Warren Buffett's Investment Best Practices

From the 1979 Berkshire Hathaway Annual Letter

Performance Measurement

• The primary test of managerial economic performance is achieving a high earnings rate on equity capital employed (without undue leverage or accounting gimmicks)
• Earnings per share alone can be misleading as a performance indicator - even a "stopped clock" can show EPS growth with low dividend payout
• For long-term performance evaluation, include realized capital gains/losses and use market value of equity securities

Business Assessment

• "Turnarounds seldom turn" - the same energy and talent are better employed in a good business at a fair price than a poor business at a bargain price
• High-quality businesses often have built-in economic advantages that make extraordinary returns almost unavoidable (like network TV stations)
• The textile business demonstrates that even statistical bargains can be mistakes when operating in challenging industries

Capital Allocation

• Avoid long-term fixed-price contracts during inflation - particularly long-term bonds denominated in dollars
• Focus investments where management can effectively utilize retained earnings to create at least equivalent market value
• "Neither a short-term borrower nor a long-term lender be" (Buffett's adaptation of Polonius)

Portfolio Management

• Concentrate investments in businesses you understand and want, without giving consideration to impact on volume
• Successful equity investments depend on the underlying companies performing well over time
• Retained earnings of investee companies (not reported in financial statements) represent significant hidden value

Business Operations

• Strong-minded underwriting discipline is essential in insurance - be willing to reduce volume to maintain profitability
• Centralize financial decisions at the top while delegating operating authority to key managers
• The right organizational structure attracts exceptional talent who perform better when given autonomy

Shareholder Relations

• Companies get the shareholder constituency they seek and deserve
• Prefer long-term shareholders who understand the operation and share expectations
• Owners deserve direct, candid communication from the CEO with the same scope, balance and candor as internal reporting

Investment Outlook

• Inflation plus taxes create an "investor's misery index" - when this exceeds business returns, real capital shrinks
• External conditions affecting currency stability may be the most important factor determining investment rewards
• True investment success means reasonable gain in purchasing power from funds committed