1989 Letter to Shareholders

The 1989 Letter is a landmark document celebrating the 25th Anniversary of Buffett and Munger’s management of Berkshire Hathaway. Financially, it was an extraordinary year with per-share book value growing by 44.4%. Philosophically, the letter is famous for the "Mistakes of the First Twenty-five Years" essay, the formalization of Look-Through Earnings, and a blistering attack on Wall Street's debt chicanery (particularly Zero-Coupon Bonds and EBDIT).

Historical Stats

Net Worth Gain: $1.515 billion (44.4%)
Compounded Annual Growth Rate (25 years): 23.8% (per-share book value grew from $19.46 to $4,296.01)
Reported Operating Earnings: $393.4 million (pre-tax) / $299.9 million (after-tax)
Look-Through Operating Earnings: Approximately $500 million (including $212 million in retained earnings from major investees)
New Convertible Preferred Investments: $1.258 billion total:
- Gillette: $600 million (8.75% coupon)
- USAir: $358 million (9.25% coupon)
- Champion International: $300 million (9.25% coupon)
Zero-Coupon Convertible Debentures Issued: $902.6 million principal amount (yielded $400 million at 44.31% of maturity value)
Insurance Group Statutory Net Worth: $6 billion (second highest in the United States)
New Corporate Jet ("The Indefensible"): Purchased for $6.7 million (replacing the $850,000 jet bought in 1986)

🏢 Corporate Performance & Operations

Borsheim's: First year under Berkshire. Sales rose significantly. Ike Friedman's high-volume, low-expense model holds costs to one-third of competitor levels. Traffic peaked at 4,000 customers a day. Completed the year with the family management team: Alan, Marvin Cohn, and Don Yale.
See's Candies: Under Chuck Huggins, volume rose 8%, driven by a major newspaper advertising campaign ($5 million total ad budget, agency Hal Riney & Partners).
Nebraska Furniture Mart: Achieved record sales and earnings, but Mrs. B (Rose Blumkin) resigned in May at age 96 due to a carpet department dispute with family management (Louie, Ron, and Irv Blumkin). She immediately opened a rival carpet business next door. Under Louie, NFM's carpet market share in Omaha rose to 75.3%.
The Buffalo News: Publisher Stan Lipsey achieved the paper's 7th consecutive profit record. Under editor Murray Light, household penetration remained #1 among metropolitan papers, and the news hole stood at 50.1%.
Fechheimer Bros. Co.: Profits declined slightly due to integration friction from a 1988 acquisition, though ROIC remained excellent under the Heldman family (Bob, George, Gary, Roger, Fred).
Scott Fetzer Co.: Under Ralph Schey, World Book began decentralizing into four locations, while Kirby experienced massive export growth (export volume quintupled in four years, rising from 5% to 20% of sales).
Insurance Group: Under Mike Goldberg and Ajit Jain, underwriting losses were held to $24.4 million pre-tax. Following the California earthquake, Berkshire offered up to $250 million in catastrophe reinsurance (CAT covers) in just ten days, positioning it as a leading global risk-bearer.
Jim Maguire (Henderson Brothers): Spreads on Berkshire's shares on the NYSE were held below 50 points (less than 1%), significantly reducing transaction costs for shareholders.

Core Themes & Insights

🔍 Look-Through Earnings & Portfolio Value

Buffett formalizes the concept of Look-Through Earnings as the correct tool to evaluate Berkshire’s true economic power.

The Concept: Traditional accounting (GAAP) only allows Berkshire to report dividends received. Under look-through accounting, Berkshire adds its share of the retained operating earnings of major investees (like Coca-Cola, GEICO, and Capital Cities/ABC) to its own operating earnings.
The Rationale: If an investee has high-quality managers who can compound capital at rates higher than Berkshire can on its own, those retained earnings are worth more to shareholders than if they were paid out as dividends.

💸 Deferred Tax Liability: The Interest-Free Loan

Buffett provides an educational review of how Berkshire’s deferred tax liability on unrealized stock gains operates.

The Math: He compares Scenario A (selling and doubling money annually, paying tax each year) to Scenario B (a single "Rip Van Winkle" investment that doubles 20 times over 20 years). Scenario B results in $692,000 after-tax, while Scenario A results in only $25,250, despite identical pre-tax compound rates.
The Concept: The deferred tax liability functions as a non-recallable, interest-free loan from the U.S. Treasury that continues to finance the underlying appreciating assets.

🏛️ The Retrospective: Mistakes of the First 25 Years

Buffett writes a candid, humorous self-assessment of his corporate errors:

Buying Berkshire (The Cigar Butt): Purchasing a declining textile business because the price was cheap. He defines the Cigar Butt style as finding a discarded butt with only one puff left—all profit, but a terrible long-term strategy unless you are a liquidator.
Hochschild Kohn: Buying a Baltimore department store at a discount, only to work for three years to sell it for break-even.
Broken-Down Nags: Buffett famously states: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."
Avoid, Don't Solve: Success comes from identifying "one-foot hurdles" to step over, rather than trying to clear "seven-footers."
The Institutional Imperative: The tendency of corporate managers to resist change, materialise projects to soak up funds, rubber-stamp leader desires with studies, and mindlessly imitate peer behavior.
Errors of Omission (Thumb-Sucking): Buffett admits that his costliest mistakes are the investments he understood but failed to make.

⚠️ The Debt Explosion & Zero-Coupon Critique

Berkshire deployed $1.258 billion into three major convertible preferred issues (Gillette, USAir, Champion International) while issuing its own zero-coupon convertible debt.

The Debt Critique: Buffett delivers a blistering attack on Wall Street’s junk-bond LBO craze. He mocks the use of EBDIT (Earnings Before Depreciation, Interest, and Taxes) as a sawed-off yardstick that ignores depreciation—which is a real, unavoidable expense.
Alchemy of Zeros: He critiques zero-coupon issuers who use the instrument to delay default by promising to pay nothing for years, comparing it to John Kenneth Galbraith's "The Bezzle" where psychic national wealth is temporarily created on paper.

💰 1989 Shareholder Letter: The Silver Anniversary and the Alchemy of Finance

"It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price." — Warren Buffett

🎭 The Narrative Context

The 1989 letter marks the 25th anniversary of Warren Buffett and Charlie Munger taking control of Berkshire Hathaway. Over those 25 years, per-share book value grew from $19.46 to $4,296.01, a per-annum compounding rate of 23.8%. To mark this milestone, Buffett writes a detailed retrospective on his management errors, contrasting his youthful "cigar butt" value style with the high-quality business model championed by Charlie Munger. At the same time, the broader corporate market is engulfed in the final, feverish collapse of the 1980s junk-bond and LBO boom. Buffett details the mechanics of Wall Street's debt schemes, demonstrating how Berkshire's own zero-coupon issuance differs fundamentally from the toxic junk bonds sold to retail and institutional investors.

💡 Philosophical Gems

The Philosophy: Cigar Butts vs. Wonderful Businesses

Buffett explains his transition from Ben Graham’s strict asset-bargain style to a focus on business quality.

The Logic: A cheap company with bad economics is a "cigar butt" that offers one free puff. But if you hold the business for a long period, the low return on capital will erode the initial bargain. Wonderful businesses, conversely, benefit from the passage of time as their high returns compound.
The Lesson: The quality of the business economics is the horse; management is the jockey. A brilliant jockey cannot make a broken-down nag win a race.
The Quote: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

The Strategy: The Institutional Imperative

Buffett formalizes the concept of the "Institutional Imperative"—the hidden force that drives rational managers to make irrational corporate moves.

The Thesis: Rationality frequently wilts under peer group pressure and bureaucratic dynamics. The imperative manifests in four ways: resistance to direction changes, work expanding to soak up cash, sycophantic studies supporting a leader's desires, and mindless imitation of peers.
The Remedy: Berkshire's decentralized structure, where managers are given total autonomy and capital allocation is centralized in Omaha, is specifically designed to eliminate the institutional imperative.
The Quote: "Rationality frequently wilts when the institutional imperative comes into play."

The Discipline: The Illusions of EBDIT (EBITDA)

Buffett delivers a devastating critique of Wall Street's attempt to ignore depreciation and interest expenses in evaluating business debt capacity.

The Thesis: Ignoring depreciation on the grounds that it is a "non-cash" expense is delusional. In almost every business, capital expenditures roughly equal to depreciation are required simply to maintain competitive position.
The Critique: Wall Street created "EBDIT" to justify prices that were otherwise mathematically impossible. Promoters used zero-coupon debt to compound interest liabilities, deferring default while extracting upfront fees.
The Quote: "Whenever an investment banker starts talking about EBDIT—or whenever someone creates a capital structure that does not allow all interest, both payable and accrued, to be comfortably met out of current cash flow net of ample capital expenditures—zip up your wallet."

The Culture: Look-Through Earnings as the True Measure

Buffett argues that standard GAAP rules distort the economic reality of Berkshire by only showing dividends received rather than the earnings retained by portfolio companies.

The Concept: Under "Look-Through" accounting, Berkshire adds its share of the operating earnings retained by investees to its own reported results.
The Rule: Because these investees are run by high-grade managers who allocate capital exceptionally well, these retained earnings are often more valuable to Berkshire than if they were distributed as taxable dividends.
The Quote: "A bird in the bush may be worth two in the hand... earnings retained by these investees will be deployed by talented, owner-oriented managers who sometimes have better uses for these funds in their own businesses than we would have in ours."

🗣️ Verbatim Masterclass

"Time is the friend of the wonderful business, the enemy of the mediocre."
"A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns."
"Easy does it... we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers."
"Help me, Oh Lord, to become chaste—but not yet." (Quoting St. Augustine on his attitude toward the corporate jet)
"Lately, those who have traveled the high road in Wall Street have not encountered heavy traffic."

🔗 Evolutionary Links

Entities: The Gillette Co., USAir Group, Inc., Champion International Corp., Borsheim's, Nebraska Furniture Mart, See's Candies, The Buffalo News, Wesco, Salomon Brothers, Aberration (Corporate Jet)
Concepts: Cigar Butt, Holding Period, Economic Goodwill, Look-Through Earnings, Institutional Imperative, Deferred Tax Liability, Capital Allocation vs Management, EBDIT (EBITDA), Zero-Coupon Bonds, Bartender Morality, Errors of Omission

[!WARNING] Investor Takeaway: Be wary of financial alchemists who promise to turn base metals into gold via capital structure. Rationality and patience are your greatest assets. Do not use leverage to accelerate returns if there is even a 1% chance it could lead to ruin. Look for businesses with one-foot hurdles, led by managers who fight the institutional imperative.

Preceded by: 1988 Letter
Followed by: 1990 Letter
Index: index