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🎵Wisdom Density:
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1965 Letter to Limited Partners

1965 was a watershed year for the partnership, featuring both the widest performance margin over the Dow in its history and the acquisition of control of Berkshire Hathaway Inc..

📊 Performance Summary

  • Dow-Jones Industrials: +14.2% (including dividends).
  • Buffett Partnerships: +47.2%.
  • Key Insight: Buffett calls this "Our War on Poverty" and notes that the results were $12.3 million "less poor" at yearend. He warns partners that this 33-point margin is "Halley's Comet" territory and unlikely to be repeated.

🏛️ Milestone: Control of Berkshire Hathaway

In the spring of 1965, the partnership acquired majority control of Berkshire Hathaway Inc., a textile manufacturer.

  • Purchase Price: Started at $7.60/share in 1962; average cost ~$14.86.
  • Valuation Strategy: Buffett values the controlling interest for the partnership audit at a price halfway between net current asset value and book value (effectively 100% of working capital and 50% of fixed assets).
  • Outlook: Buffett cautions that Berkshire is "oatmeal" (comfortable and solid) rather than a "cream puff" (high-glamour growth stock like Xerox).

🎯 New Ground Rule: Concentration

Buffett added Ground Rule 7, explicitly defending his policy of concentration:

  • The 40% Rule: BPL may invest up to 40% of net worth in a single security if the probability of being correct is extremely high and the risk of permanent change in value is low.
  • The "Noah School": Buffett mocks the standard institutional approach of "two of everything" (overdiversification), arguing that adding the 100th stock to a portfolio is illogical.

🏢 Berkshire Hathaway Corporate Operations (1965)

  • Earnings: Fiscal year ended October 2, 1965, resulted in net earnings of $2,279,206 compared to $125,586 in the prior year (pre-tax charge equivalent added for carryovers to prevent misleading interpretations).
  • Balance Sheet & Capital Allocation: Paid off $2,500,000 in bank loans and decreased inventories by $1,411,967.
  • Share Repurchases: Purchased 120,231 of its own shares, leaving 1,017,547 shares outstanding at fiscal year-end.
  • Modernization & Liquidation: Invested $811,812 in new machinery. Closed and sold the unprofitable King Philip Plant E (Fall River, MA).
  • Management Changes: Seabury Stanton resigned as President; Mr. Kenneth V. Chace was elected to succeed him. Harold V. Banks succeeded John K. Stanton as Treasurer.

🏢 Key Entities & Holdings

  • Berkshire Hathaway Inc.: Moved into the "Control" category.
  • Ken Chace: President of Berkshire Hathaway, praised for his management.
  • Seabury Stanton: Resigned as President and Director.

💰 1965 Shareholder Letter: The Transition to Control and Concentration

"This margin is Halley's Comet territory... we do not expect to see it again." — Warren Buffett, 1965 Partnership Letter

🎭 The Narrative Context

The year 1965 marks a historic crossroads. For the partnership, BPL achieved its highest ever outperformance margin over the Dow (+33%), but the defining event was taking control of Berkshire Hathaway Inc. Initially purchased as a cheap "cigar butt" textile manufacturer, the business was structurally challenged. Buffett forced out the old management (Seabury Stanton) and installed Ken Chace, immediately pivoting the company's capital allocation. Instead of pouring more capital into unprofitable mills, Buffett rationalized operations, liquidated idle textile machinery, paid off bank debt, and repurchased shares. This was the first raw laboratory of Buffett's transition from passive stock-picking to controlling owner-operator.

💡 Philosophical Gems

The Philosophy: The 40% Concentration Rule

Buffett codified his policy of extreme concentration in Ground Rule 7, rejecting the institutional consensus of broad diversification.

  • The Logic: If the probability of an investment being correct is extremely high and the risk of permanent loss is low, it is rational to invest up to 40% of net worth in a single security. Diversification beyond a few high-conviction ideas dilutes returns and increases risk by forcing capital into lower-quality positions.
  • The Critique: Buffett targets the "Noah School" of investing—carrying two of everything. He argues that adding the 100th stock to a portfolio is a choice to prioritize conventional conformity over rational performance.
  • The Quote: "If you can identify six windows, and they are all bargains, you will do much better than if you are forced to buy 100 windows."

The Strategy: The Valuation of Control (The Oatmeal vs. Cream Puff)

Buffett details how BPL values its controlling interest in Berkshire Hathaway, creating a hybrid valuation standard.

  • The Mechanism: Rather than valuing the holding at market price or book value, he values the control block at a price halfway between net current asset value (working capital) and book value. This reflects both the liquid capital of the business and the depressed value of the fixed assets.
  • The Lesson: Berkshire is described as "oatmeal"—solid, unexciting, and asset-heavy—unlike high-growth "cream puffs" like Xerox. However, the cheapness of the asset and the ability to control its capital allocation make it a valuable vehicle.
  • The Quote: "Berkshire is a delight to own... even if it is oatmeal rather than a cream puff."

The Discipline: Rationalizing Challenged Assets

At the corporate level, Buffett immediately demonstrates how an owner-operator handles a low-return business.

  • The Mechanism: Rather than trying to grow the unprofitable divisions, Buffett reduces overhead, pays off bank debt, shuts down the unprofitable King Philip E division, and uses excess capital to buy back Berkshire's own shares.
  • The Insight: Share repurchases are a highly efficient use of capital when a company's shares are cheap and its operations are being scaled down to fit its market.
  • The Quote: "This decrease in outstanding shares has been appropriate, considering the reduction in scale of the Company's operations due to closing of unprofitable mills."

🗣️ Verbatim Masterclass

  • "We do not suggest that partners run a fever over this margin... it is in the Halley's Comet category."
  • "If we can find a few situations where we are right, that is all we need."
  • "The Noah School of investing... two of everything... results in a portfolio that looks like a zoo."
  • "We are oatmeal people, and we are happy with that."

[!TIP] 1965 teaches that when you transition to controlling owner-operator, your investment framework must pivot from passive stock valuation to active capital allocation. Rationalizing low-return operations, paying off debt, and buying back cheap stock can yield excellent results even in a challenged commodity business like textiles.

📚 Read Original Full Text

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📜 View Official Berkshire Hathaway Shareholder LettersRead on Berkshire ↗