vs the S&P 500’s 4%.

The general stock market keeps on booming, and I don’t believe this type of performance is sustainable.

I make no attempt to predict where the market is going. However, I do believe speculation at levels like this will lead to the eventual reversion of price. If this occurs, prices, even of undervalued securities, will be temporarily affected.

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General Situations & Co.

Author Notes:

I am pleased to announce the launch of General Situations & Co., an informal investment “partnership” formed to achieve long-term capital appreciation through the purchase of general undervalued securities and special situations. General undervalued securities will constitute the principal investments of the partnership while still remaining invested in special situations, derived from the successful completion of specific corporate events rather than the general level or direction of the market. This is the initial description of the General Situations & Co. portfolio, setting out its positions at inception. This section will not be used to comment on portfolio changes, rather to offer the occasional thought I find worthy of mention.

Holdings as of inception:

Notes: Generals refer to undervalued securities in which the investment outcome is determined by the appreciation of price by the market, with no meaningful catalyst as the driver of said investment. Special situations are composed of securities in which the outcome is not influenced by market fluctuations, rather by the successful completion of specific corporate events, including mergers and liquidations. These are bought below the estimate of cash that is highly probable to be received after the corporate actions are completed. Such investments are expected to continue yielding predictable returns even in adverse market conditions.

These updates will be done on a quarterly basis, or sooner should I make any changes to the holdings. In the future there will be additional charts added to these updates, reflecting the annual and YTD returns of all holdings since purchase, as well as the total portfolio return.

IMPORTANT: General Situations & Co. is not a real or existing partnership, nor does it manage outside capital of any kind. It is simply a Substack newsletter.

• The Buffett who ran a small, opportunistic partnership in the 1950s-60s

• The Buffett who compounds tens of billions inside Berkshire Hathaway

They share principles, but they are not the same game. And treating them as such is where most active investors go wrong. By copying modern Buffett - buying high-quality, often large-cap businesses at fair prices - you might gain an edge against the market and achieve satisfactory returns over the long run. Nevertheless, that strategy is more of a stable, predictable way of compounding wealth that has already been created.

Most investors are comfortable with that. But if you really want to compound capital like Buffett when he had similar amounts of capital as you, then it’s the wrong approach. Modern Buffett’s approach is limited because of size. However, we investors with low sums of money (sub 50M$) can exploit market inefficiencies as he did when he had our capital, subsequently achieving much higher returns.

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The Partnership Was Built Around One Idea: Asymmetric Outcomes

Buffett anchored, and still does, on something very simple: you don’t need brilliance if the purchase price does most of the work.

It’s such a simple concept yet few know how to apply it.

In the early 60s letters, he makes it explicit that returns come from the margin of safety embedded in the purchase, not from predicting the price movement or macroeconomy. This does two things:

1. It removes the need for macro forecasts (which he openly rejects)

2. It converts investing into a probabilistic outcome rather than a narrative one

He wasn’t asking Is this a great business?, he was asking What does the price already assume, and what happens if reality is slightly better?

However, most deep value investors seem to ignore that quality is still crucial to an investment and its outcome. Quality drastically improves the probability of a positive outcome, simultaneously protecting downside and increasing upside. The asymmetry of an investment becomes even more favourable, as the estimations on value are reinforced with higher predictability thanks to said quality.

Time Horizon Was a Tool

One of the more subtle and critical points in the letters is how Buffett thought about time. He wasn’t “long-term” in the modern sense. He did in fact invest for the long term, but his holdings didn’t have to reflect that. He was outcome-driven:

• Some positions took years

• Some worked quickly

• Some were tied to corporate events

The holding period of an individual business was never the thesis. This is why he could comfortably run:

• Cheap “generals” with no immediate catalyst

• “Workouts” with defined timelines

• “Controls” where he influenced the outcome

That flexibility is the edge, though the controls are harder to execute when you’re a retail investor with only a few thousand to invest with. For that reason, the average retail investor should focus of generals and workouts.

Modern investors tend to condense everything into “buy and hold”. Buffett didn’t, and you shouldn’t either (if you’re trying to copy his approach). He allocated across different payoff profiles depending on the opportunity.

Concentration Was Rational

Many investors think that concentrating is dangerous. But rationally it’s clearly not. If you actually know what you’re doing, and opportunities are scarce, you concentrate because there is no reason not to. That was Buffett’s mindset and it has remained the same, but size forced him out of that edge.

In the mid-60s, he explicitly criticizes excessive diversification as illogical if the goal is performance. He has also spoken about it in Berkshire Hathaway letters to shareholders and annual meeting.

So if you’re willing to put in the work and analyse each company you decide to invest in, high conviction and an edge, diversification most of the time doesn't make much sense. And, in most cases, this concentration actually reduces your risk of permanent loss of capital.

The Partnership Had Something Berkshire Doesn’t: Freedom

The Partnership had 3 structural advantages:

1. Size: small enough to operate in inefficient corners

2. Flexibility: no mandate

3. Alignment: almost all of Buffett’s net worth invested alongside partners

That combination allowed for something Berkshire cannot replicate today:

The ability to continuously hunt mispricing wherever it appears.

Small caps, liquidations, obscure securities, even odd-lot situations. And importantly, he could not play when nothing was attractive. Or, as he states it:

The stock market is a no-called-strike game. You don't have to swing at everything—you can wait for your pitch.

He even shut the partnership down when the opportunity set was too scrace and he felt he couldn’t achieve the desired returns.

Berkshire Is The Solution To A Lower Opportunity Set

Berkshire is often said to be a philosophical evolution, moving from cigar butts to great businesses. That’s only partially true. The main reason is capacity. But just as importantly, the opportunity set itself changed.

• You cannot deploy billions into net-nets.

• You cannot meaningfully impact returns with small arbitrage.

• You cannot move in and out of positions without friction.

But even beyond that, those opportunities are far less abundant today, and when they do appear, they are more often value traps than actual mispricings. Markets have become more efficient, information is no longer an edge, and the simple quantitative cheapness that defined Graham rarely exists without a reason. Which makes another point clear: Buffett was never a pure Graham investor.

Even during the Partnership years, he concentrated capital, avoided irrational diversification, and applied qualitative judgment. The “cigar butt” framing is overly simplistic, as it ignores the fact that he was already filtering for business quality, downside protection, and probability-weighted outcomes, not just statistical cheapness. Moreover, he achieved far greater returns than Graham.

Achieving the returns Graham achieved with his strategy is far more difficult than with young Buffett’s, because Buffett wasn’t 100% Graham influenced.

The Mistake Most Active Investors Make

Most active investors copy Berkshire without having Berkshire’s constraints, which leads to some expected outcomes:

• They buy “quality” because Buffett does

• They hold long-term because Buffett does

• They ignore true mispricing because it looks messy

But they don’t have constraints such as:

• Size

• Limited opportunity set

• Permanent capital

So instead of inheriting Buffett’s edge, they copy his constraints without his real and past advantages. The strategy Berkshire manages isn’t necessarily bad, it’s actually incredibly powerful for compounding reliably over many decades. But most people who copy it do so with certain objectives in mind which don’t correspond to the intended objectives the strategy was created for.

Final Thought: Which Buffett Should You Follow?

Here’s a clean way to think about it:

The Partnership teaches you how to grow cash fast and efficiently. Berkshire teaches you how to compound it reliably over many decades.

Most investors try to start with the second. It isn’t wrong, but it assumes a very specific objective. Before adopting it, you need to be clear about what your objective is investing, and your style. If you’re starting with a few thousand, or even a few million, copying Berkshire’s approach isn’t a bad choice but constraints you to mostly compete in the efficient part of the market, where information is widely available, businesses are heavily analyzed, and excess returns are competed away. The result might be a more predictable outcome, but also a lower ceiling for returns.

The Partnership approach was built for the opposite.

Small capital allowed Buffett to invest where mispricings were real and persistent, in situations where securities traded at a “substantial excess of value” relative to price, creating both downside protection and meaningful upside. That’s where great sums were generated in a rather fast way.

So the question isn’t which approach is better in absolute terms. It’s which one aligns with your constraints and objectives.

If you are not forced into Berkshire's universe, choosing to operate there is inefficient unless you lack the time or willingness to analyse more obscure companies where other analysts aren't looking. If you’re looking to choose Buffett’s path when he had similar amounts of capital as you, and aiming to generate similar returns with his philosophy and strategy, you start at the partnership’s level. Buffett didn’t change because his philosophy changed, he changed because he was forced to.

If you’re interested in a more in depth analysis on his partnership strategy and how to mimic the philosophy, like or restack the post so I know!

*This is NOT financial advice. This post is only educational.

Cal-Maine Foods (NASDAQ:CALM) is the largest producer and distributor of shell eggs in the United States. Their mission is to be the most sustainable producer and reliable supplier of consistent, high quality fresh shell eggs, egg products and prepared foods in the United States. Cal-Maine’s operating approach is achieving operational excellence, sustainability and creating value for the stockholders, customers, team members and communities. They sell most of their products throughout much of the U.S. and aim to maintain efficient operations. Founded in 1957 and are headquartered in Ridgeland, Mississippi.

Many customers rely on them to provide most of their shell egg needs, including specialty and conventional eggs. Specialty eggs encompass a broad range of products. There are many cost factors that are not specifically available for conventional or specialty eggs due to the nature of egg production. They manage operations and allocate resources to these types of eggs on a consolidated basis based on the demands of their customers.

The company’s competitive advantage is its diversified egg and prepared foods portfolio, enabling it to meet evolving consumer demand across conventional and premium categories. While currently a smaller revenue contributor, free-range and pasture-raised eggs are experiencing sustained demand growth and represent attractive niche segments. Strategic expansion into prepared foods is underway, supported by the September 2024 investment in Crepini Foods and the post-FY2025 acquisition of Echo Lake Foods, strengthening its position as a trusted provider of differentiated food offerings.

- Industry Background

In 2024, ~71% of U.S. egg production was sold as shell eggs, primarily through retail food-at-home channels (57%), with smaller volumes through foodservice (12%) and exports (2%). The remaining ~29% was sold as egg products (liquid, frozen, or dried) to institutional and food manufacturing customers.

The industry has faced significant supply volatility from recurring highly pathogenic avian influenza (HPAI) outbreaks, materially impacting production, pricing, and availability in recent years.

Long-term demand for eggs generally tracks U.S. population growth, but short-term consumption and supply are highly sensitive to shocks (e.g., HPAI, COVID-19). Shell egg household penetration remains structurally high (~97% in FY2025). Per capita consumption between 2020–2024 ranged from 271–288 eggs annually, largely constrained by supply availability rather than demand.

The most notable structural demand shift is toward specialty

eggs, particularly cage-free, which continues to be the fastest-growing segment within the category.

- Shell Egg Pricing:

Wholesale shell egg prices are the primary revenue driver and are volatile and cyclical, as they are influenced by consumer demand, seasonal factors, laying hen supply, and agricultural disease outbreaks such as HPAI.

• Conventional shell eggs: Prices are tied to independently quoted wholesale markets though some transactions use cost-plus arrangements.

• Cage-free eggs: Prices reference independent market quotes, but other specialty eggs are negotiated directly with customers.

Specialty eggs typically demand higher prices due to consumer and customer willingness to pay a premium. Actual transaction prices can change from quoted market prices due to negotiated terms.

Historical weekly prices for large white conventional shell eggs over the past three fiscal years, compared with the five-year average:

- Summary of Product Sales:

The following table sets forth the contribution as a percentage of revenue and volumes of dozens sold of conventional, specialty shell eggs, egg products and prepared food sales for the following fiscal years:

- Customers:

The company maintains a highly concentrated customer base, with its top three customers accounting for approximately 49–50% of net sales over fiscal 2023-2025 (49.2% in 2025, 49.0% in 2024, and 50.1% in 2023).

Walmart (including Sam’s Club) remains the largest customer, representing 33.6% of net sales in fiscal 2025, consistent with 34.0% in 2024 and 34.2% in 2023. This shows a high level of revenue concentration with a single retail customer.

For fiscal 2025 shell egg sales:

• 86% of revenue was generated from retail customers, including national and regional grocery chains, club stores, and distributors serving independent supermarkets.

• 13% was derived from foodservice customers, including distributors supplying restaurants, healthcare, education, and hospitality sectors.

- Competition

Shell egg competition is generally based on price, service and product quality. According to Egg Industry Magazine, the ten largest producers owned approximately 54% of industry table egg layer hens at calendar year-end 2024 and 2023.

- Growth Strategy

The company’s growth strategy combines organic expansion and acquisitions, alongside continued product portfolio diversification.

• Organic Growth:

Investment in existing operations is focused on improving profitability through:

• Increasing sales

• Lowering costs

• Maintaining strong customer service

The company has continued expanding production of cage-free shell eggs and higher value specialty eggs.

• Acquisition Strategy:

In addition to internal growth initiatives, the company looks to expand its market through acquisitions. The acquisition approach focuses on favorable returns by leveraging operational efficiencies within its existing operating model. Many acquisitions have been made in the past years to expand specialty eggs and aim for more than 50% of revenues gained by the sale of these in the near future.

Risk Factors

I’ll concisely address every type of risks. Even though it will be partially summarized, no important information is left out.

Important note: The company’s business, financial condition, and results of operations are subject to numerous industry, operational, regulatory, financial, and market risks, many of which are outside its control.

1. Industry Risks

- Egg Price Volatility:

Wholesale shell egg prices are highly volatile and cyclical, impacting revenues and profitability. Small changes in industry supply or demand can significantly affect pricing. Seasonal fluctuations also limit the comparability of quarterly results.

- Demand Risk:

Consumer demand may decline due to health concerns, shifts in dietary trends, reduced at-home consumption, or negative publicity.

- Feed Cost Volatility:

Feed (primarily corn and soybean meal) represents 53-63% of total farm production costs over the past five fiscal years. Prices are influenced by weather, geopolitical events, trade policies, supply chain disruptions, and global instability. Higher feed costs without corresponding egg price increases can materially compress margins.

• Agricultural & Disease Risk (HPAI):

Avian influenza outbreaks have led to flock depopulation, supply disruptions, and operational impacts, including HPAI incidents in Kansas and Texas in fiscal 2024.

• Food Safety & Recalls:

Eggs are susceptible to microbial contamination. Product recalls could damage reputation, trigger liability exposure, and materially affect financial performance.

2. Business & Operational Risks

• Acquisition Risks:

• Over/underestimating cage-free demand

• Integration challenges

• Higher-than-expected costs

• Increased debt or shareholder dilution

• Regulatory approval uncertainty

• Echo Lake Foods Integration:

The June 2025 acquisition expands prepared foods exposure. Integration challenges, limited prior prepared foods experience, and failure to realize expected synergies could negatively impact results.

• Pandemic & Health Crises:

Public health crises may disrupt labor, supply chains, input availability, and operating costs, even if retail demand temporarily increases.

• Customer Concentration & Pricing Pressure:

Top three customers represented ~49–50% of sales (2023–2025); Walmart accounted for ~34%. Customer consolidation increases pricing pressure and bargaining power. Loss of or reduced purchases by major customers would affect results.

• High Egg Price Reactions & Government Scrutiny:

Recent high egg prices have led to customer pressure to revise pricing frameworks, a DOJ investigation into egg pricing, and increased regulatory attention. Government intervention and policy changes may impact revenues and margins.

• Competitive Intensity:

The shell egg business (94–95% of sales in recent years) is highly competitive. Prepared foods expansion introduces additional competitive pressures.

• Labor Risk:

Approximately 79% of employees are hourly workers. Rising wages, minimum wage increases, labor shortages, and regulatory changes could materially increase costs.

3. Legal & Regulatory Risks

• Animal Welfare & Cage-Free Transition:

Customer commitments and state laws are accelerating the transition to cage-free production. Cage-free eggs are more costly to produce, creating capital intensity and demand uncertainty. Overproduction could reduce specialty egg pricing and returns on investment.

• Environmental & Regulatory Compliance:

Operations are subject to extensive federal, state, and local regulations (USDA, FDA, EPA, OSHA). Non-compliance could result in fines, penalties, reputational damage, or operational disruption.

• Climate Change & Extreme Weather:

Severe weather events, climate-related impacts on feed supply, water availability, and livestock stress could increase costs and disrupt operations.

• Litigation Risk:

The company faces ongoing legal proceedings and investigations. Adverse outcomes could materially affect financial condition and reputation.

4. Financial & Economic Risks

• Macroeconomic Conditions:

High inflation and interest rates may:

• Increase input and capital costs

• Reduce consumer demand (especially for higher-priced eggs)

• Limit capital access

• Increase debt risk

• Inflation has materially increased input costs in recent years.

• Cash Concentration Risk:

Cash deposits exceed FDIC insurance limits, exposing the company to potential bank failure risk.ç

• Goodwill Impairment:

As of May 31, 2025, goodwill totaled $46.8 million. Future impairments could negatively affect earnings and net worth.

• Intellectual Property Risk:

Loss of trademarks or licensing rights could weaken competitive positioning.

Overall Risk Profile

Cal-Maine operates in a highly cyclical, commodity industry with exposure to price volatility, feed costs, disease outbreaks, regulatory shifts, and customer concentration. Additionally, capital allocation decisions related to acquisitions, cage-free expansion, and prepared foods diversification introduce execution risk.

These factors create meaningful earnings volatility and operational uncertainty.

Management is actively trying to mitigate these risks by changing their primary revenue stream to specialty eggs, which is expected to create an above average competitive advantage compared to industry peers and is likely to reduce egg price volatility. This is possible due to the fact that specialty eggs are less commodity priced, so Cal-Maine can set their own prices (relative pricing power) without the intervention of traditional shell egg prices.

Management’s Discussion and Analysis

ACQUISITIONS

During the first quarter of fiscal 2025, we acquired substantially all the commercial shell egg production, processing and egg products breaking assets of ISE America, Inc. and certain of its affiliates (“ISE”). The assets acquired included commercial shell egg production and processing facilities with a capacity at the time of acquisition of approximately 4.7 million laying hens, including 1.0 million cage-free, and 1.2 million pullets, feed mills, approximately 4,000 acres of land, inventories and an egg products breaking facility. The acquired assets also include an extensive customer distribution network across the Northeast and Mid-Atlantic states. We believe this acquisition provides us with an opportunity to significantly enhance our market reach in the Northeast and Mid-Atlantic states.

During the second quarter of fiscal 2025, we completed a strategic investment with Crepini LLC, establishing a new egg products and prepared foods venture. The new entity operates as Crepini Foods LLC (“Crepini”). We capitalized Crepini with approximately $6.75 million in cash in exchange for a 51% interest in the new venture. Crepini LLC contributed its existing assets and business in exchange for a 49% interest in the new venture.

In fiscal 2022, we announced a strategic investment in a new entity, MeadowCreek Food, LLC (“MeadowCreek”), which became a majority-owned subsidiary of the Company. During the second quarter of fiscal 2025, we acquired the remaining ownership interests in MeadowCreek and it became a wholly-owned subsidiary of the Company.

During the third quarter of fiscal 2025, we acquired certain assets of Deal-Rite Foods, Inc. and certain of its affiliates (“Deal-Rite”). The assets acquired included two feed mills and related equipment. The acquired assets will produce and deliver feed to our nearby shell egg production operations.

In the second quarter of fiscal 2024, we acquired the assets of Fassio Egg Farms, Inc. (“Fassio”) related to its commercial shell egg production and processing business. Fassio owned and operated commercial shell egg production and processing facilities with a capacity at the time of acquisition of approximately 1.2 million laying hens, primarily cage-free, and a feed mill. This acquisition provided us with an opportunity to expand our market presence in Utah and the western U.S., particularly for cage-free eggs.

In the fourth quarter of fiscal 2024, we acquired a broiler processing plant, hatchery and feed mill in Dexter, Missouri, which were purposed for use in shell egg production.

Subsequent to our fiscal 2025, the Company acquired Echo Lake Foods, LLC (formerly Echo Lake Foods, Inc.) and certain related companies (collectively “Echo Lake Foods”). The purchase price was approximately $258 million and was funded with available cash on hand.

HPAI

In calendar year 2024, 40.2 million commercial layer hens and pullets were depopulated due to HPAI, and in calendar year 2025, an additional 39.0 million commercial layer hens and pullets were depopulated through May due to HPAI. The United States Department of Agriculture (the “USDA”) reported that the estimated table-egg layer flock as of June 1, 2025 was approximately 285.5 million, compared to 304.3 million, 321.6 million, 311.5 million and 330.5 million as of June 1, 2024, 2023, 2022 and 2021, respectively.

We remain dedicated to robust biosecurity programs across our locations and have invested more than $75 million in biosecurity technology, equipment, procedures, and training across our locations since the last major HPAI outbreak in 2015. However, no farm is immune from HPAI.

The rate of depopulations slowed during our fourth quarter fiscal 2025 compared to our third quarter fiscal 2025 and there were no reported significant depopulations in June and through July 22, 2025. However, the extent of possible future outbreaks among U.S. commercial egg layer flocks, with heightened risk during migration seasons, cannot be predicted.

We have taken proactive steps to help mitigate the tight egg supply situation across the country. Our efforts resulted in a 18% increase in the average number of layer hens and a 56% increase in total chicks hatched during the fourth quarter of fiscal 2025 compared to the prior-year quarter. Our breeder flocks increased 48% as of the end of fiscal 2025 compared to the end of fiscal 2024. We also continue to invest in expansion projects within our current operations that are expected to add approximately 1.1 million cage-free layer hens and 250,000 pullets by the end of calendar 2025, and added production support through the integration of recently acquired assets.

Share Repurchase Program

On February 25, 2025, the Board approved a new $500 million share repurchase program. The share repurchase program authorizes the Company, in management’s discretion, to repurchase Common Stock from time to time for an aggregate purchase price up to $500 million.

The share repurchase program does not obligate the Company to repurchase any specific amount of shares, does not have an expiration date, and may be suspended, modified or discontinued at any time without prior notice.

During fiscal 2025, the Company repurchased approximately $50 million in shares under the program.

More recently:

• During the twenty-six weeks ended November 29, 2025, the company repurchased 846,037 shares at an average price of 88.46 per share, for approximately 74.8 million, funded from cash.

• As of November 29, 2025, 375.2 million of authorization remained for future repurchases, with no expiration date and flexibility to suspend, modify, or discontinue the program.

Dividends

In accordance with our variable dividend policy, we will pay a cash dividend totaling approximately $114.2 million, or approximately $2.362 per share, to holders of our Common Stock with respect to our fourth quarter of fiscal 2025. The dividend is paid on a quarterly basis for each quarter for which the company reports net income attributable to Cal-Maine Foods in an amount equal to one-third (1/3) of such quarterly net income.

More recently:

• For the twenty-six weeks ended November 29, 2025, dividends paid totaled 180.5 million, vs. 87.8 million in the comparable prior-year period, reflecting higher trailing earnings.

• In the equity roll-forward, Cal-Maine reports dividends of 2.097 per share for the first half of fiscal 2026.

Material Cash Requirements

We have substantial liquid assets and availability under our Credit Facility to fund future operating requirements.

Our material cash requirements for capital expenditures consist primarily of our projects to increase our cage-free production capacity.

Material construction projects approved as of May 31, 2025 (in thousands):

As of May 31, 2025, we had $75.5 million of purchase obligations outstanding, all of which is due within one year.

We believe our current cash balances, investments, projected cash flows from operations, and available borrowings under our Credit Facility will be sufficient to fund our capital needs for at least the next 12 months and to fund our capital commitments currently in place thereafter.

Working capital and liquidity have evolved since May 31, 2025:

• Working capital was 1.5 billion at November 29, 2025, compared to 1.7 billion at May 31, 2025.

• Current ratio improved to 8.0x at November 29, 2025 from 6.4x at May 31, 2025, primarily due to lower dividends payable following a smaller Q2 dividend relative to Q4 FY25.

• Cash and cash equivalents (excluding short term investments) decreased to 369.5 million at November 29, 2025, from 499.4 million at May 31, 2025, driven mainly by the Echo Lake acquisition and higher dividends.

• Investment securities available-for-sale (all current) were 769.5 million at November 29, 2025, down from 892.7 million at May 31, 2025.

REVENUE RECOGNITION

Revenue recognition is completed upon satisfaction of the performance obligation which generally occurs upon shipment or delivery to a customer based on terms of the sale.

Revenues are recognized in an amount that reflects the net consideration we expect to receive in exchange for delivery of the products. The Company periodically offers sales incentives or other programs such as rebates, discounts, coupons, volume-based incentives, guaranteed sales and other programs. The Company records an estimated allowance for costs associated with these programs, which is recorded as a reduction in revenue at the time of sale using historical trends and projected redemption rates of each program. The Company regularly reviews these estimates and any difference between the estimated costs and actual realization of these programs would be recognized in the subsequent period.

If actual results varied significantly from our estimates, it could expose us to material gains or losses.

CONCLUSION

When analyzing a business, MD&A can tell you a lot about the management’s honesty, consistency, credibility, and candor. I usually ask myself the following questions:

1. Are they owning their numbers?

• Yes. Clearly. There is evidence pattern across sections, such as exact dollar figures, exact unit economics, explicit accounting treatment, and explicit risk disclosure.

2. Are they focused on long-term value or short-term noise?

• Decisively long-term. Capital deployed into productive assets, vertical integration focus, buybacks treated as optional, and dividends as owner yield. Didn’t see any language about quarterly optics, EPS management, nor short-term stock opinions.

3. Are explanations data-driven or just PR fluff?

• Overwhelmingly data-driven and minimal PR language. Not much to comment on this, I believe it’s evident based on what’s been currently covered.

Key Numbers

1. Revenue & Growth

Cal-Maine has reported $4,261,885 in net sales for fiscal year 2025 compared to $2,326,443 in fiscal year 2024, up 83% YoY. Revenue is at all time highs, growing at an incredible 26% CAGR for the last 5 years, 10% CAGR for the past 10 years, and 11% CAGR since 2010. For the twenty-six weeks ended November 29, 2025, net sales were 1,692.1 million, down 2.8% from 1,740.5 million in the same period of fiscal 2025. Shell eggs remain the core, but prepared foods and egg products are becoming more material, and prepared foods now account for about 9% of YTD net sales compared to 1% a year earlier.

Trailing 12 months:

As observable, revenue is cyclical, as the business operates in a commodity industry. Management plans on reducing this revenue (and subsequently price) volatility by changing their focus from traditional eggs to specialty eggs. Below I’ll expand on this approach and their current success, as well as future plans.

Revenue was primarily driven by shell egg sales, which represented 94.3% and 95.3% of total net sales in fiscal 2025 and 2024, respectively. The company’s shell egg offerings for both branded and private-label products, include specialty and conventional shell eggs. Conventional shell eggs sales represent all other shell egg sales not sold as specialty shell eggs.

The second quarter of fiscal 2026 saw a sharper YoY decline in total net sales to 769.5 million from 954.7 million, primarily lower conventional egg prices as supply normalized following HPAI price spikes. Shell egg dozens sold in the first half of fiscal 2026 were essentially flat YoY, but revenue declined due to price.

• For fiscal 2025, conventional egg sales increased $1.5 billion, or 119.5%, compared to fiscal 2024, primarily due to the increase in conventional egg prices. Changes in price resulted in a $1.4 billion increase in net sales and changes in volume resulted in a $114 million increase in net sales. Conventional egg prices increased significantly during fiscal 2025 due to a resurgence of HPAI outbreaks, which decreased the supply.

• Specialty egg sales increased $258.8 million, or 28%, for fiscal 2025 compared to fiscal 2024, primarily due to a 17.3% increase in the volume of specialty dozens sold, and a 9.1% increase in price. Changes in volume resulted in a $160 million increase in net sales and changes in price resulted in a $98.7 million increase in net sales.

• The dozens sold for fiscal 2025 increased 11.8% compared to fiscal 2024. They had an increase in production capacity with the acquisition of ISE during the first quarter of fiscal 2025 as well as the continuation of full operations at their facilities, which were shutdown in the third and fourth quarters of fiscal 2024 due to HPAI outbreaks.

• For the second quarter of fiscal 2026, conventional egg sales decreased 253.0 million, or 41.0%, compared to the second quarter of fiscal 2025, primarily due to a 38.8% decrease in conventional egg prices. Changes in price resulted in a 230.4 million decrease in net sales, and changes in volume (down 3.6%) resulted in a 19.9 million decrease in net sales. Conventional egg prices fell sharply in the quarter as industry supply normalized and panic-driven buying related to HPAI in the prior year.

• Specialty egg sales decreased 1.3 million, or 0.4%, in the second quarter of fiscal 2026 compared to the second quarter of fiscal 2025, primarily due to a 0.8% decrease in specialty egg prices. The change in price resulted in a 2.1 million decrease in net sales, partially offset by a 0.3% increase in specialty dozens sold, which contributed a 1.0 million increase in net sales.

• For the twenty-six weeks ended November 29, 2025, conventional egg sales decreased 231.8 million, or 21.0%, compared to the same period of fiscal 2025, driven mainly by lower prices. A 19.4% decline in conventional egg prices resulted in a 209.5 million decrease in net sales, and a 2.0% decrease in volume resulted in an additional 22.4 million decrease in net sales.

• Specialty egg sales increased 25.4 million, or 4.7%, for the twenty-six weeks ended November 29, 2025 compared to the same period in fiscal 2025, primarily due to higher volumes. The volume of specialty eggs sold increased 3.8%, resulting in a 20.5 million increase in net sales, and prices for specialty eggs increased 0.8%, resulting in a 4.8 million increase in net sales.

• Total shell egg dozens sold were 322.6 million in the second quarter of fiscal 2026, down 2.2% from 329.8 million in the second quarter of fiscal 2025. For the twenty-six weeks ended November 29, 2025, dozens sold were essentially flat at 640.2 million vs. 639.8 million in the prior-year period, with mix shifting modestly toward specialty eggs.

2. Profitability Metrics

For fiscal 2025:

• Gross profit was $1.8 billion for fiscal 2025, compared to $541 million in fiscal 2024. Gross margin was 43.4% for fiscal 2025, compared to 23.3% for fiscal 2024. The increase was primarily due to higher selling prices (particularly for conventional eggs) and higher volumes. Gross margins are at all-time highs and 30% higher than peers.

• As a result of the above, operating income was $1.5 billion for fiscal 2025, compared to $312.5 million for fiscal 2024. Operating margin in fiscal 2025 and 2024 was 36% and 13%, respectively.

• As a result of the above, net income attributable to Cal-Maine Foods for fiscal 2025 was $1.2 billion, or $25.04 per basic and $24.95 per diluted share, compared to $277.9 million, or $5.70 per basic and $5.69 per diluted share for fiscal 2024. Net margin in the same period comparison as all of the addressed points above is 29% compared to 12% the previous year.

For the second quarter and first half of fiscal 2026:

• Q2 FY26 gross profit: 207.4 million (27.0% gross margin), compared to 356.0 million (37.3%) in Q2 FY25.

• 26 weeks FY26 gross profit: 518.7 million (30.7% gross margin), compared to 603.3 million (34.7%) in the prior-year period.

• ​Q2 FY26 operating income: 123.9 million (16.1% operating margin), compared to 278.1 million (29.2%) in Q2 FY25.

• ​26 weeks FY26 operating income: 373.1 million (22.1% operating margin), compared to 465.0 million (26.8%) in the prior-year period.

• ​Q2 FY26 net income attributable to Cal-Maine: 102.8 million (13.4% net margin), or 2.14 basic EPS compared to 4.49 in Q2 FY25.

• 26 weeks FY26 net income attributable to Cal-Maine: 302.1 million (17.9% net margin), or 6.27 basic EPS compared to 7.57 a year ago

Margins are highly volatile as the result of a commodity business. Since the expansion into specialty eggs, we should see in the near future lower volatility in revenue, margins, costs, etc. as well as higher premiums (resulting in higher margins).

3. Return Metrics

*All of the metrics below use TTM data. The results may probably differ if solely relying on 10k filing data.

• Return on Equity (ROE), calculated as Net Income / Shareholders’ Equity = 43%.

  • Normalized ROE = 33%

• Return on Assets (ROA), calculated as Net Income / Total Assets = 37%

  • Normalized ROA = 27%

• Return on Invested Capital (ROIC), calculated as NOPAT / Invested Capital = 41%

  • Normalized ROIC = 31%

• Return on Tangible Capital (ROTC), also referred to as Return on Operating Capital, is calculated using Owner Earnings: Net Income available to Common Stockholders + Depreciation, Amortization & Depletion + Other Non-Cash Charges – (maintenance CapEx + Required Incremental WC) and Tangible Capital (or operating capital): Net Property, Plant & Equipment + Net Working Capital. This approach to measuring the return on actual capital required to maintain the business operating has been commonly used by Warren E. Buffett.

  With that out of the way, ROTC = Owner Earnings / (Net PPE + NWC) = 78%

  • Normalized ROTC = 34.1%

• Return on Incremental Invested Capital (ROIIC) measures the profitability of new investments, calculated as ∆ NOPAT / ∆ Invested Capital = -54%. This decrease is due to an increase in invested capital but slight decrease in NOPAT. As we use TTM data, it would be more appropriate to look at a 5-year period:

The negative ROIIC in fiscal 2024 was on account of a decrease in NOPAT. This decrease was due to many facilities shutting down in the third and fourth quarters of fiscal 2024 due to HPAI outbreaks, as mentioned previously. In most normal years, we can expect positive ROIIC.

Note: In this case, to calculate a normalized earnings figure, I averaged out the past 6 years of earnings so I can get a defensible number for a mid-cycle year.

4. Balance Sheet Strength

Management aims to maintain a strong balance sheet and liquidity, particularly given the cyclical nature of the business. They believe a strong balance sheet supports growth opportunities and stockholder returns. Their priorities for the use of cash in recent periods have included the payment of dividends, inorganic growth through acquisitions of businesses, organic growth, and maintenance capital expenditures.

The company is currently sitting on a cash pile (including all highly liquid investments, such as Cash, Cash Equivalents & Short-Term Investments) of $1.4 billion, against no total debt, resulting in net cash of $1.4 billion. This provides financial flexibility and reduces balance sheet risk. Cash has consistently increased over the past 5 years, reflecting strong FCF, acquisitions, dividends, and buybacks. Given that cash represents 35% of marketcap, this reduces enterprise value and increases intrinsic value by a large margin.

Working capital was $1.7 billion, compared to $1 billion at June 1, 2024. The calculation of working capital is defined as current assets less current liabilities. The current ratio was 6.4 at May 31, 2025 compared to 5.5 at June 1,2024. The current ratio is calculated by dividing current assets by current liabilities. The increase in current ratio is primarily due to the increase in total current assets, which increased by $726.3 million to $2.0 billion at May 31, 2025, due to increases in cash and cash equivalents and investment securities available for sale. Due to seasonal factors, I generally expect the need for working capital to be highest in the fourth and first fiscal quarters ending in May/June and August/September, respectively.

Balance sheet is extremely clean, with a D/E ratio of 0, current ratio of 6.4, and as interest expense is so insignificant, they maintain an interest coverage ratio consistently above 2500.

For Q2 of FY2026:

• Total assets: 3,144 million at November 29, 2025.

• Total liabilities: 446.3 million, including 169.9 million of net deferred tax liabilities and 57.6 million of other noncurrent liabilities.

• ​Total shareholders’ equity: 2,697.8 million.

• Cash and cash equivalents (excluding short term investments, as they remain the same): 369.5 million; investment securities AFS: 769.5 million.

5. Cash Flow Analysis

Free cash flow is very strong and has been consistently growing, but I don’t believe this trend will continue for long, and earnings should begin to normalize in the next few years:

Current FCF margin is 28%. While this is excellent and clearly above average, I don’t expect them to maintain this margin for long. For Cal-Maine, a year with a 20%+ margin could be excellent, while a year near 0% might still be normal. Over the past five years, Cal-Maine Foods’ FCF margin averaged 18%, ranging from 3% to 28%, reflecting cyclical egg prices.

Valuation

Relative valuation:

This valuation section primarily relies on relative multiples, both on an individual sense and compared to peers. Cal-Maine currently trades at a 3.5 PE ratio, with EPS at $23.7. While this seems extremely cheap, actual normalized earnings will reflect the reality of the business in a much more realistic way. Using 5-year average EPS, which is $14.8 per share, we get a 5.6 PE ratio, or 17.6% Earnings Yield. Price to current year FCF is 3.5, and FCF Yield is 28.8%. Using enterprise value, EV/FCF and FCF Yield is 2.4 and 41.6%, respectively. This is due to the low amounts of debt (which is neglectable) and high amounts of cash, as well as the peak earnings. EV/Sales is 0.7 as expected, based on the previous multiples.

If we assume normalized earnings to be 60% below current peak levels, which reflects cyclical mean reversion rather than business deterioration, as historical margin expansion in the egg industry is primarily driven by temporary supply shocks and input cost dislocations, not durable structural pricing power. When supply normalizes and production cycles rebalance, industry margins usually compress toward long-term averages. Under this normalization, EPS would be $9.5, implying a P/E of 8.8. This is still considered very cheap, and I don’t expect earnings to fall more than 70%, especially since buybacks and specialty eggs will keep earnings per share value above historical low levels, and acquisitions will also help grow the specialty egg portion of revenue.

The Food Distribution industry has an average pe ratio of 30. Now if we are comparing to direct competitors and peers, which are the following:

• Rose Acre Farms

• Hillandale Farms

• Michael Foods

• Eggland’s Best

• Rembrandt Foods

• Vital Farms

• Henningsen Foods

publicly traded competitors:

• Post Holdings, Inc.

• Industrias Bachoco S.A.B.

and adjacent public peers (Broader Protein/Consumer Foods):

• Tyson Foods, Inc.

• Hormel Foods Corporation

• Conagra Brands, Inc.

• Performance Food Group Company

The average P/E of these companies is 24.1, excluding Conagra which has negative earnings. The average for ALL companies (including Conagra) is 19.3. Cal-Maine Foods is currently trading at a price-to-earnings far below peers. This alone could indicate undervaluation, but sometimes this isn’t the case and could be a value trap. However, as we’ll see in the absolute valuation section, it seems unlikely this is a value trap.

- Vital Farms Comparison:

Vital Farms (VITL) is the closest public comparable to what Cal-Maine is becoming. This comparison intends to show what the market will pay for a specialty egg business:

1. 85% of revenue from specialty eggs

2. 2% of US egg market (vs Cal-Maine’s 19%)

3. Trading at 14 P/E ratio

4. Gross margins: 37%

5. Owner Earnings Payback: 15.2 Years (vs CALM’s 2.8)

6. Owner Earnings Yield: 6.6% (vs 35%)

7. Less volatile earnings than Cal-Maine

Note: I find relative valuation useless if not paired with absolute valuation, as absolute valuation is probably the most important section in this entire report and analysis. I believe relying on relative valuation is a mistake, and would rather prefer just to read the absolute valuation to justify an investment. Nevertheless, relative valuation is still useful when paired with absolute valuation.

Absolute valuation:

The primary concern the market has with $CALM is revenue stability. As mentioned in various segments of this report, the unusually high revenue wasn’t driven by a new product launch or a one-off transaction, rather it was the combination of higher egg prices, increased sales volume, and industry supply constraints. The major reason Cal‑Maine Foods’ revenue was unusually high is due to the outbreaks of avian influenza (HPAI) in the US egg industry, which reduced egg supply and drove market prices much higher. As revenue has recently started to fall and normalize, the market has been discounting heavily these all-time high earnings, but to an extent that doesn’t seem that probable.

You see, while conventional eggs have taken a big hit in recent quarters (sales decreased 41% compared to the second quarter of fiscal 2025), specialty eggs have barely changed in both price and revenue, even increased slightly recently (sales decreased 0.4% compared to the second quarter of fiscal 2025, and sales increased 4.7% for the twenty-six weeks ended November 29, 2025 compared to the same period in fiscal 2025).

As demonstrated, specialty eggs are likely to experience significantly lower price volatility and should generate higher revenue in periods of rising egg prices, while maintaining revenue and earnings during periods of declining egg prices. We can use this knowledge to determine the portion of current owner earnings that is solely from these specialty eggs, and assume conventional eggs to generate 0 cash flow. Under this conservative assumption, I’ll proceed to calculate a floor for intrinsic value.

Firstly, let’s calculate current owner earnings:

I estimated maintenance Capex to be $112M, roughly with depreciation expense. Depreciation is currently as of the publication date of this report $108M, and total capital expenditures are $188. For asset intensive businesses such as Cal-Maine Foods, depreciation tends to be a reasonable proxy for maintenance capex, as the majority of capital spending is toward maintaining laying facilities, processing infrastructure, and related equipment required to sustain existing production capacity. The capital spending above this relates to the company’s transition toward cage-free eggs. As disclosed by management, and seen in the MD&A section of this report “Material Cash Requirements”, $248M of expansion projects were approved in fiscal 2025, the majority of which has already been spent with roughly $53M remaining. These investments are growth capex rather than recurring maintenance requirements and therefore are not deducted from owner earnings.

Note: once the cage-free (specialty eggs) transition is practically complete, depreciation and maintenance requirements may increase due to larger assets. However, with the company’s strong balance sheet and current profitability, this potential increase is unlikely to materially affect the intrinsic value estimates presented in this report.

On a no-growth basis, applying a 10% hurdle rate, and adjusting for net cash, intrinsic value per share comes at around $253, or a 65% margin of safety. This is on peek earnings, so I wouldn’t use this intrinsic value as a reasonable price, but rather as an upper floor. Of course, I’ve updated this report and analysis to reflect current price, which I believe is still undervalued. Current price is 88$, but when I first analyzed the company price was at 73$ a share and is up 20% since then. If not already evident, the margin of safety was marginally higher, and valuation was much cheaper. Even so, I’ve updated this to reflect the most recent price as of the date in which I’m writing this report. I don’t want my analysis to make the stock appear cheaper than it currently is, even though this was previously once the case.

Secondly, I’ll calculate the portion of owner earnings that is from specialty eggs. As previously discussed in “Key Numbers: Revenue drivers”, the portion that has come from specialty eggs from egg revenue is 44%, but from total revenue it’s 37% so Owner Earnings from Specialty Eggs = Owner Earnings * 0.37 = $406. Assuming no growth forever, discounted at 10%, no earnings from conventional eggs or prepared foods (as these can wildly fluctuate in price so any cash flow that’s been generated is considered optionality) and adjusting for net cash position, we get an intrinsic value per share of $109, or 20% margin of safety. Remember, this is without ANY type of growth or gain from the sale of conventional eggs or prepared foods:

This is an unrealistic floor. I believe a better way to visualize the floor is including prepared foods:

We now get an intrinsic value per share of $130, or a 33% margin of safety. This is materially more than believing that only specialty eggs exist. Even if specialty eggs maintain ZERO growth forever and conventional eggs collapse entirely, intrinsic value is $109-130 per share. At current price of $88, this represents 20-33% margin of safety even in the worst case.

Note: Because Cal-Maine Foods holds a net cash balance and has no debt, the company’s enterprise value and equity value differ by the addition of this excess cash.

Thirdly, I’ll do a less punitive and more realistic valuation. When earnings begin to normalize, something that will always happen eventually in a cyclical commodity company, the extraordinary profitability currently coming from conventional eggs will likely decline as supply recovers from the HPAI shock and prices revert closer to historical levels. At present, owner earnings from conventional eggs stand at $517, a figure that is clearly inflated by these pricing conditions. Over the medium-term, roughly three years, a reasonable assumption is that this segment’s earnings will decline by around 80% as the market normalizes, based on historical data (80% decline in 3 years is just an assumption, and a very imprecise one due to the nature of the volatility of commodity prices). This would bring conventional egg owner earnings closer to $103, reflecting a return to more typical industry economics rather than the extreme margins observed during supply shortages.

However, as discussed previously multiple times, the specialty egg segment is different. Specialty products tend to be more stable and less exposed to commodity price swings. Because of this, I assume specialty earnings grow modestly at 2% per year throughout the period and into perpetuity, consistent with long term inflation and the consumer shift toward specialty eggs. The same happens with prepared foods, although the growth and stability is still unproven as acquisitions have been made very recently.

Following this paragraph, I will model how total owner earnings evolve under this scenario: 80% normalization in conventional egg profits with 2% annual specialty and prepared foods growth and 2% perpetual growth from year 3 onwards for all groups, to estimate what the company’s more sustainable earnings power might look like:

- % Of revenue from Conventional Eggs: 47.3%

- % Of revenue from Specialty Eggs: 37.1%

- % Of revenue from Prepared Foods: 9.3%

Note: 2026C “Total Owner Earnings” is lower than actual current owner earnings, as I treat all other products to never produce anything in the future (anything that is not conventional eggs, specialty eggs, or prepared foods).

This, of course, is just an estimation. An 80% drop in conventional egg prices could occur at an unexpected timing, or never occur, something that is expected. Now, I’ll adjust for net cash to get equity value:

So estimated Intrinsic Value per share is 191$, or 54% margin of safety, without including any buybacks or any gain from other products.

Before concluding the absolute valuation, there are a few more considerations worth addressing that I do not explicitly capture above in formulas, but that meaningfully affect the intrinsic value per share.

- Sensitivity table based on margin changes:

- Buybacks: As of November 29, 2025, $375.2M of the $500M repurchase of common stocks remain. At current prices of $88 per share, the company could buyback around 4.3M additional shares, reducing the outstanding share count from 47.6 million to 43.3 million. Applying this to the equity value would bring intrinsic value per share closer to $210, a clear increase just by capital return to shareholders. I am not assuming everything gets deployed. Management has been disciplined with buybacks, but it is reasonable to assume more repurchase given the stock trades at a big discount to any reasonable estimate of intrinsic value.

- Echo Lake Foods: The $258 million acquisition closed fiscal 2025 and does not appear in the owner earnings used. I have not attempted to model its earnings contribution, primarily because there is insufficient public data on its profitability. However, as Cal-Maine paid $258 million from cash on hand with low goodwill and management has a strong track record of acquiring assets at good returns, it is reasonable to assume the acquisition generates low earnings in the near term and accretive over the medium term as prepared foods scale. I did not include any prepared foods earnings in the model to be conservative, but as observed it is unnecessary. I am treating it conservatively as a $0 earnings contributor in the current model, meaning any future contribution from Echo Lake is entirely upside not captured in the $205 base case, or any case.

Note: Buybacks alone bring intrinsic value per share to approx. $210 without assuming any growth, any contribution from Echo Lake, or any recovery in conventional egg earnings beyond what is already modeled. I don’t believe these are aggressive assumptions, they are simply accounting for capital allocation decisions that are already happening.

Egg prices are cyclical due to supply changes, feed costs, and disease disruptions such as HPAI. As a result, earnings for conventional eggs can fluctuate significantly from year to year, something mentioned previously many times in this report. The valuation above should therefore be interpreted as an estimate of normalized earnings rather than a precise forecast of future annual results.

Specialty Profitability:

Although I’ll try to calculate specialty eggs profitability, I cannot calculate the exact specialty egg asset base because there is no exact disclosure of PPE by product type.

Capital Invested in Specialty Eggs (Cage-Free):

• ISE Acquisition (Q1 FY25):

  • Cash paid: $111.5M

  • Assets acquired: 4.7M laying hens (1.0M cage-free), feed mills, 4,000 acres of land, processing facility

  • Property, plant & equipment acquired: $90.6M

• Fassio Acquisition (Q2 FY24):

  • Cash paid: $53.7M

  • Assets acquired: 1.2M laying hens, feed mill, land in Utah

  • Property, plant & equipment acquired: $44.5M

• Approved Cage-Free Projects:

  • Total approved capex: $248.4M

  • Spent to date: $195.2M

  • Remaining: $53.2M

Total PPE on Specialty is approximately $330.3M. Is I’ve repeated before, this isn’t a precise amount, but a very educated estimation.

As current owner earnings from specialty eggs are $406M and total PPE spent to date is approx. $330M, the Return on Invested Capital for Specialty Eggs = 146%. If we include current NWC, which is $267.63, the return becomes 68%. This validates the thesis; specialty eggs are a high return business, not a commodity business.

Pricing Power and Structural Competitive Advantage:

Cal-Maine’s transition toward specialty eggs and prepared foods clearly improves the quality and sustainability of earnings, but it still results in relative rather than absolute pricing power. I now view the company’s pricing as sufficiently differentiated to consider the company does have some sort of pricing power and competitive advantage, primarily thanks to the rapid and sustainable transition from conventional eggs to specialty eggs, as well as increasing the portion of prepared foods.

As we’ve seen and discussed before, in fiscal 2025, conventional shell egg sales grew 119.5% YoY, driven primarily by price, as the HPAI supply shortage pushed egg market prices higher. Specialty eggs, however, grew 28% on the back of both 17.3% higher volume and a 9.1% increase in realized prices, indicating that customers accepted higher specialty pricing while still expanding their purchases. In the second quarter of fiscal 2026, as the industry cycle is normalizing off peak conditions, conventional egg prices declined 38.8% and sales fell 41%, while specialty egg prices declined 0.8% and volumes were essentially flat. This behavior shows us were dealing with a business that cannot control the commodity price of conventional eggs but can create sustainable pricing power within its specialty portfolio and maintain that pricing even when commodity prices normalize. They are starting to become price makers, not price takers.

- Margins:

Fiscal 2025 gross margin reached 43.4%, up from 23.3% in fiscal 2024, with operating and net margins of 36% and 29%, respectively. These margins clearly reflect the unusual and non-recurring prices and strong volumes driven by HPAI supply shortage, yet the business has not (and will probably not) reached historical low prices and revenues. In the first half of fiscal 2026, gross margin remained 30.7%, with operating and net margins of 22.1% and 17.9%, with lower conventional egg prices and the normalization of the market. This appears to be raising the margin floor after cycles, even if results remain cyclical.

- Market position and mix:

Cal-Maine is the largest producer and distributor of shell eggs in the US, and their acquisition program has moved the portfolio toward more stable, resilient and cash generating categories of foods. The ISE acquisition added around 4.7M laying hens (including about 1.0 million cage-free), a breaking facility, and Northeast and Mid-Atlantic distribution, while the Fassio Egg Farms acquisition expanded cage-free capacity and presence in the western US. The subsequent purchase of Echo Lake Foods and the investments in Crepini and MeadowCreek increased their exposure to egg products and prepared foods, which now represent roughly 9% of YTD net sales versus 1% a year ago. At the same time, specialty revenue has grown to roughly one third of shell egg revenue by Q2 of fiscal 2026, and specialty dozens have risen into the 30%s of shell egg volume. Management has mentioned countless times that they aim for specialty eggs to contribute more than 50% of revenue in the near future.

At the same time, the company’s customer concentration and industry put a ceiling on pricing power. The top three customers account for roughly 50% of net sales, with Walmart alone representing about 34% in fiscal 2023–2025. This concentration gives large retailers a lot of bargaining power and creates the risk of pricing pressure, contract repricing, or volume loss if Cal-Maine wants to expand margins too aggressively. Competition in shell eggs remains anchored on price, service and quality, and has meaningful price sensitivity. While specialty eggs, mainly cage-free, organic, and other types are much less tied to commodity prices and allow for negotiated prices, they still sell those eggs in a market where stores constantly compare prices, and customers can switch to cheaper options if the price gap gets too big.

- Consumer Loyalty:

The company does not disclose consumer loyalty metrics. Demand is strong because supermarkets have promised to sell more cage‑free and specialty eggs, and supply and demand support those products. Cal‑Maine wins a lot of that business because it is big, reliable, and can consistently supply what retailers need. But there’s no evidence that consumers are specifically buying from Cal‑Maine as a brand. They’re mostly buying specialty eggs in general.

- Conclusion:

Putting this together, I can conclude the following: First, the company can raise and sustain prices on specialty eggs while growing volumes, maintain stable specialty prices and costs through downswings in conventional prices, and have high margins when industry conditions change negatively. Second, the transition to specialty eggs, egg products, and prepared foods is shifting the business toward negotiable prices and less tied to wholesale benchmarks, thereby raising the cycle margin and revenue floor and reducing earnings volatility compared to a pure commodity egg business. Third, however, Cal-Maine is still exposed to egg and feed cycles, concentrated retail customers, and other regulatory and disease shocks (like what happened with HPAI) that can quickly change the industry economics.

Cal-Maine is the largest egg producer in the US, controlling approximately 19% of the market, but this has not historically prevented margin compression during supply shifts. The specialty egg transition is the best indicator of some durable competitive advantage, but it is important to be precise about what kind of advantage it is. Cal-Maine has relative pricing power, not absolute. It can negotiate prices above commodity prices and sustain them through downturns, as fiscal 2026 has showed. What it does not have, and may never have, is consumer loyalty because of their brand. Some examples of companies from the food sector that do have brand pricing power are Coca-Cola, Pepsi, or even McDonalds. Buyers are purchasing specialty eggs in general, not Cal-Maine eggs.

Conclusion & Summary

Cal-Maine Foods is an unusual business. A commodity company in an undervalued transition, run by honest management, with a fortress of a balance sheet, and trading at a discount to any reasonable estimate of intrinsic value. Throughout this report I try to deliver thorough analysis about the business so that you, the reader, can decide if you want to invest in this business or not. In this section I will also lay out both what I know with confidence and what remains open to question.

What the Analysis Confirms

The balance sheet is exceptional, without a doubt. No debt, $1.4Bn in net cash, a current ratio above 6x, and an interest coverage ratio which is practically infinite. Cal-Maine can survive down years with ease, and can even buy competitors when this happens. The balance sheet provides both downside protection and upside potential, as well as the freedom to act fast, something management has shown recently with their acquisitions.

Management allocates capital well. Paying out 1/3 of their net income to shareholders as dividends ties shareholder returns directly to business performance, and the buyback program at current prices tells us that management believes shares are undervalued, as I’ve clearly evaluated. Also, their acquisition track record reflects a consistent returns approach rather than them trying to grow just for the sake of growing.

Specialty eggs are clearly a different business. The pricing behavior across fiscal 2025 and the first half of fiscal 2026 makes this clear. Conventional egg revenues fell 41% YoY in Q2 FY26 as the HPAI supply shock normalized and is currently being normalized. Specialty egg revenues fell 0.4% over the same period, and grew 4.7% over the first half of fiscal 2026. We can see specialty eggs have different demand and pricing. Specialty customers accept higher prices, don’t easily change, and are purchasing more even as commodity egg prices collapse. Estimated ROIC for the specialty segment is incredibly high, so this is more a high return business, not a commodity business like conventional eggs.

The market’s valuation seems inefficient. Even under the conservative assumptions, which are zero conventional egg earnings, zero growth forever, zero contribution from prepared foods, intrinsic value per share is $109, with a 20% margin of safety at the current price of $88. A more realistic scenario, incorporating modest specialty growth and a normalization of conventional earnings, gives an intrinsic value of approximately $191 per share, implying a 54% margin of safety. Buybacks alone, fully deployed, bring this closer to $210 without assuming any growth at all. Also, based on some research, the current amount of analysts covering the stock are 4. For reference, in midcaps the usual range is approximately 11 to 17 analysts for an individual stock. This also reinforces the high possibility of a mismatch between intrinsic value and price, which reinforces the idea that the analysis is probably more accurate than what the market is pricing.

What Still Remains Uncertain

- Whether specialty eggs will maintain their pricing power as it scales

- Whether specialty eggs will ever grow or decline in price/revenue

- Whether conventional eggs will decline as modeled

- Whether the prepared foods strategy management is implementing will create value or destroy it

- Whether HPAI or any type of diseases will create new supply shocks

Final Conclusion

Cal-Maine Foods is a cyclical commodity business in the early stages of a value creating transition, run by management that is credible, and is currently priced as though the specialty egg transition does not exist and the balance sheet has no value.

The primary concern the market has, as we’ve seen at the beginning of the “Valuation: Absolute Valuation” section, is correct. The problem is that they are over discounting it and treating specialty eggs as conventional. Specialty egg economics

have already proven durable in fiscal 2026, prepared foods are growing, buybacks are reducing the share count at attractive prices, and management has $375M of buyback authorization remaining with no expiration date, plus they pay a dividend 1/3 of their net income.

The floor on intrinsic value, under the conservative assumptions, is $109-130 per share. A more realistic estimate is $191 per share. At $88 per share, the market is assuming that specialty eggs either do not exist or will eventually be repriced to commodity levels, an assumption that the last twelve months of data contradict.

However, the risks are real. Walmart concentration is not good for the business, especially for specialty pricing, feed cost inflation could lower margins regardless of egg prices, the moat is relative rather than absolute, and conventional egg earnings will normalize further from here. Though none of these risks are sufficient to explain the price.

Cal-Maine is not a Coca-Cola. It will always be exposed to commodity cycles, disease risk, and bargaining pricing power by the retail customers. But it is a well run, financially resilient business in the middle of a transition and strategy that is working, trading at a price that prices in a worst case that doesn’t seem that probable. There is a big enough margin of safety and growth potential that will most probably give us, the investors, a satisfactory medium to long term return. Thanks to the dividends and buybacks, we are also getting paid just for waiting for the stock to rerate.

Final Note: Shareholder Yield is 13%, something phenomenal, but remember this is at unusual all time highs in revenue. Under the assumption of normalized owner earnings, its around 6.5%. If prices surge, shareholder yield will evidently be lower if you purchase at that higher price, and the margin of safety will also be lower.

*All analysis reflects my independent views as of March 8, 2026. This is not investment advice.

Report Summary

Greenland Technologies Holding Corporation (or GTEC) designs, develops, manufactures and sells components and products for the global material handling industries, mainly forklift trucks. Their drivetrain products serve forklifts ranging from about 1 ton up to 15 tons capacity, some with mechanical shift and some with automatic shift. Greenland sells these transmission products directly to forklift truck manufacturers.

Greenland also builds electric industrial vehicles with their subsidiary HEVI, including electric forklifts, heavy industrial equipment, and also provide battery driven drivetrain systems (a drivetrain is the system of parts that connects the engine to the wheels, giving power to make a vehicle move).

Greenland was incorporated on December 28, 2017. In October 2019, they changed its name from Greenland Acquisition Corporation to Greenland Technologies Holding Corporation.

With current free cash flows around $11M, shareholder’s equity close to $70M, net tangible assets at $69M, and operating in one business with secure and relatively stable cash flows (in the long term) while the other one (HEVI) has incredible growth optionality, the company is still currently trading at $18M. That’s almost 65% FCF Yield and 0.25x net tangible assets! I’ll uncover potential hidden risks, and assess if the market is being rational about the business’s value or not. I believe this could be an incredible opportunity for all quality, growth and value investors.

SEC FILING Q3 — EXTRACTED INFORMATION & PERSONAL COMMENTS

Overview:

Greenland designs, develops, manufactures and sells components and products for the global material handling industries.

Through its PRC subsidiaries, Greenland offers transmission products, which are key components for forklift trucks used in manufacturing and logistic applications, such as factories, workshops, warehouses, fulfilment centers, shipyards, and seaports. Forklifts play an important role in the logistic systems of many companies across different industries in China and globally. Generally, industries with the largest demand for forklifts include the transportation, warehousing logistics, electrical machinery, and automobile industries. Greenland’s revenue increased from approximately $64.57 million for the nine months ended September 30, 2024 to $66.80 million for the nine months ended September 30, 2025. The increase in revenue was primarily the result of an increase of approximately $2.22 million in the Company’s sales volume of transmission products for the nine months ended September 30, 2025. Based on the revenues for the nine months ended September 30, 2025 and 2024, Greenland believes that it is one of the major developers and manufacturers of transmission products for small and medium-sized forklift trucks in China.

Greenland’s transmission products are used in 1-ton to 15-tons forklift trucks, some with mechanical shift and some with automatic shift. Greenland sells these transmission products directly to forklift-truck manufacturers. For the nine months ended September 30, 2025 and 2024, Greenland sold an aggregate of 123,856 and 114,075 sets of transmission products, respectively, to more than 100 forklift manufacturers in the PRC.

In January 2020, Greenland formed HEVI to focus on the production and sale of electric industrial vehicles to meet the increasing demand for electric industrial vehicles and machinery powered by sustainable energy in order to reduce air pollution and lower carbon emissions. HEVI is a wholly owned subsidiary of Greenland incorporated under the laws of the State of Delaware. HEVI’s electric industrial vehicle products currently include GEF-series electric forklifts, a series of lithium powered forklifts with three models ranging in size from 1.8 tons to 3.5 tons, GEL-1800, a 1.8 ton rated load lithium powered electric wheeled front loader, GEX-8000, an all-electric 8.0 ton rated load lithium powered wheeled excavator, and GEL-5000, an all-electric 5.0 ton rated load lithium wheeled front loader. In addition, HEVI introduced a line of mobile DC battery chargers that support DC powered EV applications. These products are currently available for purchase in the U.S. In August 2022, Greenland launched a 54,000 square foot industrial electric vehicle assembly site in Baltimore, Maryland to support local services, assembly and distribution of its electric industrial heavy equipment products line. In July 2024, HEVI announced a partnership with Lonking Holdings Limited to develop and distribute heavy electric machinery and related technology specialized for the U.S. market. In August 2024, HEVI launched its H55L all-electric wheeled front-end loader, which can lift up to six tons in indoor and outdoor applications without the mess and emissions of diesel, and the H65L all-electric wheeled front-end loader, a lithium battery powered electric wheel loader commercially available in North America.

Greenland serves as the parent company of HEVI and Greenland Holding, a company incorporated in the State of Delaware and a wholly-owned subsidiary of Greenland, which in turns holds 100% of the equity interests in Zhongchai Holding, a holding company formed under the laws of Hong Kong. Zhongchai Holding’s subsidiaries include Zhejiang Zhongchai, Hangzhou Greenland, and Hengyu Capital. Through Zhongchai Holding and its subsidiaries, Greenland develops and manufactures traditional transmission products for material handling machineries in the PRC.

Greenland was incorporated on December 28, 2017 as a British Virgin Islands company with limited liability. Following the Business Combination (as described and defined below) in October 2019, the Company changed its name from Greenland Acquisition Corporation to Greenland Technologies Holding Corporation.

Results of Operations. Most important (from Income Statement):

Revenue:

Greenland’s revenue was approximately $23.40 million for the three months ended September 30, 2025, representing an increase of approximately $4.57 million, or 24.3%, as compared to that of approximately $18.83 million for the three months ended September 30, 2024. The increase in revenue was primarily the result of an increase of approximately $4.61 million in the Company’s sales volume of transmission products for the three months ended September 30, 2025. On an RMB basis, our revenue for the three months ended September 30, 2025 increased by approximately 25.9% as compared to that for the three months ended September 30, 2024.

Cost of Goods Sold:

Greenland’s cost of goods sold consists primarily of material costs, freight charges, purchasing and receiving costs, inspection costs, internal transfer costs, wages, employee compensation, amortization, depreciation and related costs, which are directly attributable to the Company’s manufacturing activities. The write down of inventory using the net realizable value impairment test is also recorded in cost of goods sold. The total cost of goods sold was approximately $15.83 million for the three months ended September 30, 2025, representing an increase by approximately $1.96 million, or 14.1%, as compared to that of approximately $13.87 million for the three months ended September 30, 2024. Cost of goods sold increased due to the increase in our sales volume.

Gross Profit:

Greenland’s gross profit was approximately $7.57 million for the three months ended September 30, 2025, representing an increase by approximately $2.61 million, or 52.5%, as compared to that of approximately $4.97 million for the three months ended September 30, 2024. For the three months ended September 30, 2025 and 2024, Greenland’s gross margins were approximately 32.4% and 26.4%, respectively. The increase in gross profit in the three months ended September 30, 2025 compared to the three months ended September 30, 2024 was primarily due to the increase in our sales volume and a decrease in raw material costs. Gross margins are currently above the average of Greenland’s industry, which could be a sign of pricing power, and sequentially indicating some kind of competitive advantage.

Research and Development (R&D) Expenses:

R&D expenses consist of R&D personnel compensation, costs of materials used in R&D projects, and depreciation costs for research-related equipment. R&D expenses were approximately $0.56 million for the three months ended September 30, 2025, representing an increase of approximately $0.12 million, or 28.0%, as compared to that of approximately $0.44 million for the three months ended September 30, 2024. Such increase was primarily attributable to a significant increase in the Company’s R&D activities during the three months ended September 30, 2025.

Income from Operations:

Income from operations for the three months ended September 30, 2025 was approximately $5.07 million, representing an increase of approximately $2.14 million, as compared to that of approximately $2.93 million for the three months ended September 30, 2024.

Interest Income and Interest Expenses:

Greenland’s interest income was approximately $0.43 million for the three months ended September 30, 2025, representing an increase of approximately $0.19 million, or 80.8%, as compared to that of approximately $0.24 million for the three months ended September 30, 2024. The increase in interest income was because more cash was deposited in banks during the three months ended September 30, 2025 as compared to the three months ended September 30, 2024.

Greenland’s interest expenses were nil for the three months ended September 30, 2025, representing a decrease of approximately $0.01 million, or 100.0%, as compared to that of approximately $0.01 million for the three months ended September 30, 2024. The decrease was primarily due to a decrease in the aggregate amount of our short-term loans for the three months ended September 30, 2025, compared to that for the three months ended September 30, 2024.

Working Capital:

“Our working capital was approximately $47.81 million as of September 30, 2025, as compared to $35.11 million as of December 31, 2024. The increase in working capital of $12.70 million was primarily contributed to an increase in accounts receivable and short-term investment.”

Liquidity and Capital Resources (from Q3):

“Greenland is a holding company incorporated in the British Virgin Islands. Current PRC regulations permit our PRC subsidiaries to pay dividends to us only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, our PRC subsidiaries are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds until the total amount set aside reaches 50% of their respective registered capital. Our PRC subsidiaries may also allocate a portion of their after-tax profits based on PRC accounting standards to employee welfare and bonus funds at their discretion. These reserves are not distributable as cash dividends.”

“We have funded working capital and other capital requirements primarily by equity contributions, cash flow from operations, short-term bank loans and bank acceptance notes, and long-term bank loans. Cash is required primarily to purchase raw materials, repay debts and pay salaries, office expenses, income taxes and other operating expenses.”

“For the nine months ended September 30, 2025, our PRC subsidiary, Zhejiang Zhongchai, paid off approximately $1.00 million of loans from related parties, lent approximately $0.69 million to third parties, and maintained $33.04 million cash on hand. We plan to maintain the current debt structure and rely on governmentally supported loans with lower cost, if necessary.”

“Government subsidies mainly consist of an incentive granted by the Chinese government to encourage transformation of fixed assets in China and other miscellaneous subsidies from the Chinese government. Government subsidies are recognized when there is reasonable assurance that the subsidy will be received, and all conditions be completed. Total government subsidies recorded under long-term liabilities were $1.12 million and $1.26 million as of September 30, 2025 and December 31, 2024, respectively.”

Greenland Technologies Holding Corporation currently plans to fund its operations through cash flow from its operations, renewal of bank borrowings, additional equity financing, and continuation of financial support from its shareholders and affiliates controlled by its principal shareholders, if necessary. They might implement a stricter policy on sales to less creditworthy customers and plans to continue to improve its collection efforts on accounts with outstanding balances. Fortunately, they are actively working with customers and suppliers and expects to fully collect the remaining balance.

Current Cash position, and Cash Equivalents:

“We believe that the Company has sufficient cash, even with uncertainty in the Company’s manufacturing and sale of electric industrial heavy equipment in the future and decline on sale of transmission products. However, our capital contribution from existing funding sources, to operate for the next 12 months will be sufficient. We remain confident and expect to continue to generate positive cash flow from our operations.”

“We may need additional cash resources in the future, if the Company experiences failure in collecting account receivables, changes in business condition, changes in financial condition, or other developments. We may also need additional cash resources, if the Company wishes to pursue opportunities for investment, acquisition, strategic cooperation, or other similar actions. If the Company’s management and its board of directors determine that the cash required for specific corporate activities exceed Greenland’s cash and cash equivalents on hand, the Company may issue debt or equity securities to raise cash.”

“Historically, we have expended considerable resources on building a new factory and paid off a considerable amount of debt, resulting in less available cash. However, we anticipate that our cash flow will continue to improve for the remainder of fiscal year 2025. More specifically, Zhejiang Zhongchai can pledge the deed of its factory as a collateral to banks in order to obtain loans, refinance expiring loans, restructure short-term loans, and fund other working capital needs upon acceptable terms to Greenland.”

Cash equivalents refers to all highly liquid investments purchased with original maturity of three months or less. As of September 30, 2025, Greenland had approximately $3.94 million of cash and cash equivalents, representing a decrease of approximately $2.72 million, or 40.80%, as compared to approximately $6.66 million as of December 31, 2024. The decrease in cash and cash equivalents appears to be mainly due to an increase in short-term investment, as compared to that as of December 31, 2024. The current Short-Term Investments are $29.09M, an increase of 57% since FY2024. These are highly liquid investments (likely <1 year maturity) but are not included in “cash and cash equivalents”, which explains why cash fell from $6.66M to $3.94M even though overall liquidity actually improved.

Receivables:

• Accounts Receivable:

As of September 30, 2025, Greenland had approximately $21.55 million of accounts receivables, an increase of approximately $5.75 million, or 36.43%, as compared to approximately $15.80 million as of December 31, 2024. They conclude that the increase in accounts receivables was due to their “slowed-down efforts in receivables collections.”

Greenland recorded approximately nil of allowance for expected credit losses as of September 30, 2025 and December 31, 2024. Greenland conducted an aging analysis of each customer’s delinquent payments to determine whether allowance for expected credit losses is adequate. In establishing the allowance for expected credit losses, Greenland considers historical experience, economic environment, and expected collectability of past due receivables. An estimate of expected credit losses is recorded when collection of the full amount is no longer probable. When bad debts are identified, such debts are written off against the allowance for expected credit losses. Greenland will continuously assess its expected credit losses based on the credit history of and relationships with its customers on a regular basis to determine whether its allowance for expected credit losses on its accounts receivables is adequate. Greenland believes that its collection policies are generally in line with the transmissions industry’s standard in the PRC.

• Notes Receivable:

As of September 30, 2025, Greenland had approximately $16.46 million of notes receivables, which Greenland expects to collect within the next twelve months. The decrease was approximately $6.27 million, or 27.59%, as compared to approximately $22.74 million as of December 31, 2024.

IMPORTANT RISK: The recent receivable trends could indicate weakening cash-conversion quality. The combination of slower collections, a 36% increase in accounts receivable, and the absence of any credit-loss allowance suggests that reported earnings may overstate the company’s underlying economic performance. I think we need to monitor the collection patterns and future adjustments to loss reserves to assess the reliability and durability of the company’s financial results, as it’s also highly relevant in the next TTM. But, as we will se in the “Risks” section, this problem may seem more relevant than it actually is.

That said, the probability of collecting all notes receivables in the next 12 months is high, which can improve Greenland’s cash position. This dramatically strengthens liquidity, reduces risk of short-term cash problems, and gives flexibility for operations or investments. If we also include highly liquid investments, the total liquid cash position for the next year (notes receivables + short-term investments + cash and equivalents) is around $49.5M. This gives the company a great cushion of cash if any short term debt emerges unexpectedly. But, assuming a conservative approach that excludes notes receivable, as they may not be collectible within the next 12 months, the company’s current liquid cash position is $33.04M.

Cash Flow (from Q3):

Operating Activities:

“Net cash provided by operating activities for the nine months ended September 30, 2025 was approximately $7.80 million, primarily attributable to net income of approximately $8.39 million, adjusted for non-cash item of depreciation and amortization expenses of approximately $1.56 million, stock-based compensation expense of approximately $6.95 million and changes in operating assets and liabilities including: (i) an increase of approximately $3.94 million in accounts payable because we extended the payment cycle, (ii) a decrease of approximately $5.30 million in accounts receivable due to our slowed-down efforts in receivables collections, and (iii) a decrease of approximately $12.08 million in other current and non-current assets because we deposited cash into short-term investment.”

Net cash provided by operating activities for the nine months ended September 30, 2024 was approximately $8.98 million, primarily attributable to net income of approximately $9.80 million, adjusted for non-cash item of depreciation and amortization expenses of approximately $1.65 million, change in accrued expense of approximately $1.01 million and changes in operating assets and liabilities including: (i) an increase of approximately $3.07 million in inventories because we reduced the prepared goods, (ii) a decrease of approximately $4.10 million in accounts receivable due to our slowed-down efforts in receivables collections, and (iii) a decrease of approximately $1.80 million in other current and non-current assets because we deposited cash into fixed deposits.

Investing Activities:

Net cash used in investing activities resulted in cash outflow of approximately $0.68 million for the nine months ended September 30, 2025. Cash used in investing activities for the nine months ended September 30, 2025 was mainly due to approximately $0.27 million used for purchases of long-term assets and approximately $0.69 million loaned to third parties.

Net cash used in investing activities resulted in cash outflow of approximately $2.11 million for the nine months ended September 30, 2024. Cash used in investing activities for the nine months ended September 30, 2024 was mainly due to approximately $1.42 million used for purchases of long-term assets and approximately $0.69 million in loans to third parties.

Financing Activities:

Net cash used in financing activities resulted a cash outflow of approximately $12.26 million for the nine months ended September 30, 2025, which was mainly attributable to approximately $6.26 million in repayment of loans from related parties and approximately $5.48 million in repayment of notes payable.

Net cash used in financing activities resulted a cash outflow of approximately $14.39 million for the nine months ended September 30, 2024, which was mainly attributable to approximately $8.56 million in repayment of short-term bank loans and approximately $11.39 million in repayment of notes payable. Such amounts were further offset by approximately $5.56 million in proceeds from short-term bank loans.

Credit Risk:

The 2025 Q3 SEC file quotes “Assets that potentially subject the Company to significant concentration of credit risk primarily consist of cash and cash equivalents. The maximum exposure of such assets to credit risk is their carrying amount as at the balance sheet dates. As of June 30, 2025, cash and cash equivalents of $10,831,342 were deposited in financial institutions in the PRC, and each bank account is insured by the PRC government with the maximum limit of RMB500,000 (equivalent $69,800). To limit exposure to credit risk relating to deposits, the Company primarily places cash and cash equivalent with large financial institutions in China which management believes are of high credit quality and the Company also continually monitors their credit worthiness.”

And “A majority of the Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC as well as by the general state of the PRC’s economy. In addition, the Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, rates and methods of taxation among other factors.”

RISK FACTORS

Evaluation of Disclosure Controls and Procedures:

From the management team: “As of September 30, 2025, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based upon such evaluation, our chief executive officer and chief financial officer concluded that, as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures were ineffective. Such conclusion is based on the presence of the following material weakness in internal control over financial reporting as of September 30, 2025:

- Accounting and Financial Reporting Personnel Material Weakness - We concluded that in lack of sufficient and competent financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements to prepare consolidated financial statements and related disclosures in accordance with U.S. GAAP and SEC reporting requirements, we did not maintain effective controls and did not implement adequate and proper supervisory review to ensure that significant internal control deficiencies can be detected or prevented.”

As a result, Greenland has developed a plan to strengthen its accounting and financial reporting functions. To strengthen Greenland’s internal control over financial reporting, the company is currently implementing the following:

- Developing and formalizing of key accounting and financial reporting policies and procedures;

- Recruiting more financial reporting and accounting personnel who have adequate U.S. GAAP knowledge;

- Training key position staff by U.S. accountant with U.S. corporate accounting experiences, and gaining additional knowledge and professional skills about SEC regulations and U.S. GAAP;

- Planning to acquire additional resources to strengthen the financial reporting function and set up a financial and system control framework; and

- Establishing effective oversight and clarifying reporting requirements for non-recurring and complex transactions to ensure consolidated financial statements and related disclosures are accurate, complete and in compliance with U.S. GAAP and SEC reporting requirements.

Risks Related to Their Business and Industry (summarized):

Every statement from the following list is directly extracted and quoted from Q3 2025 SEC filing report:

- “Our subsidiaries’ business operations are cash intensive, and our subsidiaries’ business could be adversely affected if we fail to maintain sufficient levels of liquidity and working capital;

- We grant relatively long payment terms for accounts receivable which can adversely affect our cash flow;

- Our subsidiaries face short lead-times for delivery of products to customers. Failure to meet delivery deadlines could result in the loss of customers and damage to our reputation and goodwill;

- Our subsidiaries face intense competition, and if we are unable to compete effectively, we may not be able to maintain profitability;

- Our revenues are highly dependent on a limited number of customers and the loss of any one of our subsidiaries’ major customers could materially and adversely affect our growth and revenues;

- As our subsidiaries expand their operations, they may need to establish a more diverse supplier network for raw materials. The failure to secure a more diverse supplier network could have an adverse effect on our financial condition;

- To remain competitive, our subsidiaries are introducing new lines of business, including the production and sale of electric industrial heavy equipment. If these efforts are not successful, our results of operations may be materially and adversely affected;

- New lines of business, including the production and sale of electric industrial heavy equipment, may subject us and our subsidiaries to additional risks;

- Volatile steel prices can cause significant fluctuations in our operating results. Our revenues and operating income could decrease if steel prices increase or if our subsidiaries are unable to pass price increases on to their customers; and

- We are subject to various risks and uncertainties that may affect our subsidiaries’ ability to procure raw materials.”

Greenland has strong liquid assets, positive FCF, and low debt, which can protect them against some operational risks. However, the company is small, concentrated, and expanding into new EV markets, which introduces execution risk, financial risk, and market risk. These risks suggest that while the intrinsic value floor is strong, the company’s upside is more sensitive to operational execution and market conditions.

Other important risks (based on my own analysis):

- Small, high-growth companies sometimes hide weakness through receivable expansion, so earnings may be overstated relative to true cash earnings. However, notes receivable are expected to be assets that should convert over 12 months, based on management’s message to shareholders. Summed liquid assets available in less than 12 months is approximately $49.5M. That’s very strong for a microcap manufacturer. Liquidity risk is lower than it looks if you solely look at cash and equivalents, but earnings quality risk is still relevant.

- Operating cash flow is currently artificially inflated by extended payables, and it looks reduced because cash is moved to short-term investments. However, OCF remains meaningfully positive, which is in Greenland’s favor. Fortunately, investing cash outflows are tiny and financing outflows reflect deleveraging, which is strategically sound.

Addressing receivables: Although the business has acknowledged intentionally slowing the collection of accounts receivable relative to FY2024, resulting in a reported increase, the figures remain consistent in historical context. As we will see in the next section, across the last five quarters and the last four fiscal years of 10-Q and 10-K filings, receivables have remained within a range, indicating no structural deterioration in credit quality or collection behavior.

HISTORICAL FINANCIALS

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*This following list only includes the most important and fundamental financial metrics. To access the entire historical financial statements from official filings, click here.

VALUATION

Quality metrics:

- ROA = 11.6%

- ROE = 18.7%

- ROC (calculated as EBIT / (Net PPE + NWC)) = 27.8%

- ROIC = 15.4%

- ROIIC (TTM Q3 2025 – TTM Q3 2024) = 46.8%

- Gross margins = 32.4%

- Debt/Equity = 0.2x

Multiples:

- PE = 1.1x

- EBIT/EV = 597%

- P/FCF = 1.6x

- FCF/EV = 378%

- P/NTA = 0.25x

- P/B = 0.25x

- P/NCAV = 0.40x

- P/Graham Number = 0.1x

Realistic (but conservative) Discounted Cash Flow Analysis:

• Current FCF = $11,344,029

Assuming $4M of these are accounting errors, FCF would be close to $7M. On that point on, let’s assume modest growth (specifically 8% annually) for the next 5 years and then make free cash flows decline 5% in perpetuity, so that in a certain point of time in the future all cash flows become economically irrelevant. Basically, I assume the core transmission business will continue to grow for the next 5 years, but then HEVI burns cash until the business is useless. This is unlikely and deeply conservative, as I want to secure a big margin of safety but don’t want to make valuation completely unrealistic, so I believe this is a good in between.

I always discount using an appropriate interest rate. But for this conservative valuation, I’ll set the discount rate to an almost unrealistic 20% and continue to forecast cash flows:

All numbers in thousands.

To calculate the equity value, just sum all discounted future cash flows, add total highly liquid assets (available in less than 12 months) and subtract total debt. As management said, they may be overestimating (or underestimating) earnings, cash, assets, and more. So, I’ll assume 20% of highly liquid assets are accounting errors:

All numbers in thousands.

My conservative intrinsic value estimate for the business is around $51,891, or $2.98 per share, and current market cap is $18M, or 1.06$ per share.

My personal opinion: this might be completely nonsensical (by the market) if the business doesn’t suddenly deteriorate or is accused of fraud, which doesn’t appear to be the case. This means we’ve got increadible downside protection and big upside.

Even so, the business appears deeply undervalued, with a 65% margin of safety on a deeply conservative assumption. I would usually present more equity value changes under different FCF growth rates, discount rates, or HEVI success scenarios, but I don’t find it necessary.

(Future me here: I should’ve used owner earnings to forcast growth instead of FCF, but it’s still reasonable and will do it in a more buffett aligned way in the follow-up)

• Upside to Conservative Case: +153% (highly estimated)

Catalysts:

Greenland has two strong catalysts: improved operational efficiency and margin expansion, which could help the market revaluate over time if it becomes sustainable, and the pivot to its HEVI business. The second catalyst is probably the clearest under-appreciated catalyst today. The company launched HEVI in January 2020 to focus on the production and sale of electric industrial vehicles (more on HEVI’s business in the “Overview” section, 3^rd page). Management signaled a strategic refocus away from traditional drivetrain systems toward electric industrial vehicles, a segment with growing demand under ESG and decarbonization trends. GTEC has built out infrastructure around HEVI, expanding its Authorized Service Provider (ASP) network. It also secured a strategic manufacturing partnership with Lonking Holdings Limited, a major global heavy-machinery manufacturer, to co-develop electric heavy machinery for the U.S. market under HEVI’s brand. In April 2024, GTEC delivered its first all-electric front loader to Port of Baltimore. Concurrently, 2024 results show GTEC achieved a net profit of US$15.15 million after a prior year loss, reflecting cost discipline and increasing contribution from its EV-heavy equipment business. On February 2024 the board approved separating the legacy drivetrain systems business from the industrial EV business (HEVI). That could unlock value for shareholders, as the subsidiary business (HEVI) could improve current cash flows and provide long-term growth for the entire company.

However, risks still remain. The board’s “spin-off plan” to separate the drive train business from the EV industrial business is still a plan, and HEVI remains relatively small compared to original operations. Additionally, there remains no specific shareholder capital return and have issued new shares, which could destroy shareholder value.

Fortunately, management stated that on December 29, 2025, every shareholder can vote for Share Capital Reorganization & Re-classification. If approved, this could give the board the flexibility to do buybacks, retire shares, or reorganize share classes, which would help undo some of the dilution from past issuances. It doesn’t mean buybacks will happen for sure, but at least shareholders would have the option to push for something that actually adds value, instead of just watching their ownership get diluted.

Pricing Power & Competitive Advantages:

Past price hikes:

Greenland does not disclose specific list price increases or systematic selling‑price actions over the last five years; instead, management discusses revenue changes primarily in terms of volumes, product mix, and foreign exchange. For Q3 2025, revenue increased 3.4% year‑on‑year to USD 66.8 million while cost of goods sold fell slightly, leading to a 14.9% increase in gross profit, which indirectly suggests improved realized pricing or mix relative to input costs.​

Q2 2025 revenue declined 5.6% YoY but gross margin decreased modestly from 29.4% to 26.5%, while Q3 2025 revenue grew 24.3% with gross margin expanding from 26.4% to 32.4%. Management states margin improvements are due to higher sales volume, better product mix and cost management, so there is no evidence that volume was maintained after price rises. This lowers my confidence about the company’s pricing power.​

Gross margins:

Greenland’s gross margin improved from 26.9% in YTD Q3 2024 to 29.9% in YTD Q3 2025, and Q3 2025 gross margin reached 32.4%. This seems to be highly relevant as the company operates in an “intensely competitive transmission market” where OEM customers have significant negotiating leverage, and the business had past margin pressure.​

Compared to larger forklift manufacturers, margins are still modest. A direct competitor, Hangcha Group, reported approximately $2.3B in revenue in 2024 with strong net profit growth, implying stronger scale economies and likely better pricing. However, for a small component supplier, these gross margins are healthy.

Average gross margins for the industry are close to 26%, placing Greenland’s current margin outperformance above peers. This makes it difficult to maintain current gross margins levels for extended periods in time.

Market share:

Important clarification: GTEC is a drivetrain supplier, not a forklift OEM. Industry market size numbers don’t reflect their real addressable market. True TAM is unknown, so market share can’t be accurately assessed. This is a rough estimation using the global forklift truck market.

Greenland reported revenues of $66.8M for the trailing nine months of 2025, which is annualized roughly at $90M. Some global forklift truck market studies have estimated industry revenue between $59.8B and $79.2B, which implies Greenland’s sales are under 0.2% market share. In recent years, the company’s revenues have been volatile rather than compounding stably, so there is no sustained market share growth in the steadily expanding forklift market.​

Customer Loyalty:

Five customers represent about 40% of revenue and the largest customer, Hangcha Group, accounts for around 15% of sales. Management warns that the current concentration can give customers power to demand better prices or payment terms, which doesn’t indicate strong pricing power.

High concentration limits pricing power, which isn’t a sign of competitive advantage.

Final Verdict:

Greenland currently demonstrates weak pricing power, with margin improvements driven primarily by mix and input costs rather than sustainable price leadership. This will make it hard to maintain current gross margins. This is not a great business. It is a cyclical, niche business at a very low price, with a speculative EV option.

Dilution History:

As mentioned previously, the company has issued new shares in 2025, primarily through stock-based compensation and equity issuances”.

Dilution history and outstanding shares:

Greenland issued “incentive awards” in the form of common stock awards to employees and the management team. The stock awards are part of the company’s compensation plan.

(Future me here, again: I ignored the possible risk of material shareholder dilution, something i’ve corrected in the follow-up)

Insider Trading:

There have been no meaningful transactions to justify any bullish or bearish signal. Peter Wang, a director and the biggest shareholder, bought and sold simultaneously 6,211,740 shares at $1.00 per share on April 22, 2025. The transaction likely reflects a structural reorganization of holdings rather than a bet on the company’s performance. In June 2025, he sold 200,000 shares, which is minimal relative to his total holdings. This was likely for liquidity.

The CEO (Raymond Z. Wang) bought 66,500 shares on May 22, 2023, showing limited recent insider conviction. Overall, insider ownership is at 47%, which provides strong alignment with shareholder interest but also reduces free float, which can contribute to volatility.

This insider trading activity is currently neutral. The buy and sell by Peter Wang appear to be a structural reorganization. Management remains invested, which gives some alignment with shareholders, but holding such a big portion of the company still concerns me.

CONCLUSION

Based on the full analysis, Greenland seems to be a small manufacturer with acceptable economics, a solid balance sheet, and a speculative EV option that the market prices as if it will not only fail but also drag the entire business into a permanent decline (which doesn’t seem to be the case). From a value investor’s standpoint, this stock could be a great opportunity that could drive some satisfactory returns, given that normalized free cash flow of roughly $7M and current free cash flow at $11M against an $18M market capitalization, which means the market is requiring a very high return while simultaneously assuming a perpetual and steep decline in cash flows. Even after cutting current FCF, marking down liquid assets, and using an almost unrealistic 20% discount rate with negative terminal growth, the resulting intrinsic value estimate still sits more than 150% above the current price.

This isn’t a wonderful business as modern Warren Buffett would describe. It operates in a competitive market, depends on a concentrated customer base, and carries real risk in the HEVI segment and in receivables management. This is the type of business Buffett (when he was working for Graham) would possibly buy. The main drivetrain business currently seems unlikely to become a big competitor, and recent share issuance and internal‑control weaknesses are still relevant concerns that require us, the investors, to conduct due diligence to deduce if the problem is getting bigger or becoming irrelevant. The thesis is not on moat expansion or fast growth, but on durable, if unexciting for most investors, cash flows, a conservative balance sheet, and a valuation by the market that already discounts the majority of these ongoing risks, limiting downside while upside can become exponential.

The upside case is that management gradually improves disclosure and controls, keeps capital allocation disciplined, and lets the drivetrain business continue to generate sufficient returns on capital while HEVI either succeeds modestly or, at worst, remains as an option rather than a burning cash machine. If that happens, there is more than enough room for the market to re‑rate the business closer to a lower earnings yield in the 10-15% on normalized FCF and a more reasonable multiple of net tangible assets, which would more than double, triple or multiply by even more today’s price without requiring aggressive assumptions. The downside case is long-term receivables bubble, a deterioration in customer relationships or pricing, or big HEVI spending that burns the balance sheet and turns today’s margin of safety into something irrelevant since the beginning.

Greenland is not a compounder to buy at any price and hold forever, but a statistically cheap, asset backed, and a cash generating business where the real asymmetric bet appears in favor of a patient, rational investor with an owner’s mindset. We are not buying a stock ticker, we are buying a small part of a functional business. The margin of safety comes not from a perfect quality company, but from paying far less than conservative intrinsic value for a business that doesn’t need to be great to justify a much higher price than the market is currently offering, and it’s also easy to understand the core business. Anyone willing to wait patiently will have the odds (not guaranteed) of achieving a satisfactory medium-term return.

*This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk.

Buffett has given many speeches on how he approaches intrinsic value, so with all the information available to the pubic, I extracted some of the most important things he said throughout the years in his Berkshire Hathaway annual meetings, as well as a masterclass he gave in 2001. I have condensed some speeches for simplicity, but everything he said is practically there, unchanged from the original.

July 18, 2001: The Masterclass

Warren gives a masterclass about investing, mainly by answering questions from the students studying in the University of Georgia, specifically at the Terry College of Business. One student asks 2 short questions about calculating intrinsic value:

Question number one:

• How do you find intrinsic value in a company?

Well, intrinsic value is what is the number that, if you were all-knowing about the future and could predict all the cash that a business would give you between now and Judgment Day, discounted at the proper discount rate, that number is what the intrinsic value of businesses is. In other words, the only reason for making investment and laying out money now is to get more money later on. That’s what investing is all about.

Now, when you look at the bond you know what you’re gonna get back, it says it right on the bond. It says when you get the interest payments, it says when you get the principal, so it’s very easy to figure out the value of a bond. The cash flows are printed on the bond. The cash flows aren’t printed on a stock certificate. That’s the job of the analyst, is to take that stock certificate, which represents an interest in the business, and change that into a bond and say, “This is what I think it’s going to pay out in the future.”

It’s the same thing for a big business. If you buy Coca-Cola today, the company is selling for about a hundred and ten to fifteen billion dollars in the market. The question is, would you lay it out today to get what the Coca-Cola company is going to deliver to you over the next two or three hundred years?

How much cash they’re going to give you isn’t a question of how many analysts are gonna recommend it, or what the volume in the stock is, or what the chart looks like. It’s a question of how much it’s going to give you. It’s true if you’re buying a farm. It’s true if you’re buying an apartment house. You’re laying out cash now to get your cash back later on. And the question is, how much you’re gonna get, and how sure are you.

When I calculate intrinsic value of a business, whether we’re buying all of a business or a little piece of a business, I always think we’re buying the whole business. I look at it and say, what will come out of this business, and when?

Berkshire has never distributed anything to its shareholders, but its ability to distribute goes up as the value of the businesses we own increases. The real question is, if you’re gonna buy the whole company for a hundred and five billion now, can we distribute enough cash to you soon enough, at present interest rates, to lay out that cash now? If you can’t answer that question, you can’t buy the stock.

There’s a lot of companies that I can’t answer that for, and I just stay away from those.

Question number two:

• So you get formulas involved in finding intrinsic values on certain companies. I mean, you’ve got a mathematical. It’s not just got a present value of future cash out. Second question is, why haven’t you written down your set of formulas or your strategies in written forms that you can share with everyone else?

I think I actually have written about that. If you read the annual reports over the years, I use the illustration of Aesop. He said, “A bird in the hand is worth two in the bush.” Now, that isn’t quite complete, because the question is, how sure are you that there are two in the bush, and how long do you have to wait to get them out?

That’s all there is to investing: how many birds are in the bush, when are you gonna get them out, and how sure are you. If interest rates are fifteen percent, you’ve got to get two birds out of the bush in five years to equal the bird in the hand. If interest rates are three percent and you can get two birds out in twenty years, it still makes sense, because it all gets back to discounting against an interest rate.

May 3, 1999: Berkshire Hathaway Annual Meeting

It’s the Berkshire Hathaway annual meeting in 1999. Dan Kur, and investor from Bonita Springs, Florida, attempts to calculate the intrinsic value of Berkshire:

• Dan Kur: You’ve given many clues to investors to help them calculate Berkshire’s intrinsic value. I’ve attempted to calculate the intrinsic value of Berkshire using the discounted present value of its total look-through earnings. I’ve taken Berkshire’s total look-through earnings and adjusted them for normalized earnings at GEICO, the Supercat business, and General Re. Then I’ve assumed that Berkshire’s total look-through earnings will grow at 15% per annum on average for 10 years, 10% per annum for years 11 through 20, and that earnings stop growing after year 20, resulting in a coupon equaling year 20 earnings from the 21st year onward. Lastly, I’ve discounted those estimated earnings streams at 10% to get an estimate of Berkshire’s intrinsic value.

• My question is, is this a sound method? Is there a risk-free interest rate, such as a 30-year Treasury, which might be the more appropriate rate to use here, given the predictable nature of your consolidated income stream? Thank you.

Well, that is a very good question. Investment is the process of putting out money today to get more money back at some point in the future. And the question is how far in the future, how much money, and what is the appropriate discount rate to take it back to the present day and determine how much you pay.

And I would say you’ve stated the approach. I couldn’t state it better myself. The exact figures you want to use, whether you want to use 15% gains in earnings or 10% gains in the second decade, I have no comment on those particular numbers. But you have the right approach.

We would probably use the long-term government rate to discount it back, but we wouldn’t pay that number after we discounted it back. We would look for appropriate discounts from that figure. But it doesn’t really make any difference whether you use a higher figure and then look across them, or use our figure and look for the biggest discount. You’ve got the right approach.

We try to give you all of the information that we would find useful ourselves in evaluating Berkshire’s intrinsic value in our reports. I can’t think of anything we leave out of our published materials.

Now, one important element in Berkshire is that because we retain all earnings and because we have a growth of float over time, we have a considerable amount of money to invest. And it really is the success with which we invest those retained earnings and growth in float that will be an important factor in how fast our intrinsic value grows. And to an important extent, what happens there is out of our control.

If we run into favorable external circumstances, your calculation of intrinsic value would result in a higher number than if we run into the kind of circumstances that we’ve had the last 12 months.

Charlie: For many decades around here, we’ve had more than 100% of book net worth in marketable securities and a lot of wonderful wholly owned subsidiaries. We still got the wonderful businesses, but we’re having trouble with the new money.

May 5, 1997: Berkshire Hathaway Annual Meeting

It’s another Berkshire Hathaway annual meeting, this time from 1997. Fred Kocher from Boulder, Colorado, is the first person to ask a question after Kelly tells Buffett “we should start with number two, zone two”. Here they not only talk about intrinsic value, but also opportunity cost, which are two concepts highly correlated:

• Fred Kocher: This is a question about intrinsic value, and it’s a question for both of you (referring Warren Buffett and Charlie Munger), because you have written that perhaps you would come up with different answers. You write and speak a great deal about intrinsic value, and you indicate that you try to give shareholders the tools in the annual report so they can come to their own determination.

• What I’d like you to do is expand upon that a little bit. First of all, what do you believe to be the important tools, either in the Berkshire annual report or other annual reports that you review, in determining intrinsic value? Secondly, what rules or principles or standards do you use in applying those tools? And lastly, how does that process relate to what you have previously described as the filters you use in determining your evaluation of a company?

Warren Buffett: If we could see, in looking at any business, what its future cash inflows or outflows from the business to the owners would be over the next hundred years, or until the business is extinct, and then discount that back at the appropriate interest rate, that would give us a number for intrinsic value. It would be like looking at a bond that had a whole bunch of coupons on it. If you could see what those coupons are, you could figure the value of that bond. Businesses have coupons that are going to develop in the future. The only problem is they aren’t printed on the instrument, and it’s up to the investor to try to estimate what those coupons are going to be over time.

In high-tech businesses, we don’t have the faintest idea what the coupons are going to be. When we get into businesses where we think we can understand them reasonably well, we are trying to print the coupons. We are trying to figure out what businesses are going to be worth in 10 or 20 years. When we bought See’s Candy in 1972, we had to come to the judgment as to whether we could figure out the competitive forces that would operate and how that would look over a long period. And if you attempt to assess intrinsic value, it all relates to cash flows. The only reason for putting cash into any kind of investment now is because you expect to take cash out by what the asset itself produces.

That’s true if you’re buying a farm. It’s true if you’re buying a business. The filters you described are designed to make sure we’re in businesses where we have a high degree of confidence that we’re in the ballpark. We basically use long-term, risk-free government bond–type interest rates to think back in terms of what we should discount at. That’s what investment is all about: putting out money to get more money back later on from the asset itself.

If you’re an investor, you’re looking at what the asset is going to do. If you’re a speculator, you’re focusing on what the price is going to do, and that’s not our game. If we’re right about the business, we’re going to make money, and if we’re wrong, we don’t expect to. In looking at Berkshire, we try to tell you as much as possible about our business. We give you the information that, if the positions were reversed, we would want to get from you. In companies like Coca-Cola or Gillette or Disney, you can understand what they’re doing and then sit down and try to print out the future.

Charlie Munger: One filter that’s useful in investing is the idea of opportunity cost. If you already have something you like better than 98% of things you see, you can screen out the rest. People who use opportunity cost tend to make better investments. That leads to a concentrated portfolio, which we don’t mind.

Warren Buffett: If somebody shows us a business, the first thing we ask is whether we would rather own that or more Coca-Cola. There are very few businesses we’re as certain about as those, and we measure everything against that standard.

Charlie Munger: The concept of intrinsic value used to be easier when you could buy stocks at huge discounts to liquidation value. No matter how bad the management, you had a lot going for you. That’s much harder to find now. Those simple systems don’t work anymore. You’ve got to get into Warren’s kind of thinking, and that is a lot harder. I think you can predict the future best where the business is simple and understandable. You don’t need complex models; you just need to really understand a few simple things.

Warren Buffett: Charlie talks about liquidation value. You don’t talk about closing up the enterprise, but about what somebody else would pay for that stream of cash. You could have looked at a collection of television stations owned by Cap Cities, for example, in 1974, and it would have been worth four times what the company was selling for. Not because you’d close the stations, but because their stream of income was worth that to somebody else. The marketplace was very distressed. On a negotiated basis, you could have sold the properties for four times what the company was selling for, and you got wonderful management.

Those things happen in markets, and they will happen again. But part of investing in calculating intrinsic value is, if you get the wrong answer, if it says don’t buy, you can’t buy just because somebody else thinks it’s gonna go up, or because your friends have made a lot of easy money lately. You have to be able to walk away from anything that doesn’t work. And very few things work these days. You also have to walk away from anything you don’t understand. You would agree with that, Charlie?

Charlie Munger: Yeah. And it’s harder now partly because of the amount of capital we run. If we were running a small amount of money, our opportunities would be much greater. Our universe of ideas would expand by a huge factor.

We are looking at things today that, by their nature, a lot of people are looking at. There were times in the past when we were looking at things that very few people were looking at. And there were other times in the past when we were looking at things where the whole world was just looking at them kind of crazy. And that’s a decided help.

February 27, 1986: Berkshire Hathaway Shareholder Letter

As Buffett mentioned in his 2001 masterclass, he has indeed written before about how he approaches calculating intrinsic value. At the end of his 1986 letter to shareholders, in section “Purchase-Price Accounting Adjustments and the Cash Flow Fallacy”, he presents a short quiz. “Which business is the more valuable?”:

(None of the following is redacted or summarized, everything is complete from that specific section and in Warren E. Buffett’s exact wording)

First a short quiz: below are abbreviated 1986 statements of earnings for two companies. Which business is the more valuable?

As you’ve probably guessed, Companies O and N are the same business - Scott Fetzer. In the “O” (for “old”) column we have shown what the company’s 1986 GAAP earnings would have been if we had not purchased it; in the “N” (for “new”) column we have shown Scott Fetzer’s GAAP earnings as actually reported by Berkshire.

It should be emphasized that the two columns depict identical economics - i.e., the same sales, wages, taxes, etc. And both “companies” generate the same amount of cash for owners. Only the accounting is different.

So, fellow philosophers, which column presents truth? Upon which set of numbers should managers and investors focus?

Before we tackle those questions, let’s look at what produces the disparity between O and N. We will simplify our discussion in some respects, but the simplification should not produce any inaccuracies in analysis or conclusions.

The contrast between O and N comes about because we paid an amount for Scott Fetzer that was different from its stated net worth. Under GAAP, such differences - such premiums or discounts - must be accounted for by “purchase-price adjustments.” In Scott Fetzer’s case, we paid $315 million for net assets that were carried on its books at $172.4 million. So we paid a premium of $142.6 million.

The first step in accounting for any premium paid is to adjust the carrying value of current assets to current values. In practice, this requirement usually does not affect receivables, which are routinely carried at current value, but often affects inventories. Because of a $22.9 million LIFO reserve and other accounting intricacies, Scott Fetzer’s inventory account was carried at a $37.3 million discount from current value. So, making our first accounting move, we used $37.3 million of our $142.6 million premium to increase the carrying value of the inventory.

Assuming any premium is left after current assets are adjusted, the next step is to adjust fixed assets to current value. In our case, this adjustment also required a few accounting acrobatics relating to deferred taxes. Since this has been billed as a simplified discussion, I will skip the details and give you the bottom line: $68.0 million was added to fixed assets and $13.0 million was eliminated from deferred tax liabilities. After making this $81.0 million adjustment, we were left with $24.3 million of premium to allocate.

Had our situation called for them two steps would next have been required: the adjustment of intangible assets other than Goodwill to current fair values, and the restatement of liabilities to current fair values, a requirement that typically affects only long-term debt and unfunded pension liabilities. In Scott Fetzer’s case, however, neither of these steps was necessary.

The final accounting adjustment we needed to make, after recording fair market values for all assets and liabilities, was the assignment of the residual premium to Goodwill (technically known as “excess of cost over the fair value of net assets acquired”). This residual amounted to $24.3 million. Thus, the balance sheet of Scott Fetzer immediately before the acquisition, which is summarized below in column O, was transformed by the purchase into the balance sheet shown in column N. In real terms, both balance sheets depict the same assets and liabilities - but, as you can see, certain figures differ significantly.

The higher balance sheet figures shown in column N produce the lower income figures shown in column N of the earnings statement presented earlier. This is the result of the asset write-ups and of the fact that some of the written-up assets must be depreciated or amortized. The higher the asset figure, the higher the annual depreciation or amortization charge to earnings must be. The charges that flowed to the earnings statement because of the balance sheet write-ups were numbered in the statement of earnings shown earlier:

1. $4,979,000 for non-cash inventory costs resulting, primarily, from reductions that Scott Fetzer made in its inventories during 1986; charges of this kind are apt to be small or non-existent in future years.

2. $5,054,000 for extra depreciation attributable to the write-up of fixed assets; a charge approximating this amount will probably be made annually for 12 more years.

3. $595,000 for amortization of Goodwill; this charge will be made annually for 39 more years in a slightly larger amount because our purchase was made on January 6 and, therefore, the 1986 figure applies to only 98% of the year.

4. $998,000 for deferred-tax acrobatics that are beyond my ability to explain briefly (or perhaps even non-briefly); a charge approximating this amount will probably be made annually for 12 more years.

It is important to understand that none of these newly-created accounting costs, totaling $11.6 million, are deductible for income tax purposes. The “new” Scott Fetzer pays exactly the same tax as the “old” Scott Fetzer would have, even though the GAAP earnings of the two entities differ greatly. And, in respect to operating earnings, that would be true in the future also. However, in the unlikely event that Scott Fetzer sells one of its businesses, the tax consequences to the “old” and “new” company might differ widely.

By the end of 1986 the difference between the net worth of the “old” and “new” Scott Fetzer had been reduced from $142.6 million to $131.0 million by means of the extra $11.6 million that was charged to earnings of the new entity. As the years go by, similar charges to earnings will cause most of the premium to disappear, and the two balance sheets will converge. However, the higher land values and most of the higher inventory values that were established on the new balance sheet will remain unless land is disposed of or inventory levels are further reduced.

What does all this mean for owners? Did the shareholders of Berkshire buy a business that earned $40.2 million in 1986 or did they buy one earning $28.6 million? Were those $11.6 million of new charges a real economic cost to us? Should investors pay more for the stock of Company O than of Company N? And, if a business is worth some given multiple of earnings, was Scott Fetzer worth considerably more the day before we bought it than it was worth the following day?

If we think through these questions, we can gain some insights about what may be called “owner earnings.” These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges such as Company N’s items (1) and (4) less (c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in (c) ). However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.

Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since(c) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes - both for investors in buying stocks and for managers in buying entire businesses. We agree with Keynes’s observation: “I would rather be vaguely right than precisely wrong.”

The approach we have outlined produces “owner earnings” for Company O and Company N that are identical, which means valuations are also identical, just as common sense would tell you should be the case. This result is reached because the sum of (a) and (b) is the same in both columns O and N, and because (c) is necessarily the same in both cases.

And what do Charlie and I, as owners and managers, believe is the correct figure for the owner earnings of Scott Fetzer? Under current circumstances, we believe (c) is very close to the “old” company’s (b) number of $8.3 million and much below the “new” company’s (b) number of $19.9 million. Therefore, we believe that owner earnings are far better depicted by the reported earnings in the O column than by those in the N column. In other words, we feel owner earnings of Scott Fetzer are considerably larger than the GAAP figures that we report.

That is obviously a happy state of affairs. But calculations of this sort usually do not provide such pleasant news. Most managers probably will acknowledge that they need to spend something more than (b) on their businesses over the longer term just to hold their ground in terms of both unit volume and competitive position. When this imperative exists - that is, when ( c) exceeds (b) - GAAP earnings overstate owner earnings. Frequently this overstatement is substantial. The oil industry has in recent years provided a conspicuous example of this phenomenon. Had most major oil companies spent only (b) each year, they would have guaranteed their shrinkage in real terms.

All of this points up the absurdity of the “cash flow” numbers that are often set forth in Wall Street reports. These numbers routinely include (a) plus (b) - but do not subtract (c) . Most sales brochures of investment bankers also feature deceptive presentations of this kind. These imply that the business being offered is the commercial counterpart of the Pyramids - forever state-of-the-art, never needing to be replaced, improved or refurbished. Indeed, if all U.S. corporations were to be offered simultaneously for sale through our leading investment bankers - and if the sales brochures describing them were to be believed - governmental projections of national plant and equipment spending would have to be slashed by 90%.

“Cash Flow”, true, may serve as a shorthand of some utility in descriptions of certain real estate businesses or other enterprises that make huge initial outlays and only tiny outlays thereafter. A company whose only holding is a bridge or an extremely long-lived gas field would be an example. But “cash flow” is meaningless in such businesses as manufacturing, retailing, extractive companies, and utilities because, for them, ( c) is always significant. To be sure, businesses of this kind may in a given year be able to defer capital spending. But over a five- or ten-year period, they must make the investment - or the business decays.

Why, then, are “cash flow” numbers so popular today? In answer, we confess our cynicism: we believe these numbers are frequently used by marketers of businesses and securities in attempts to justify the unjustifiable (and thereby to sell what should be the unsalable). When (a) - that is, GAAP earnings - looks by itself inadequate to service debt of a junk bond or justify a foolish stock price, how convenient it becomes for salesmen to focus on (a) + (b). But you shouldn’t add (b) without subtracting (c) : though dentists correctly claim that if you ignore your teeth they’ll go away, the same is not true for (c) . The company or investor believing that the debt-servicing ability or the equity valuation of an enterprise can be measured by totaling (a) and (b) while ignoring (c) is headed for certain trouble.

To sum up: in the case of both Scott Fetzer and our other businesses, we feel that (b) on an historical-cost basis - i.e., with both amortization of intangibles and other purchase-price adjustments excluded - is quite close in amount to (c) . (The two items are not identical, of course. For example, at See’s we annually make capitalized expenditures that exceed depreciation by $500,000 to $1 million, simply to hold our ground competitively.) Our conviction about this point is the reason we show our amortization and other purchase-price adjustment items separately in the table on page 8 and is also our reason for viewing the earnings of the individual businesses as reported there as much more closely approximating owner earnings than the GAAP figures.

Questioning GAAP figures may seem impious to some. After all, what are we paying the accountants for if it is not to deliver us the “truth” about our business. But the accountants’ job is to record, not to evaluate. The evaluation job falls to investors and managers.

Accounting numbers, of course, are the language of business and as such are of enormous help to anyone evaluating the worth of a business and tracking its progress. Charlie and I would be lost without these numbers: they invariably are the starting point for us in evaluating our own businesses and those of others. Managers and owners need to remember, however, that accounting is but an aid to business thinking, never a substitute for it.

Conclusion

Buffett has been very consistent over the years with his answer on what he defines intrinsic value. Here are the key things we learnt about from Warren on what is intrinsic value, and how to estimate it:

• Intrinsic value is the present value of all the future cash flows that a business can generate for its owners, discounted at an appropriate interest rate.

• To estimate future cash flows, start with current owner earnings, not GAAP reported. The formula is:

  • Reported earnings plus

  • Depreciation, depletion, amortization, and other non-cash charges
    less

  • The average annual amount of capitalized expenditures required to fully maintain the business’s long-term competitive position and unit volume plus any additional working capital to maintain its competitive position and unit volume, included in maintenance CAPEX.

• Unlike a bond, where cash flows are explicit, a stock’s future cash flows are not printed on the certificate. They must be estimated by the security analyst, which is us, the investors.

• You must discount these estimated future cash flows back to today using an appropriate discount rate. This discount rate isn’t calculated by using CAPM, WACC, or any academic formula. He uses the long term US bond yield, but does sometimes adjust for uncertainty. The adjustment is usually unnecessary, as he then applies a margin of safety. He will not pay for that estimated intrinsic value, he pays below it.

• The discount rate accounts for the time value of money and risk.

• Focus on what the business produces, not the market price. Intrinsic value is independent of stock market fluctuations or analysts’ opinions.

• Buffett only attempts to calculate intrinsic value for businesses he understands reasonably well. He avoids many early tech or unpredictable businesses because the future cash flows are too uncertain, so it’s very difficult to make an educated guess on intrinsic value. Even if the business is uncertain, with low amounts of capital and a big margin of safety, he would still buy. However, this type of uncertainty only applies to cyclical type businesses that have proven products. Uncertainty isn’t necessarily bad and depresses market price, which created bigger discrepancies between intrinsic value and price. If uncertainty is related to unproven products, very unstable cash flows, or significant risks that don’t protect downside, then he wouldn’t invest as he cant make an educated and conservative guess on the future (even if near term) of the company.

• Buffett considers the cash flows over the entire life of the business, potentially decades or even hundreds of years into the future. This is very difficult to estimate, so you can make a reasonable guess on the next few years of cash flows and then assume no growth in perpetuity, making the terminal value the same as:

  • Owner Earnings / Appropriate Interest Rate (usually a 10-30 year bond yield)

Always remember it’s far better to be approximately right than precisely wrong. So don’t stress about calculating every decimal, if the margin of safety is big enough, it will be clear its undervalued. Always start assuming no future growth. If the company offer a satisfactory margin of safety assuming no growth when its more likely for it to grow, the margin between intrinsic value and current price is much bigger and undervaluation is highly probable.

I hope I helped you to understand what intrinsic value actually is, how to actually calculate it, how to calculate owner earnings, and how you can apply it in your decision making when investing!

This post has been created for educational purposes only. It is not advice or recommendation for investing in securities. Security investing always carries risk.

Puma Biotechnology is a biopharmaceutical company dedicated to the acquisition, development, and commercialization of novel therapeutics for the treatment of cancer. They focus on in-licensing innovative drug candidates that are undergoing or have already completed initial clinical testing for the treatment of various forms of cancer and then seek to further develop these drug candidates for commercial use. Puma was founded in September 2010 as a private company and incorporated in Delaware, and on October 4, 2011, Puma completed a reverse merger with Innovative Acquisitions Corp., a publicly reporting “shell” company with no specific business plan or purpose. As a result of the merger, Puma became a wholly owned subsidiary of Innovative Acquisitions. The merged company changed its name to Puma Biotechnology and adopted Puma’s business plan, and the company began publicly trading on April 20, 2012.

Puma Biotechnology markets Nerlynx in the United States and has several sub-licenses in various regions outside the United States to commercialize Nerlynx in some international markets. In September 2022, Puma Biotechnology in-licensed global development and commercialization rights to alisertib, an aurora kinase A inhibitor, from Japan’s Takeda. Puma Biotechnology plans to develop alisertib for the treatment of various types of cancer indications, including hormone receptor-positive breast cancer as well as small-cell lung cancer (SCLC). Alisertib is currently being developed in separate mid-stage studies, both as monotherapy and in combination with other therapies, for the treatment of lung cancer and breast cancer.

Even though I don’t invest in biotechnology, as most of them are startups and speculative, this may be a rare opportunity, mainly thanks to their clear undervaluation, growing profits, cash rich, and already have proven products.

Latest Earnings Report Overview

• Product revenues from Nerlynx totaled $49.2 million in the second quarter, up around 10.8% year over year.

• Nerlynx’s product sales were within management’s guidance of $48-$50 million.

• Nerlynx sales increased 14.2% sequentially.

• In the reported quarter, Nerlynx demand increased 2% year over year and 4% on a sequential basis.

• Royalty revenues amounted to $3.2 million, increasing around 18.5% on a year-over-year basis.

• Total operating costs (including stock-based compensation expense) in the quarter were $45.8 million, down 7.1% year over year.

• Selling, general and administrative expenses (including stock-based compensation expense) declined 28% year over year to $18 million.

• Research and development expenses (including stock-based compensation expense) totaled $15.5 million, up almost 14% year over year.

Fundamental Analysis

1. This formula of Return on Capital (ROC) is used to determine how efficiently a company uses its essential operating capital to generate profits, generally good for relative comparisons across a large universe. The formula is EBIT / (Net PPE + Net Working Capital). The company’s ROC is 85%, much higher than industry peers and the general market, indicating clear efficient use of their capital to generate profits.

2. Return on Invested Capital (ROIC), the commonly used formula, for detailed analysis and cross industry comparisons, is around 38%, which is very impressive. Much higher than the required cost of capital, regardless of using WACC or treasury bonds. As ROIC is higher than WACC, this means it’s creating economic value for its shareholders.

3. Now, I like to compare Gross Margin to the company’s industry average, so I can determine if based on fundamentals, the company has a competitive advantage based on product pricing:

   • PBYI’s gross margin = ~75%

   • Biotechnology average gross margin = ~70%

   • Gross margin - industry average = ~5%

4. The company’s risk of default is very low, and so is its risk of bankruptcy, despite being a biotechnology stock. One of their sustainable competitive advantage is leverage, having liquid cash and equivalents higher than their total debt, and a Debt-to-equity of 0.5.

5. Now, let’s look at the most important thing of a business: cash. In the following image, we can observe the company’s 5 year free cash flow generation:

   

   As we can see, this year the company has reported positive free cash flow, and has also been positive and growing in the last 2 years, despite being negative in 2022. This gives the company the ability to reinvest, repurchase shares, or pay out dividends, crucial for growth, and possible price appreciation.

6. The average annual compound change in operating income over the past 3 years is about 75%, incredible growth performance. Despite that, the stock has depreciated in price since its highest point this year, specifically -23%. This is probably market irrationality.

Valuations

Now, I usually do something that many investors should, and that is inverting. Instead of figuring out what the company will grow at, making it very sensitive to speculation, I try to figure out what the market believes the company will growth at, and then compare it to a reasonable, conservative growth assumption. If the market believes the company will grow at a much lower rate than I assume it might be, then it’s most probably undervalued.

On average, the company’s free cash flows to the firm have been growing on average at a 97.68% rate yearly. After my inverse discounted cash flow analysis, I have concluded the market believes the company’s FCFF to decline at a -25% yearly for the next 5 years. This, in my opinion is irracional, as I assumed at least a 10% growth, indicating clear undervaluation.

Now, let’s talk about relative valuations. Many people use the p/e ratio or EV/EBITDA, but I take a different approach. I take the company’s EBIT (which is not distorted by depreciation and amortization) and divide it by the Enterprise Value. This is essentially an Earnings Yield, and gives a clearer picture on what the company earns per dollar invested in the entire business. PBYI’s p/e ratio is 4.52, and its EBIT/EV is 29.50%. A very high Earnings Yield, indicating to us the company is currently cheap. To put into perspective, the SP500 average is close to 5%, and the 90th percentile is around 9%, while PBYI has a 29.50% Earnings Yield. The company also has a 21% FCF Yield.

Conclusion: Potencial appreciation?

The company is prioritizing growth and customer quality, while having very high gross margins and very high returns on their invested capital. Despite that, the stock still has no meaningful analyst coverage. This makes the opportunity even more attractive. If the stock can deliver such performance without attention, additional coverage could drive even greater investor interest and further price appreciation.

After this equity research, lets try deducing the following: is it a good investment or not?

I believe so. There are some risks, but the potential reward outweighs them.

- Brief qualitative summary:

• Reasons to buy:

  • Acquisition of Alisertib: In September 2022, Puma Biotechnology inlicensed global development and commercialization rights for alisertib, an aurora kinase A inhibitor, from Japan’s Takeda. The company is developing alisertib for hormone receptorpositive breast cancer as well as small-cell lung cancer (SCLC). Puma Biotechnology believes that alisertib has huge potential in HR-positive, HER2-negative breast cancer, triple-negative breast cancer, head and neck cancer and SCLC. If successfully developed for the aforementioned indications, alisertib has the potential to boost the company’s position in the anticancer drug market and should help lower its heavy dependence on Nerlynx for revenue.

  • Improving Nerlynx Sales: Nerlynx generated sales worth $195.2 million in 2024. Nerlynx sales improved during the second half of 2024 compared to the first half. Sales of the drug rose 9% on a year-over-year basis to $92.3 million in the first six months of 2025. The company expects continued demand driven growth in Nerlynx sales during the second half of 2025. Improved sales of Nerlynx have resulted in the stock outperforming the industry so far this year. The stock has surged 65.3% compared with the industry’s rise of 2.7%, but has declined since its highest point this year, which gives us a better buying opportunity with higher potential upside.

  • Huge Potential in HER2+ Breast Cancer Market: Breast cancer is the most common malignancy and is the leading cause of cancer-related death in women across the world. More than 2 million new cases of breast cancer are reported every year, with more than 500,000 deaths per year globally. Puma Biotechnology is a strong competitor in this industry.

  • Favorable Debt Profile: The company currently has a long-term debt of $11 million and short-term debt of $34 million on its balance sheet. Cash and cash equivalents totaled approximately $98 million as of June 31, 2025, which is sufficient to pay its short-term debt of.

• Potencial Risks:

  • Overdependence on Nerlynx: Puma Biotechnology has no approved product other than Nerlynx. As a result, the company remains heavily dependent on Nerlynx for revenues and overall growth. In some previous quarters, Nerlynx’s sales have suffered due to lower overall demand. A similar instance in the future could hurt revenues.

  • Pipeline Setbacks: With an increasingly stringent regulatory environment, gaining approval for pipeline candidates has become extremely difficult. Due to the lack of a robust pipeline, the company remains heavily dependent on Nerlynx for growth. We also note that clinical development involves a high degree of risk. In March 2023, Puma Biotechnology announced that it is discontinuing the SUMMIT phase II basket study on Nerlynx for treating solid tumors in patients with activating EGFR, HER2 or HER4 mutated cancers.

  • Stiff Competition in HER2+ Breast Cancer Market: The HER2-positive breast cancer market holds significant commercial promise, but Nerlynx faces strong competitive pressure. Existing therapies such as Roche’s Herceptin and Novartis’ Tykerb are already available, while some major players are also advancing treatments for SCLC. This creates substantial challenges for the company, as alisertib, even if successfully developed, would likely encounter intense competition in its market.

I hope you found this useful! If so, please consider subscribing for future posts! Please consider sharing your thoughts in the comments, I’ll try read them all.

REMINDER: This is NOT financial advice. My assumptions can be wrong, and price may depreciate. Investing always carries risks. This post is only informative.

I bought SIGA on June 23, 2025, but even after its 44% growth since that position, it still has room to grow. And, it could be a potential candidate for anyone thats reading to consider in their investments.

Fundamental analysis

1. Returns and profitability comparisons:

• Return on Capital (ROC), used to determine how efficiently a company uses its capital to generate profits, good for relative comparisons across a large universe:

  • EBIT TTM = 101.05M$

  • Net PPE = 1.05M$

  • Working Capital: 206.49M$

  • Final ROC = 48.69%

• Return on Invested Capital (ROIC), the commonly used formula, for detailed analysis and cross industry comparisons:

  • EBIT TTM = 101.05M$

  • Effective Tax Rate = 23%

  • Shareholders' Equity = 209.31M$

  • Total Debt = 1.07M$

  • Final ROIC = 36.84%

• Weighted Average Cost of Capital (WACC) is around 9% based on multiple analysts, but I estimated WACC to be around 12%. Regardless, ROIC is more than double the WACC, so it really isn’t important to estimate an exact number. As ROIC is higher than WACC, this means its creating economic value for its shareholders.

• Gross Margin vs industry, to determine if based on fundamentals, the company has a moat:

  • SIGA’s gross margin = 77%

  • Drug manufacturers average gross margin = 53%

  • Gross margin - industry average = 26%

2. Balance sheet safety and earnings growth:

• Debt/equity = 0.0, as Shareholders' Equity = 209.31M$ and Total Debt = 1.07M$. The company’s risk of default is very low, and so is its risk of bankruptcy.

• In the following image, we can observe the company’s 5 year free cash flow generation:

  

  Having positive free cash flow lets the company have the ability to reinvest, repurchase shares, or pay out dividends.

• The average annual compound change in operating income over the past 3 years is only 3%, but in the past 5 years it’s around 40% CAGR. This is due to a significant increase in sales and contracts in the earlier part of the 5 year period, but slower growth and profitability pressures in the past three years due to market dynamics and cost factors.

Valuations

• I’ve made a profound growth analysis on SIGA, and found that SIGA’s strategy is focused on delivering long-term shareholder value. To achieve this, the company has concentrated its efforts in four areas to drive growth. These priorities include continuing their partnership with the U.S. government, advancing regulatory approvals for TPOXX in new indications and formulations, cultivating strategic partnerships to expand global access to TPOXX, and leveraging their capabilities to move into complementary therapeutic areas. This suggests management is committed in growing the business, and assuming historical growth and future conservative assumptions, we can expect an ~15% growth YoY. This is clearly an assumption, and it may be far from the actual future growth. Even if it’s 10%, he have a great margin.

  

  After getting the current FCFF, and making a conservative growth approximation based on historical growth and future growth, we can assume future FCFF. Then, we discount those FCFF with our discount rate, which I calculated it to be 12.47%. Although analysts approximate this number to be lower, I always prefer using a margin of safety on top of my margin of safety! I also prefer to use the perpetuity growth model at 2% after 5 years instead of exit multiple, as when I calculate the intrinsic value, no component of market speculation should be included.

I estimate an intrinsic value of ~13$. I had been covering and keeping track of the company since the 23rd of June, 2025, but didn’t create my substack account until now. Still, the company is clearly undervalued.

• Now, I usually do something that many investors should, and that is inverting. Instead of figuring out if a stock is undervalued solely based on future growth predictions, I figure out what the market believes it will growth, and then compare it to my conservative predictions. And how can you do it? Well, when you finish your DCF analysis, copy it, and change the 5-10 year growth assumption until the intrinsic value matches the current stock price. In the case of SIGA, the market is projecting a irrational growth of 0.75%. This gives us a better picture of how the market itself is valuing the stock, and I don’t believe it will grow at a miserable 0.75%.

• Now, let’s talk about relative valuations. Many people use the p/e ratio or EV/EBITDA, but I take a different approach. I take the company’s EBIT (which is not distorted by depreciation and amortization) and divide it by the Enterprise Value (formula is EBIT/EV). This is essentially an Earnings Yield, and gives a clearer picture on what the company earns per dollar invested in the entire business. SIGA’s p/e ratio is 7.81, and its EBIT/EV is 22.10%. A very high Earnings Yield, indicating a clear undervaluation. To put into perspective, the SP500 average is close to 5%, and the 90th percentile is around 9%, while SIGA has a 22.10%.

Undervalued, and lacking analysts?

Undervalued and undercovered. Yes, you heard right. Despite rising 42% since the start of the year, the stock still has no meaningful analyst coverage. This makes the opportunity even more attractive. If the stock can deliver such performance without attention, additional coverage could drive even greater investor interest and further price appreciation.

This could happen very soon, as opportunities like this usually don’t go unnoticed much time, even after the price appreciation of this year, so it’s a bigger opportunity than it may seem.

This is my first substack post, so if you found it interesting, please consider sharing your thoughts in the comments, I’ll try read them all. Always remember that this is not financial advice, and investing always caries risk.