1979
Click here to read the letter.🧠 Key Takeaways
Don’t focus on earnings per share. Instead, look at return on capital employed.
Companies with serious fundamental issues rarely manage to turn things around. Sure, the struggling company's stock might seem like a steal because it's cheap, but there's a reason for that low price. On the other hand, a higher-quality company might not be as cheap, but there’s less uncertainty in its ability to generate returns over time.
If a company's management team constantly talks about short-term profits or worries mainly about pleasing Wall Street's obsession with immediate share price gains, they'll likely attract shareholders who prioritize short-term gains too, and are more likely to trade in and out of the stock. In other words, they’ll be more likely to attract traders, speculators, and gamblers instead of actual investors.
✍️ Memorable Quotes
“The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share. In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per share, and upon yearly changes in that figure.”
Your focus (as well as the management team’s) shouldn't just be on whether the earnings per share goes up consistently every year. Instead, a better way to judge the performance of a company’s management team is by looking at how much profit they're making compared to the money they've invested. This is the return on capital employed, and this metric is more impervious to tricky accounting methods, and gives a clearer understanding of how well the company is really doing.
“Both our operating and investment experience cause us to
conclude that “turnarounds” seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price.”
Companies with serious fundamental issues rarely manage to turn things around. Sure, the struggling company's stock might seem like a steal because it's cheap, but there's a reason for that low price. It's facing serious problems, and there's no guarantee those problems will get fixed. On the other hand, a higher-quality company might not be as cheap, but there’s less uncertainty in its ability to generate returns over time.
“In large part, companies obtain the shareholder constituency that they seek and deserve. If they focus their thinking and communications on short-term results or short-term stock market consequences they will, in large part, attract shareholders who focus on the same factors.”
If a company's management team constantly talks about short-term profits or worries mainly about pleasing Wall Street's obsession with immediate share price gains, they'll likely attract shareholders who prioritize short-term gains too, and are more likely to trade in and out of the stock. In other words, they’ll be more likely to attract traders, speculators, and gamblers instead of actual investors.
However, if a company's leadership is more focused on sustainable, long-term growth strategies and communicates this clearly to investors, they'll likely attract shareholders who share these long-term goals.
Ultimately, the type of shareholders a company attracts can greatly influence its direction and decision-making. By prioritizing long-term sustainability and growth over short-term profits, a company can build a stronger foundation and attract ride-or-die investors who are in it for the long haul.
This understanding on the part of the shareholder can enable the company to make decisions that drive more stable and prosperous growth over time, rather than being at the mercy of short-sighted share price movement.