In his 1986 letter to Berkshire Hathaway shareholders, Warren Buffett reports a 26.1% gain in net worth and then does something unusual: he grades himself below his own managers. They ran their businesses superbly, he writes, while he failed to deploy the capital they generated — finding no stocks worth buying and spending the year paying down debt and stockpiling cash. It is the letter where the famous line first appears: be fearful when others are greedy, and greedy only when others are fearful. Buffett describes the euphoria in a market where the rewards to owners have become “gloriously uncoupled” from the performance of the businesses themselves, introduces the moat-around-the-castle idea through GEICO’s rock-bottom cost structure, and explains his ‘til-death-do-us-part commitment to Capital Cities, GEICO and the Washington Post. He tells how a shareholder’s letter brought him the Fechheimer Brothers Company, a business he bought without ever visiting it; marvels at 93-year-old Mrs. B still outselling everyone at Nebraska Furniture Mart; dissects who really pays corporate taxes after the Tax Reform Act of 1986; and confesses to a third straight year of loss-reserve error, noting that if Pinocchio’s rules applied to him, his nose would now draw crowds. The letter closes with the appendix that gave investing one of its most important concepts — “owner earnings” — and a withering attack on the Wall Street cash flow figures that add back depreciation while ignoring the capital spending a business actually needs to survive. Essential listening on value investing, accounting, capital allocation and Berkshire Hathaway history.
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