During the 1994 Berkshire Hathaway Annual Meeting, Warren Buffett explained why some of the best businesses don’t grow. Here’s an excerpt from the meeting:
AUDIENCE MEMBER: I’m Howard Bask (PH). I’m from Kansas City.
When you are estimating a growth rate on a company (inaudible), a very predictable company, I imagine you apply a big margin of safety to it. What kind of rate do you generally apply? I mean, high single digits?
WARREN BUFFETT: In the margin of safety, or —
AUDIENCE MEMBER: What kind of growth rate would you, on a predictable company, might you —
WARREN BUFFETT: We are willing to —
AUDIENCE MEMBER: — stab at?
WARREN BUFFETT: — buy companies that aren’t going to grow at all.
AUDIENCE MEMBER: OK.
WARREN BUFFETT: It — assuming we get enough for our money when we do it. So, it — we are not looking — we are looking at projecting numbers out, as to what kind of cash we think we’ll get back over time.
But you know, would you rather have a savings — if you’re going to put a million dollars in a savings account, would you rather have something that paid you 10 percent a year and never changed, or would you rather have something that paid you 2 percent a year and increased at 10 percent a year? Well, you can work out the math to answer those questions.
But you can certainly have a situation where there’s absolutely no growth in the business, and it’s a much better investment than some company that’s going to grow at very substantial rates, particularly if they’re going to need capital in order to grow.
There’s a huge difference in the business that grows and requires a lot of capital to do so, and the business that grows, and doesn’t require capital.
And I would say that, generally, financial analysts do not give adequate weight to the difference in those. In fact, it’s amazing how little attention is paid to that. Believe me, if you’re investing, you should pay a lot of attention to it.
CHARLIE MUNGER: I agree with that. But it’s fairly simple, but it’s not so simple it can all be explained in one sentence. (Laughter)
WARREN BUFFETT: Our — some of our best businesses that we own outright don’t grow. But they throw off lots of money, which we can use to buy something else. And therefore, our capital is growing, without physical growth being in the business.
And we are much better off being in that kind of situation [than] being in some business that, itself, is growing, but that takes up all the money in order to grow, and doesn’t produce at high returns as we go along. A lot of managements don’t understand that very well, actually.
You can listen to the entire conversation here:
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