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2010: How does Buffett determine if every dollar Berkshire retains creates at least one dollar of value?
ANDREW ROSS SORKIN: This question comes from Tomer Malon (PH) from Tel Aviv, Israel. And he has clearly been a long-time shareholder because he references your 1984 Chairman Letter.
He writes, “You have previously stated that a company should retain its earnings only if, quote, ‘For every dollar retained, at least one dollar of market value will be created for owners,’ unquote.
“You also noted that if such conditions will no longer apply to Berkshire, as measured on the basis of a five-year rolling average, then quote, ‘We will distribute all unrestricted earnings that we believe cannot be effectively used.’
“However, during the five-year period between July third — I’m sorry, January 3rd, 2005 and December 31st, 2009, the average annual earnings per share for class A, as reported, amounted to $5,930, while at the same period the average annual change in the share’s market price was only $2,420.
“Consequently, are you considering a distribution of a dividend or buying back shares? I imagine I know the answer, but I thought we had to ask.” (Laughter)
WARREN BUFFETT: Well, he does know the answer, but we’ll elaborate.
I did write that, not only in 1984 but continuously in the back of the Berkshire annual report where I’ve got our economic principles.
And frankly, the way I wrote that the first time was not well thought out. And in the 2009 annual report, partly because somebody asked that question last year, I actually rewrote that section.
And I pointed out that even when I wrote it in 1984, we would have flunked the test in many previous years when, generally speaking, the stock market had suffered a significant decline over a period of time.
As you can tell by looking at our report, right now every dollar that we have left in the business, you know, has produced, in present value terms, something over $1.30 of market value.
We have met the test of retained earnings proving their worth. But the way I phrased that originally, anytime the stock market went down a whole lot in a five-year period, because we were carrying our Coca-Cola at a certain price five years earlier or whatever it was that entered into our asset value, we could have done a great job of allocating capital in the five-year period and we still would have looked bad.
And similarly if the stock market had gone up a whole lot, we could have done a dumb job and looked good.
So, if you will look in the back of the 2009 annual report, I think it’s number 11, or — I’m not sure about that.
But read the economic principles. You’ll see that I had to confess my error in how I originally worded that.
But I think it is still intellectually honest, in terms of meeting what I intended to say.
You know, I voted against this before I voted for it, or something like John Kerry said in 2004. (Laughs)
I think it does meet the test of a dollar retained earnings producing more than a dollar of market value. And we will continue to measure ourselves based on whether we meet that test.
If we don’t — if keeping a buck doesn’t produce more than a buck in present value, I don’t mean every day or every week, but over time, we should figure out something else to do.
CHARLIE MUNGER: Well, I like people that parse through a long series of documents and find an error and rub my nose in it, particularly when it’s your error.
WARREN BUFFETT: Rub my nose in it. (Laughter)
CHARLIE MUNGER: Yeah, yeah.
WARREN BUFFETT: How tolerant. (Laughter)
I should have had him word it originally. Actually I think those were his words. It’s just coming back to me. (Laughter)