In his 1984 Berkshire Hathaway Annual Letter, Warren Buffett argues that companies should only retain unrestricted earnings if there is a reasonable prospect that retaining the earnings will create at least an equivalent amount of market value for shareholders.
He acknowledges that managers often prefer to retain earnings for reasons such as expanding their control or ensuring financial security. However, Buffett believes the only valid reason for retention is if the retained capital can generate incremental earnings that are at least as high as what investors could typically earn elsewhere.
This principle emphasizes the importance of effective capital allocation and shareholder value creation.
Here’s an excerpt from the letter:
This principle is not universally accepted. For a number of reasons managers like to withhold unrestricted, readily distributable earnings from shareholders—to expand the corporate empire over which the managers rule, to operate from a position of exceptional financial comfort, etc.
But we believe there is only one valid reason for retention. Unrestricted earnings should be retained only when there is a reasonable prospect—backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future—that for every dollar retained by the corporation, at least one dollar of market value will be created for owners.
This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.
You can find a copy of the letter here:
1984 Berkshire Hathaway Annual Letter
For all the latest news and podcasts, join our free newsletter here.
Don’t forget to check out our FREE Large Cap 1000 – Stock Screener, here at The Acquirer’s Multiple:
