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The 15 Owner-Related Business Principles of Warren Buffett

Updated 8/15/15

Warren Buffett has amassed a fortune of over $70 billion dollars – thanks to his uncanny investing acumen.

He has outlined 15 owner-related business principles in Berkshire Hathaway’s annual reports.

Simply put, when Buffett talks about how to run a business, you should listen – even if you don’t run a business.  Why?

Because you can apply Warren Buffett’s 15 owner-related principles to your stock investments to decide which businesses are worthy of your investment dollars.

This article analyzes and interprets each of Warren Buffett’s 15 Owner Related Business Principles.  Each of the 15 principles is listed below:

Principle 1:  The Shareholders Own the Business

“We (Warren Buffett & Charlie Munger) do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.”
– Berkshire Hathaway 2013 Annual Report, page 103

The first principle is arguably the most important.  Instead of seeing Berkshire Hathaway as a company that has taken investment money from shareholders, Warren Buffett and Charlie Munger view Berkshire Hathaway as a conduit for holding shareholder assets.  Instead of viewing the corporation as the owner of business assets, they view shareholders as the ultimate owner.  This means they will attempt to maximize shareholder value rather than maximizing corporate size.

A business that follows this principle will do what is best for shareholders rather than what is best for increasing company size.  An example would be repurchasing shares (when below intrinsic value) or paying dividends instead of pursuing acquisitions of overvalued businesses that only serve to grow company size without expanding shareholder value.

Principle 2:  Managers Own Stake In Business

“Most of our directors have a major portion of their net worth invested in the company. We eat our own cooking.”
– Berkshire Hathaway 2013 Annual Report, page 103

The second principle aligns shareholder returns with management returns.  If the managers of a company have a large stake in the company, they are more likely to maximize shareholder value (since they are major shareholders) rather than pay egregious salaries that benefit only themselves.

Businesses where management has a large stake in the outcome of what happens better align shareholder interests with management interests.  It forces managers to think like shareholders.  The higher the percentage of ownership management has in a business, the less likely they are to destroy shareholder value by making selfish decisions.

Principle 3:  Goal Is to Maximize Long-Term Growth In Intrinsic Value Per Share

“We do not measure the economic significance or performance of Berkshire by its size; we measure by per-share progress”
– Berkshire Hathaway 2013 Annual Report, page 103

The goal of any manager should be to maximize long-term shareholder value on a per share basis.  Growing a business by issuing shares does little for shareholders.  Owning 10% of a $1,00,000 business is exactly the same as owning 1% of a $10,000,000 business.  When companies do not show per share numbers but instead focus on overall business growth, they are likely raising money by issuing shares which dilutes shareholder value.  I have noticed this is especially prevalent in the investor presentations of REITs.

Principle 4:  Own Cash Generating Businesses with Above Average Returns on Capital

“Our preference would be to reach our goal by directly owning a diversified group of businesses that generate cash and consistently earn above-average returns on capital.”
– Berkshire Hathaway 2013 Annual Report, pages 103 and 104

Warren Buffett is known to look for businesses with a strong competitive advantage.  Businesses that generate cash instead of use cash and have above average returns on capital are more likely to have strong competitive advantages that will protect and grow the business for years (or decades).  A diversified portfolio of high quality businesses generate cash for shareholders with which to buy more high quality businesses in a virtuous cycle.

Principle 5:  Give Investors Data That Matters

“We believe in telling you how we think so that you can evaluate not only Berkshire’s businesses but also assess our approach to management and capital allocation.”
– Berkshire Hathaway 2013 Annual Report, page 104

GAAP accounting standards do not always paint the most accurate picture of business performance and value.  As a result, management should give investors additional data that better demonstrates the company’s progress.

Principle 6:  Maximize Intrinsic Value, Not Accounting Value

“Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable.”
– Berkshire Hathaway 2013 Annual Report, page 104

As mentioned in principle 5, GAAP accounting rules do not always show the true underlying economics of a business.  Managers should not attempt to maximize earnings per share based on accounting metrics, but rather maximize intrinsic value per share.

Principle 7:  Use Debt Conservatively

“The financial calculus that Charlie and I employ would never permit our trading a good night’s sleep for a shot at a few extra percentage points of return.”
– Berkshire Hathaway 2013 Annual Report, pages 104 and 105

The more debt a business takes on, the greater the odds the business will be forced into bankruptcy.  Debt takes future earnings and uses them in an attempt to grow faster now.  Berkshire Hathaway has a debt to equity ratio of about 30%.  Heavily indebted companies face serious problems if they incur even short-term issues with their business operations.  Businesses that are conservatively financed are better prepared to handle recessions and business downturns.

Principle 8:  Don’t Grow The Business To Satisfy Your Own Ego

“A managerial ‘wish list’ will not be filled at shareholder expense. We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders.”
– Berkshire Hathaway 2013 Annual Report, pages 105

The manager of a large corporation may want to acquire other businesses when it is not in shareholder’s best interest.  The reason is that growing the size of a business (but not necessarily shareholder value) often brings higher pay and a sense of satisfaction that the manager is controlling an ever greater empire.

Principle 9:   Only Retain Earnings When You Can Generate Positive Returns

“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.”
– Berkshire Hathaway 2013 Annual Report, page 105

A company should only retain and reinvest earnings if they can generate returns greater than paying out earnings in the form of dividends or repurchasing shares.  Retaining earnings for the sake of building a cash hoard and nothing else does not maximize shareholder value.

Principle 10:  Only Issue New Shares if they Are Fairly Valued Or Overvalued

“We will issue common stock only when we receive as much in business value as we give.”
Berkshire Hathaway 2013 Annual Report, page 105

If a company issues shares when they are undervalued, it is actively destroying shareholder value.  Issuing shares when a company’s stock is overvalued is an excellent way to build shareholder value as management can reinvest proceeds into fairly valued or undervalued investment options.

Principle 11:  Never Sell Good A Good Business

“Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations.”
Berkshire Hathaway 2013 Annual Report, pages 105 and 106

Warren Buffett is famous for his ability to buy a stock and hold it for decades without selling.  When a company is generating positive cash flows for you, it is often better to take the cash flows you are getting than selling and buying a different stock or business.  When you buy and sell, you incur frictional costs including brokerage fees, price slippage, and taxes, not to mention lost time and wasted emerging fretting over which holdings to sell and which to buy.  A simple buy and hold strategy leads to lower costs and much less second-guessing and worrying.

Principle 12:  Inform Your Shareholders, Don’t Mislead Them

“We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value. Our guideline is to tell you the business facts that we would want to know if our positions were reversed.”
Berkshire Hathaway 2013 Annual Report, page 106

Principle 12 is similar to Principle 6.  The corporate officers of publicly traded companies should not mislead their shareholders.  Rather, they should inform shareholders of both positive and negative events in the business in order to paint the most accurate picture possible.  A management that deliberately misleads its shareholders wastes time and effort on ‘bending the truth’; energy that should be focused on maximizing shareholder value.  If a top executive has proven to be less than truthful, there is no telling what other skeletons there are in the corporate closet (hopefully not literal skeletons) that have not yet come to light.

Principle 13:  Don’t Give Competitors Your Best Ideas

“Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are. Therefore we normally will not talk about our investment ideas.”
Berkshire Hathaway 2013 Annual Report, page 106

Principles 6 and 12 discuss being candid with shareholders.  Principle 13 explains the limits of this candor.  Managers should tell shareholders the philosophy and guiding rules that will dictate future company growth, but not the exact and specific details.  Otherwise, competitors may copy a company’s unique competitive edge.

Principle 14:  It’s As Bad For Your Stock To Be Overvalued As It Is To Be Undervalued

“Our it’s-as-bad-to-be-overvalued-as-to-be-undervalued approach may disappoint some shareholders. We believe, however, that it affords Berkshire the best prospect of attracting long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners.”
– Berkshire Hathaway 2013 Annual Report, page 106

An overvalued stock attracts the wrong kind of investors.  Warren Buffett looks for shareholders that share his long-term approach to investing; shareholders that will buy when the stock is at fair value or better and hold to realize the long-term intrinsic growth in the company.  A stock that is highly overvalued intices shareholders looking for quick gains, or who do not act rationally.  Neither shareholder is likely to stick around for the long-run.

Principle 15:  Long-Term Value Growth Should Outpace the S&P500

We regularly compare the gain in Berkshire’s per-share book value to the performance of the S&P 500. Over time, we hope to outpace this yardstick. Otherwise, why do our investors need us?
– Berkshire Hathaway 2013 Annual Report, page 106

The long-term per share intrinsic value of a business should grow faster than the S&P 500 over a several year period.  If not, investors are better off putting their money into low-cost index funds rather than investing within a specific corporation.

Distilling the 15 Principles

I believe the core of Warren Buffett’s 15 owner related principles can be expressed succinctly in the following sentence:

Look for a management team that seeks to maximize long-term per share intrinsic value that is operating a high quality business that treats shareholders as business owners.

Rational long-term investors should look for the following when purchasing fractional ownership in a business (stock investing):

  1. High quality business with strong competitive advantage
  2. Management that does not take excessive risks
  3. Management that places emphasis on shareholder value
  4. Management skilled in capital allocation
  5. Management that seeks to maximize per share intrinsic value

Final Thoughts

These characteristics are actually quite difficult to find.  There are very few truly high quality businesses that can withstand the test of time and grow per share intrinsic value for decades.  Finding a management team that places shareholder interests first is also not easy.

When an investor does find the rare combination of a great business and a great management team, all that is left to do is buy and hold.  The business and management team will compound investor wealth as it grows intrinsic value on a per share basis year after year.

Additional Resources & Sources

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