Learn to invest with Buffett

Chapter 33

Chapter 5 Section 5 Undistributed Profit: It is very important to be able to "roll interest"
If the company wants to retain profits without distribution, there is only one reason that is justified, that is, every dollar of retained earnings can generate at least $1 of market value for shareholders, and this expected rate of return must be based on historical evidence and detailed and thorough data analysis support.

--Warren Buffett
When the enterprise develops to a certain stage, it will generate more cash surplus.At this time, the company can choose to distribute the profits to shareholders, or it can choose to keep the profits without distribution.Buffett believes that only when the company can ensure that every dollar of undistributed profit can generate at least one dollar of market value, it is correct for a company to choose to retain profits without distribution.

In Buffett's view, when dealing with the company's earnings, the company's management must act cautiously.If the company's surplus is used for internal investment and can obtain better returns than the national average return on investment, then the company should retain the surplus and continue to invest to earn more returns for shareholders.If the company's surplus is used for internal investment and the rate of return obtained is lower than the national average return on investment, then the company should distribute the profits to shareholders and let shareholders hold their own cash for investment. The reason is very simple.

Assuming that a company now has undistributed profits of 100 yuan, the national average return on investment is 15%.If the company uses the 100 yuan for internal investment, it can obtain a market value of 120 yuan, that is, a 20% return on investment, then the company should retain the profits and not distribute them for investment.If the company uses the 100 yuan for internal investment and can only get a market value of 110 yuan, that is, a 10% return on investment, then the company should distribute the profits to shareholders and let shareholders make further investment.Of course, if internal investment is made at this time, the shareholders will not lose money, but the profits earned will be less.The bottom line is that the company can use this 100 yuan for internal investment to obtain at least 100 yuan in market value.Otherwise, shareholders will not only lose money, but also lose money.It's like if a company invests $100 and only gets a market value of $90, then $10 of that value evaporates.

Berkshire, which Buffett is in charge of, has not distributed profits.The reason for not distributing profits is that Buffett believes that he can reinvest shareholders' earnings and increase shareholders' interest.Berkshire often uses "1 dollar can generate at least 1 dollar of market value" to test whether Berkshire's decision to retain profits without distribution is wise.In fact, Berkshire is doing pretty well.Berkshire has so far complied with that requirement.Buffett used his practical actions to realize at least $1 of market value for Berkshire shareholders, making shareholders' income more and more like a snowball.

Buffett believes that when investors choose an investment target, they must pay attention to whether the company has distributed profits, the distribution ratio, and whether the incremental capital has increased.Moreover, investors must pay attention to what projects the company invests its undistributed profits in, and whether that project has a higher rate of return.Because sometimes the company's main business is very profitable, but the undistributed profits may be invested in a money-losing project.In this way, the enterprise can use the profit of the main business to cover up the loss of the investment project.If you only look at indicators such as dividends, investors can't see any clues.

Investment motto:

When investors choose to invest in companies, they must keep in mind Buffett's philosophy that "1 dollar generates at least 1 dollar of market value".If you choose a company with retained earnings, make sure that the company's retained earnings generate a higher-than-average return so that your investment is worthwhile.

(End of this chapter)