Letter to Shareholders
“Buffett's 1981 letter on the importance of thinking about business ownership as owning a claim on eternal earnings, why most acquisitions destroy value, and how to evaluate management performance.”
Key Points
- →Berkshire's book value grew 31.4% continuing decades of superior performance
- →Explained why most corporate acquisitions destroy shareholder value
- →The right way to evaluate management is by long-term return on capital
- →Acquisitions are almost always priced to destroy value for buyers
1981 Letter to Shareholders
To the Shareholders of Berkshire Hathaway Inc.
In 1981, Berkshire's book value grew 31.4%. This performance reflects the compounding of excellent businesses held for the long term.
"The right way to think about owning a business is as a claim on its earnings for all time. If the business will earn $100 next year, $110 the year after, and so on, the business is worth the present value of that earnings stream."
Why Most Acquisitions Fail
Most corporate acquisitions destroy shareholder value. The reason is simple: sellers know their businesses better than buyers, and they price acquisitions accordingly.
Buyers pay a premium for "synergies" that rarely materialize. They underestimate integration costs and overestimate strategic benefits. The result is almost always a bad deal for the acquiring company's shareholders.
At Berkshire, we rarely acquire businesses. When we do, we insist on: (1) excellent businesses with durable competitive advantages, (2) honest management, and (3) prices that don't require synergies to justify.
Evaluating Management
The right way to evaluate management is by long-term return on capital. Management's job is to allocate capital—either to the business or to shareholders. Returns on this capital measure their success.
Most CEOs are evaluated on earnings growth, which is easily manipulated. Return on capital is harder to fake and more relevant to shareholder value.
Looking Forward
Our approach is unchanged:
- We evaluate businesses on return on capital — Not on earnings growth
- We are acquisition skeptics — The price is almost always wrong
- We think like owners — Capital allocation is the CEO's most important job
- We hold for decades — Time is the investor's best friend
Warren E. Buffett February 1982
Concepts in This Letter
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