No. of Recommendations: 6
9. We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely.This was revised in 2010, according to RationalWalk (article from 3 years ago, well worth reading):
https://newsletter.rationalwalk.com/p/berkshire-ha...The test was revised significantly after the 2009 annual meeting when a question regarding the original test made Warren Buffett realize that the wording did not reflect his intentions.
The revised earnings test reads as follows:
“I should have written the ‘five-year rolling basis’ sentence differently, an error I didn’t realize until I received a question about this subject at the 2009 annual meeting.
When the stock market has declined sharply over a five-year stretch, our market-price premium to book value has sometimes shrunk. And when that happens, we fail the test as I improperly formulated it. In fact, we fell far short as early as 1971-75, well before I wrote this principle in 1983.
The five-year test should be: (1) during the period did our book-value gain exceed the performance of the S&P; and (2) did our stock consistently sell at a premium to book, meaning that every $1 of retained earnings was always worth more than $1? If these tests are met, retaining earnings has made sense.”According to my calculations, this test was met in 5-year periods ending in 2018 and 2019.
Berkshire failed in 5-year periods ending 2013-2017 and 2020-2025.
Buybacks over book value would skew the results a bit towards failure.
