Berkshire's reported profit rose to $41.9 million in 1980. Buffett's first move is to tell you that figure leaves out more than it includes. The biggest part of what the company truly earned for its owners never reached the page.

Because Berkshire's insurers hold so many small slices of other businesses, much of its real earning power sits in that ignored corner. In 1980 the profits those part-owned companies retained (the part not paid out to Berkshire as dividends) came to more than Berkshire's entire reported operating earnings. Conventional accounting, Buffett writes, let less than half of the earnings "iceberg" show above the surface. He does not think this is a quirk of one year; given how Berkshire is built, he expects it to keep happening.

His point is that ownership is ownership, whether it is 100% or 1%. A dollar of profit kept and wisely reinvested by a company Berkshire part-owns builds value just as surely as a dollar Berkshire keeps itself, even though no rule lets it appear in the accounts. As he puts it, it is the act that counts, not the actors. The clearest case is GEICO: Berkshire's share of its earning power runs about $20 million a year, yet only a little over $3 million arrives as dividends. The other roughly $17 million is kept and working, invisibly, on the owners' behalf.

Buffett returns to the worry that dominated last year's letter, the shrinking dollar, and gives it the homeliest possible measuring stick. Forget percentages for a moment, he says. Count in hamburgers.

His hamburger test runs like this. You skip ten hamburgers today to make an investment. Later it pays you dividends that, after tax, buy two hamburgers, and when you sell, the after-tax proceeds buy eight more. Two plus eight is ten: you can buy back exactly what you gave up. No matter how many extra dollars you are holding, you have earned no real income at all. Or, in the line that has outlived the letter, you may feel richer, but you won't eat richer.

The arithmetic behind the joke is grim. With inflation at 12%, a company earning a fine-looking 20% on equity that pays it all out to an owner in the 50% tax bracket actually shrinks that owner's real wealth: tax takes half the gain, inflation eats the rest, and the owner ends the year with 98% of the buying power they started with, having spent nothing. Worse, the inflation tax does not care whether you owe income tax. If inflation hit 16%, Buffett notes, the owners of the 60%-plus of American companies earning less than that would lose ground in real terms even if every tax on dividends and gains were abolished. He calls the predicament an investor running up a down escalator that keeps speeding up. Berkshire, he admits plainly, has no escape to offer.

Last year Buffett warned that turnarounds seldom turn. In 1980 he sharpens the rule with an exception that proves it. GEICO, Berkshire's largest stockholding, had come back from the brink, and he is careful to explain why that does not make it a turnaround at all.

GEICO had been built to be the low-cost seller in the huge auto-insurance market, an advantage rivals with old-fashioned sales forces could not easily match. By the mid-1970s it was reeling at the edge of bankruptcy, and Jack Byrne, arriving in 1976, supplied the managerial brilliance to save it. But the prized franchise had never gone away; it was only submerged in a sea of financial and operating troubles. Buffett likens it to American Express after the 1964 salad-oil scandal: an extraordinary business with what he calls a localized, removable cancer, needing a skilled surgeon, not a fundamental rebuild. A real turnaround, by contrast, asks managers to pull off a corporate Pygmalion, and those, he has learned, rarely come off.

The economics show why he is so pleased. Berkshire's GEICO stake cost about $47 million and was worth $105 million at year-end. More to the point, its share of GEICO's earning power is roughly $20 million a year. To buy that much earning power outright, in a business this good, he reckons would cost at least $200 million through a negotiated purchase of a whole company. He paid a quarter of that for a slice of a business that, in his words, simply can't be replicated.

Tucked into the letter is what Buffett calls a short commercial, and it is one of his earliest. When a fine company's shares trade for far less than the business is worth, he says, the surest profitable use of its cash is to buy them back.

The logic is simple, he writes: buying part of a wonderful business at a bargain is a more certain use of capital than almost anything else. And he points to the auction nature of the stock market, where a finely run company can often repurchase pieces of itself for under half of what the same earning power would cost by negotiating to buy a whole other company. GEICO is again the example. In just two years its buybacks shrank the share equivalents outstanding from 34.2 million to 21.6 million, a third of the company retired, lifting every remaining owner's stake in a business that, he repeats, can't be replicated. The owners, he says, could not have been better served.

Behind the look-through earnings of Lesson 1 sits an actual list. By the end of 1980 Berkshire's net interest in common stocks had cost about $325 million and was worth around $530 million. These are the part-owned businesses whose kept-back profits make up the hidden half of the iceberg.

The list had grown well beyond insurance and media into aluminum, retailing, tobacco, security guards and more. Buffett notes that his insurers owned about 3% of Kaiser Aluminum and 1¼% of Alcoa, giving Berkshire, by his reckoning, a larger economic stake in the aluminum business than in most of the companies it actually controlled. Here is the portfolio, paid against worth.

The longest stretch of the 1980 letter is a warning about Berkshire's own industry. An accounting convention, Buffett argues, was letting insurers hide enormous bond losses, and that hidden hole was about to warp the way the whole business priced its policies.

The danger, Buffett explains, is one of scale. Many insurers held long-term bonds worth two to three times their net worth. If bonds had fallen by a third and that loss were ever put on the books, a company carrying three times its net worth in them would be wiped out. Some of the largest names already had nominal or even negative net worth once their bonds were valued honestly. So they froze: selling a bond would force the loss into the open, so they would not sell. And to keep the premium cash flowing (the very pool that funds those bonds) they kept writing policies at any price. Buffett gives it a name, "asset maintenance" underwriting: accepting terrible business just to hold on to the assets you already have. The industry's combined ratio, he reports, rose from 100.6 in 1979 to an estimated 103.5 in 1980, and he expects it to climb further in 1981 and 1982.

The cruel part is that one desperate insurer infects the rest. If a big group keeps selling at any price to defer its troubles, every competitor has to come close to matching it. The next-worst thing to having financial problems yourself, Buffett notes, is having a crowd of rivals who do. Berkshire's own position he calls satisfactory: valuing bonds honestly, he believes its net worth is the strongest relative to premiums of any large stock insurer. Phil Liesche's National Indemnity again posted its best-ever margins, on flat volume, and is expected to write even less in 1981. Yet he refuses to crow, confessing that he too lost real money in bonds because, as he puts it, your Chairman was talking when he should have been acting.

The letter closes on how Buffett handles money itself: when to borrow, what to buy, and why he keeps Berkshire armed with cash it has no immediate use for. It is the same conservatism, stated as plainly as ever.

In August, Berkshire sold $60 million of 12¾% notes due in 2005, not because it needed the money, but because it expected chances to use it well long before the loan came due, perhaps when credit was expensive or simply unavailable. Better to hold the firepower and wait. His acquisition rule follows the same instinct: he wants businesses that generate cash, not ones that consume it. As inflation bites, he warns, more companies must spend everything they earn just to stand still, a mirage-like quality where pretty earnings never become spendable cash. Berkshire would keep ample liquidity and modest, well-structured debt even at some cost to its return on equity, because it is the only way he is willing to operate.

And then a quieter farewell. On the last day of 1980 Berkshire completed the separation of the Illinois National Bank in Rockford, which banking rules forced it to let go, by letting shareholders exchange Berkshire stock for shares in the bank's holding company. Months earlier, on July 2, the bank's founder, Gene Abegg, had died at 82. Buffett devotes his closing paragraphs not to numbers but to the man, who ran the bank for nearly fifty years, kept enough cash on hand during the 1933 bank holiday to pay every depositor in full, and "never forgot he was handling other people's money." It is the kind of tribute that tells you what Buffett looks for in the people he backs.