After Reading Buffett's Shareholder Letters from 40 Years Ago, Here's What I Want to Tell You
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After Reading Buffett's Shareholder Letters from 40 Years Ago, Here's What I Want to Tell You
As Warren Buffett prepares to step down after nearly 60 years at the helm of Berkshire Hathaway, revisiting the core tenets of his early thinking has become especially important. This article is a compilation and analysis of Buffett’s 1981–1982 shareholder letters. Even after more than 40 years, his insights—on “rejecting mediocre acquisitions,” “inflation as a corrosive worm eroding businesses,” and “real economic earnings surpassing accounting profits”—remain profoundly cautionary for today’s Web3 investors, DAO governance participants, and corporate operators.
Navigating Web3 tides with focused insightsAuthor: BoringBiz_
Compiled by: TechFlow
Original link: X Thread @BoringBiz_
As Warren Buffett nears the end of nearly six decades leading Berkshire Hathaway as CEO and prepares to pass the torch, I’ve revisited and begun studying all of his annual shareholder letters.
If you’d like to read the lessons from the 1977–1980 letters, see here: 1977–1980 Summary
Below are some timeless lessons—classics for both investors and operators.
1981 Shareholder Letter
On Criteria for Acquisition Decisions
“Our acquisition decisions aim to maximize real economic gains—not to expand managerial empires or boost accounting numbers on paper. (In the long run, managers who emphasize accounting appearances over economic substance usually fail at both.)”
“We would much rather buy 10% of an excellent company T at price X per share than buy 100% of T at 2X per share—even if the latter boosts reported earnings immediately. Yet most corporate managers prefer the latter option, and never lack justifications for doing so.”
Why CEOs Pay Premiums in M&A and LBOs
“We suspect that in most high-premium acquisitions, the following three motives—usually unspoken—are the primary drivers, acting alone or in concert:
- Leaders in business and other fields rarely lack ‘animal spirits’; they often enjoy increased activity and challenge. At Berkshire, our pulse has never raced more than when an acquisition looms.
- Most organizations, whether in business or elsewhere, tend to measure themselves—and be measured—by size. Managerial compensation is far more frequently tied to size than any other metric. (Ask a Fortune 500 CEO where his company ranks on that famous list, and the number he instantly recalls will almost certainly be the sales-based ranking. He may not even know where his company stands in profitability rankings, which Fortune also faithfully records.)
- Many managers seem to have been psychologically shaped too deeply by the story of the Frog Prince—where a handsome prince trapped inside a frog’s body is transformed by a kiss from a beautiful princess. Thus, they firmly believe their own ‘managerial kiss’ can work miracles on target company T.”
This optimism is essential. Without such pleasant illusions, why would shareholders of acquirer A support paying 2X for T’s equity when they could simply buy it in the secondary market at X?”
Investors Should Seek to Buy “Princes” at “Frog Prices”
“Investors can always buy frogs at the market price for frogs. If investors fund ‘princesses’ willing to pay double to kiss frogs, those kisses better deliver real magic.
We’ve observed many such kisses—but rarely seen miracles. Still, many managerial ‘princesses’ remain confident in the power of their future kisses—even as their backyards fill up with unresponsive frogs.
We’ve occasionally tried buying frogs cheaply, with results detailed in past reports. Clearly, our kisses failed completely. We’ve done well with a few ‘princes’—but they were princes when we acquired them. At least our kiss didn’t turn them into frogs. Finally, we’ve occasionally succeeded brilliantly in buying partial stakes in easily identifiable ‘princes’ at ‘frog-like’ prices.”
What Makes an Acquisition Successful?
“We must acknowledge that some acquisition records are indeed impressive. These generally fall into two categories:
The first involves companies that, through careful design or fortunate coincidence, acquire businesses exceptionally well-suited to inflationary environments. Such favored businesses must possess two traits:
- The ability to raise prices easily—even when demand is weak and capacity underutilized—without fear of losing significant market share or volume;
- The ability to handle substantial dollar-volume growth (often driven by inflation, not real growth) with minimal additional capital investment.
Even mediocre managers focusing on such criteria have achieved outstanding results in recent decades. However, very few businesses naturally possess both traits, and competition to acquire them has become so intense it’s now self-destructive.
The second category involves managerial geniuses—those rare individuals who can identify the rare prince disguised as a frog and possess the management skill to strip away the disguise. We salute such managers.”
Stable Price Levels Are Like Virginity
“We’ve explained how inflation renders our otherwise satisfactory long-term performance figures illusory when measuring owners’ true investment outcomes.
We applaud Federal Reserve Chairman Volcker’s efforts and note that various price indices have recently shown moderation.
Yet we remain pessimistic about long-term inflation trends. Like virginity, stable price levels appear maintainable—but irreparable once lost.”
On Equity Risk Premium
“The economic justification for investing in equities has traditionally been this: overall, applying managerial and entrepreneurial skills to equity capital generates excess returns above passive investment returns (i.e., interest on fixed-income securities).
Additionally, it’s believed that because equity capital bears greater risk than passive investments, it ‘deserves’ higher returns. The ‘bonus’ generated by equity thus seems natural and guaranteed.
But is this really true? Decades ago, a mere 10% return on equity (ROE) was enough to classify a business as ‘good’—meaning that reinvesting $1 could logically be valued by the market at over $1.00.
This made sense: when long-term taxable bonds yielded 5% and tax-exempt bonds 3%, a business generating 10% ROE clearly offered investors value above its equity cost. Even after combining dividend and capital gains taxes—which reduced the investor’s take from 10% to 6–8%—this still held.
Markets acknowledged this reality. At the time, the average U.S. corporate ROE was about 11%, and stocks traded well above book value—averaging over 150 cents per dollar of book value. Most businesses were ‘good,’ as their earning power far exceeded their cost of capital (passive funds). The total value added by equity investment was enormous.
That era is gone. But its lessons die hard. Though investors and managers must live in the future, their memories and neural wiring often remain rooted in the past. For investors, using historical P/E ratios—or for managers, historical valuation benchmarks—is far easier than rethinking assumptions daily.
When change is slow, constant re-evaluation isn’t advisable—it yields little and slows response. But when change accelerates, clinging to yesterday’s assumptions comes at great cost. And the pace of economic change has become breathtaking.”
Inflation Is a Corporate Tapeworm
“In an inflationary environment, owners of ‘bad’ businesses face a particularly ironic punishment. To maintain operations, these low-return businesses typically must retain most of their earnings—regardless of how punitive this policy is for shareholders.
Rational behavior would be the opposite. If someone holds a long-term bond yielding 5%, they wouldn’t reinvest the interest at par to buy more 5% bonds—especially when similar bonds are available for 40 cents on the dollar. Instead, they’d withdraw the interest and—if reinvesting—seek the highest safe current return. Good money shouldn’t chase bad.
The same logic applies to shareholders. Logically, a company with high historical and expected returns should retain most or all earnings, enabling owners to earn premium returns on enhanced capital.
Conversely, low ROE implies a very high dividend payout policy, allowing owners to redeploy capital into more attractive areas. (The Bible agrees: in the Parable of the Talents, the two productive servants are rewarded with 100% retention and encouraged to grow. The third, unproductive servant is not only rebuked—‘wicked and lazy’—but forced to hand over all capital to the best performer. Matthew 25:14–30.)
But inflation transports us into Wonderland, where everything is upside down. When prices rise, ‘bad’ businesses must retain every dollar they can. Not because equity capital is an attractive home—but precisely because it isn’t. Low-return businesses must follow high-retention policies. If they wish to continue operating as before—something most entities, including corporations, desire—they have no choice.
Inflation acts like a giant ‘corporate tapeworm.’ It preemptively consumes the dollars needed for daily investment, regardless of the host’s health. No matter the reported profit level (even zero), businesses require increasing dollars in receivables, inventory, and fixed assets just to maintain last year’s output. The sicker the business, the larger the proportion of available capital consumed by the worm.
Under current conditions, a business earning 8% or 10% ROE typically has no surplus left for expansion, debt repayment, or ‘real’ dividends.
The inflationary tapeworm merely cleans the plate. (The inability of low-return firms to pay dividends is often well hidden. U.S. corporations are increasingly adopting dividend reinvestment plans, sometimes with discounts that almost force shareholders to reinvest. Others engage in ‘robbing Peter to pay Paul’—issuing new shares to Peter to fund dividends to Paul. Beware dividends that can only be paid if someone commits to replacing the distributed capital.)”
1982 Shareholder Letter
Set Predefined Yardsticks
“Yardsticks are rarely discarded when results are good. But when performance deteriorates, most managers discard the yardstick—not the manager.
For managers facing poor results, a more flexible system often emerges: shoot the arrow of performance at a blank canvas, then carefully draw the bullseye around where it lands. We place far more trust in predefined, long-lasting, narrowly targeted metrics.”
Accounting Is the Starting Point, Not the Endpoint, of Business Valuation
“We favor the concept of ‘economic’ earnings, which includes all undistributed profits regardless of ownership percentage. In our view, the value of retained earnings to owners depends on how effectively those earnings are used—not on your percentage stake. If you owned 0.01% of Berkshire over the past decade, you economically participated fully in our retained earnings—no matter how your accounting system recorded it. Proportionally, your benefit was identical to someone holding a charming 20% stake. But if you owned 100% of many capital-intensive businesses over the same period, the retained earnings fully and accurately booked to your name under standard accounting might have generated negligible or even zero economic value.
This isn’t a criticism of accounting. We wouldn’t want to design a better system. It’s simply to emphasize that managers and investors alike must understand: accounting numbers are the starting point of business valuation—not the endpoint.”
Retained Earnings and Market Valuation
“Although over time total retained earnings have generally translated into at least equivalent market value gains for shareholders, this conversion has been highly uneven across companies and irregular and unpredictable in timing.
Yet it is precisely this unevenness and irregularity that creates opportunities for value-oriented buyers of fractional equity interests.
Such investors can select from nearly all major U.S. corporations—including many far superior to businesses available via negotiated whole acquisitions. Moreover, partial ownership purchases occur in auction markets, where prices are set by participants whose behavior sometimes resembles a herd of manic-depressive lemmings.
Within this vast auction arena, our task is to choose businesses with strong economic characteristics, ensuring each dollar of retained earnings ultimately translates into at least one dollar of market value. Despite many mistakes, we’ve achieved this so far—with great help from economics’ patron saint: St. Offset.
That is, in some cases, retained earnings attributable to our ownership have had negligible or even negative impact on market value; in others, a dollar retained by the investee has translated into two dollars or more of market value. So far, our star performers have more than offset the laggards. If we sustain this record, it will validate our strategy of maximizing ‘economic’ earnings—regardless of its impact on ‘accounting’ earnings.”
On M&A Deals
“When reviewing other companies’ major acquisitions in 1982, our reaction wasn’t envy—but relief that we weren’t involved.
In many such deals, managerial rationality shrinks in competition with managerial adrenaline; the thrill of the chase blinds pursuers to post-capture consequences. Pascal’s observation seems apt: ‘I find that all human misfortunes stem from one simple cause: man’s inability to sit quietly in his room.’”
What Drives Profitability?
“An industry possessing both ‘severe overcapacity’ and ‘commoditized’ products (undifferentiated in performance, appearance, service, or other customer concerns) is a prime candidate for profitability woes. True, these problems might be avoided if prices or costs are administratively controlled, partially insulated from normal market forces.
This control may arise through: (a) legal government intervention (until recently, including truck freight pricing and deposit costs for financial institutions); (b) illegal collusion; or (c) extralegal foreign cartels like OPEC (from which domestic non-cartel players may also benefit).
However, if costs and prices are determined by full competition, with overcapacity present, and buyers indifferent to whose product or delivery service they use, the industry’s economics are almost certain to be mediocre—or even disastrous.
Hence, every supplier constantly strives to establish and emphasize unique product or service qualities. This works for candy bars (consumers buy by brand, not ‘two ounces of chocolate bar’), but fails for sugar (how often do you hear: ‘Coffee with cream and C & H sugar,’ instead of just ‘sugar’?)
In many industries, differentiation is fundamentally impossible. Only if a few producers have broad, sustainable cost advantages might they perform well consistently. By definition, such exceptions are rare—and nonexistent in many industries. For the vast majority selling ‘commodity’ products, a grim business equation prevails: persistent overcapacity + lack of administered pricing (or cost control) = poor profitability.
Of course, overcapacity may eventually self-correct—via capacity shrinkage or demand growth. Unfortunately, for participants, such corrections are often long delayed. When they finally occur, the euphoria of recovery often triggers widespread expansion, recreating overcapacity within years—leading to another unprofitable cycle. In short, nothing succeeds like success—at creating failure.
The long-term profitability of such industries ultimately depends on the ratio of ‘tight-supply years’ to ‘plentiful-supply years.’ Usually, this ratio is dismal. (It seems our textile business’s last tight-supply period—years ago—lasted barely half a morning.)
But in some industries, supply tightness persists for long periods. Sometimes, actual demand growth exceeds forecast growth for extended durations. In others, adding capacity requires long lead times due to complex facilities needing planning and construction.”
Using Stock as Currency in Acquisitions
“We follow a simple rule in stock issuance: we won’t issue shares unless the intrinsic business value we receive equals or exceeds what we give up. This policy seems self-evident. You might ask: why would anyone trade a $1 bill for 50 cents in coins? Yet many corporate managers consistently do just that.
Managers’ preferred method for acquisitions is cash or debt. But CEO ambitions often exceed available cash and credit (of course, my ambitions always do too). Moreover, these ambitions often arise when their own stock trades well below intrinsic business value. This creates a moment of truth. As Yogi Berra said: ‘You can observe a lot just by watching.’ Shareholders then discover whether management truly prioritizes empire-building or owner wealth preservation.
The reason for this choice is simple: a company’s stock often trades below its intrinsic business value. But when a company seeks to sell itself entirely via negotiation, it inevitably wants—and usually gets—the full business value in whatever currency.
If cash is used, the seller’s calculation is straightforward. If paid in the buyer’s stock, the seller’s math remains relatively easy: calculate the market cash value of the shares received.
Meanwhile, a buyer wishing to use its own stock as currency faces no problem—if its shares trade at full intrinsic value.
But suppose its shares trade at only half their intrinsic value. Then the buyer confronts the painful prospect of using severely undervalued currency to buy a fully valued asset.
Ironically, if the buyer itself were to sell its entire business, it could negotiate—and likely obtain—full intrinsic value. But when the buyer engages in a ‘partial self-sale’—which issuing stock for an acquisition essentially is—it usually cannot assign its shares a value higher than the market does.
Still, if such an acquisition proceeds, the buyer ends up using undervalued (market-priced) currency to pay for a fully valued (negotiated-price) asset. Effectively, the buyer gives up $2 to get $1. Under these circumstances, even a superb business bought at a fair price becomes a terrible deal. Because gold priced as gold cannot be wisely purchased using gold—or silver priced as lead.”
How CEOs Justify Value-Destroying Acquisitions
“If the hunger for size and action is strong enough, acquiring managers can always find ample justifications for value-destroying stock issuances. Friendly investment bankers will gladly validate their actions. (Never ask a barber whether you need a haircut.)
Here are common excuses used by managers issuing stock:
- “The company we’re acquiring will be worth more in the future.” (Presumably, the existing business being traded away will also appreciate; future prospects are already embedded in valuations. If you exchange 2X in stock for X, the imbalance remains when both parts double in value.)
- “We must grow.” (One might ask: who is ‘we’? For existing shareholders, the reality is that issuing stock shrinks their stake in all existing businesses. If Berkshire issued stock tomorrow for an acquisition, we’d own everything we have plus a new business—but your ownership in See’s Candy Shops, National Indemnity, and other exceptional businesses would automatically decrease. If (1) your family owns a 120-acre farm, (2) you invite a neighbor with 60 acres of similar land to merge into an equal partnership—with you as managing partner—then (3) your managerial domain grows to 180 acres, but your family’s ownership in land and crops permanently shrinks by 25%. Managers eager to expand empires at owners’ expense might consider government jobs.)
- “Our stock is undervalued, and we’ve minimized its use in the deal—we just needed to offer 51% stock and 49% cash to sellers so some shareholders could achieve tax-free exchanges.” (This argument admits that minimizing stock issuance benefits the acquirer—we like that. But if 100% stock issuance harms old shareholders, 51% likely does too. After all, if a cocker spaniel messes up your lawn, you won’t care it wasn’t a St. Bernard. Sellers’ preferences shouldn’t dictate buyers’ best interests—goodness knows what would happen if sellers demanded the replacement of the acquirer’s CEO as a merger condition.)
How to Avoid Value-Destroying Acquisitions
“Three methods exist to avoid destroying shareholder value when issuing stock for acquisitions:
First: conduct a true ‘business-value-for-business-value’ merger—one that is fair to both sets of shareholders, with each side giving and receiving equal intrinsic business value. It’s not that acquirers avoid such deals; they’re just extremely hard to achieve.
Second: occurs when the acquirer’s stock trades at or above intrinsic business value. In this case, using stock as currency may actually increase shareholder wealth. Between 1965–1969, many mergers were based on this principle—yielding results opposite to most post-1970 activity: sellers of acquired companies received grossly inflated currency (often inflated by questionable accounting and promotional tactics), making them the wealth losers in those deals.
In recent years, this second path has worked for only a few large companies—mainly those in glamorous or promotional industries temporarily rated at or above intrinsic value by the market.
Third: the acquirer proceeds with the acquisition but subsequently repurchases the same number of shares issued in the merger. This effectively converts a ‘stock-for-stock’ deal into a ‘cash-for-stock’ acquisition. Such buybacks are ‘damage-control’ measures. Regular readers will correctly guess we prefer buybacks that directly enhance owner wealth—not merely repair prior damage. Scoring a touchdown beats recovering your own fumble. But when a fumble occurs, recovering the ball matters. We strongly endorse this type of restorative buyback that turns a bad stock deal into a fair cash transaction.”
Red Flags in M&A Language
“Language in M&A often obscures issues and encourages irrational managerial behavior. For example, ‘dilution’ is typically calculated on a pro forma basis using book value and current EPS—especially emphasizing the latter.
When the calculation is negative (dilutive) from the acquirer’s perspective, management offers internal (if not public) justifications, claiming the lines will favorably cross at some future date. (Though such deals often fail in practice, they never fail in projections—if the CEO clearly desires the acquisition, subordinates and advisors will provide the necessary forecasts to justify any price.) If the numbers are immediately positive—i.e., ‘accretive’—no explanation is deemed necessary.
Excessive focus on this form of dilution is misplaced: current EPS (even projected EPS for several years) is an important variable in most valuations—but far from decisive.
Many acquisitions are technically ‘non-dilutive’ yet instantly destroy value for the acquirer. Conversely, some mergers that dilute current and near-term EPS are actually value-enhancing. What truly matters is whether the deal is dilutive or accretive in terms of ‘intrinsic business value’—a judgment involving many variables. We believe calculating dilution this way is crucial—yet rarely done.
A second linguistic issue involves the exchange equation. If Company A announces a stock-for-stock merger with Company B, it’s typically described as ‘A acquires B’ or ‘B sells to A.’ A clumsier but more accurate description would clarify thinking: ‘a portion of A is sold to acquire B’ or ‘B’s owners receive part of A in exchange for their assets.’ In trade, what you give up is as important as what you gain—even if settlement is deferred.
Any subsequent issuance of common stock or convertible debt to finance the deal or restore balance sheet strength must be fully included when assessing the original acquisition’s fundamental math. (If mating inevitably leads to pregnancy, facing that fact should happen before the act.)
Managers and directors can sharpen their thinking by asking: would they be willing to sell 100% of the business on the same basis as selling a portion? If selling the entire business on those terms isn’t wise, they should question why selling a part is. A pile of tiny managerial follies accumulates into one massive folly—not greatness. (Las Vegas thrives on the wealth transfer that occurs when people engage in seemingly minor unfavorable capital transactions.)”
Value Dilution in Acquisitions (“Double Whammy” Effect)
“Finally, when value-destroying stock issuance occurs, there’s a ‘double whammy’ effect on the acquirer’s owners. The first blow is the loss of intrinsic business value caused by the merger itself.
The second blow is a rational downward revision in market valuation applied to the now-diluted business value. Current and potential owners naturally hesitate to pay high prices for assets managed by leaders with a track record of destroying wealth through acquisitions…”
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