Compound Interest: The Eighth Wonder of the World According to Warren Buffett

By sagebytes — 05 Apr 2025

Insights from Berkshire Hathaway's 2019 Annual Letter

Focus on the Long Term

Think like a business owner, not a stock trader: "What we see in our holdings is an assembly of companies that we partly own and that, on a weighted basis, are earning more than 20% on the net tangible equity capital required to run their businesses."
Ignore short-term market fluctuations: Avoid being influenced by "downgrades by 'the Street,' an earnings 'miss,' expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour."

Value companies that reinvest profits wisely: "Well-managed industrial companies do not distribute to the shareholders the whole of their earned profits... Thus there is an element of compound interest operating in favor of a sound industrial investment."
Appreciate the compounding effect: "Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders."

Businesses that earn good returns on net tangible capital
Honest and able management
Available at sensible prices
Businesses with low debt levels: Look for companies that "earn their profits without employing excessive levels of debt."

Buy good businesses: "To achieve a reputation as a good manager, just be sure you buy good businesses."
Be aware of optimism bias: "The deck is stacked in favor of the deal that's coveted by the CEO."
Maintain healthy skepticism: "Don't ask the barber whether you need a haircut."

Long-term preference for equities: "If something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments."
Warning for leveraged investors: The combination of the "American Tailwind" and compounding makes "equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!"

Buy back shares only when:
- The stock is selling for less than its intrinsic value
- The company is left with ample cash after repurchase
Be patient and disciplined: "Neither of us feels any urgency to buy an estimated $1 of value for a very real 95 cents."

Maintain financial strength: "Berkshire's financial affairs will unfailingly be managed in a manner allowing the company to withstand external shocks of an extreme nature."
Be prepared for market drops: "Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater."

Ignore short-term accounting fluctuations: "Charlie and I urge you to focus on operating earnings and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized."