Wall Street Journal / David G. Santry / April 20, 1981

A must-read Warren Buffett letter on inflation investing

“In the 16 years since present management assumed responsibility for Berkshire, book value per share with insurance-held equities valued at market has increased from $19.46 to $400.80, or 20.5% compounded annually. (You’ve done better: The value of the mineral content in the human body compounded at 22% annually during the past decade.)” Such is the inimitable style with which Chairman Warren E. Buffett of Berkshire Hathaway Inc. writes his annual letter to shareholders, which appears, along with details of his investment acumen (table), in the recently issued annual report of the conglomerate that he runs from Omaha.

Buffett, 50, is widely regarded as one of America’s finest investors. Clearly, he is also one of the most penetrating observers of the country’s business and financial scene. Year in and year out, Buffett’s shareholder letters have been carefully read by investors. This year’s letter should be no exception. It deals with, among other things, accounting, inflation, and the property and casualty insurance industry.

Berkshire, being basically an insurance company, makes investments in other companies. Generally, if Berkshire owns less than 20% of a company, it can include in its earnings only dividends received on the stock. Says Buffett: “Many of these companies pay out relatively small proportions of their earnings in dividends. This means that only a small proportion of their current earning power is recorded in our own current operating earnings.” Buffett explains that the portion of earnings not paid out in dividends by the companies last year exceeded Berkshire’s total reported operating earnings. Conventional accounting allows “less than half of our earnings ‘iceberg’ to appear above the surface,” he says.

Stock repurchases. “We would rather have earnings for which we did not get accounting credit put to good use in a 10%-owned company by a management we did not hire,” says Buffett, “than have earnings for which we did get credit put into projects of more dubious potential. . . . Our insurance companies will continue to make large investments in well-run, favorably situated, noncontrolled companies that pay out in dividends only a small portion of their earnings. We would expect our long-term return to continue to exceed the return derived annually from reported operating earnings.”

One use of retained earnings that Buffett favors is a company’s repurchase of its own shares. “If a fine business is selling in the marketplace for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price? . . . The auction nature of security markets often allows finely run companies the opportunity to buy portions of their own businesses at a price under 50% of that needed to acquire the same earnings power through the negotiated acquisition of another enterprise,” he says.

Inflation, however, makes investing all the more difficult, according to Buffett. “High rates of inflation create a tax on capital that makes much corporate investment unwise. . . . At present inflation rates, we believe individual owners in medium or high tax brackets should expect no real long-term return from the average American corporation. The average return on equity of corporations is fully offset by the combination of implicit tax on capital levied by inflation and explicit taxes levied on dividends and gains in value produced by retained earnings.”

Lost options. Buffett also has some sober thoughts on the property and casualty insurance business, which is in a down phase of its underwriting cycle. He takes issue with those in the industry who minimize the problem of having huge amounts of bonds in their portfolios that are selling below cost (page 98). Indeed, many large companies have no net worth when bond holdings are valued at the current market price. Yet many in the industry say that as long as the bonds do not have to be sold, there is no problem. Buffett contends that under such circumstances investment options disappear, perhaps for decades. “When large underwriting losses are in prospect, it may make excellent business logic for some insurers to shift from tax-exempt into taxable bonds,” he says. “Unwillingness to recognize major bond losses may be the sole factor that prevents such a sensible move.”

But unrealized bond losses have other serious consequences. The losses can force a company into disastrous price-cutting just to maintain cash flow to invest at current high rates of interest while hoping for an improvement in underwriting and bonds.

Still, owing to Buffett’s investing, Berkshire prospered in 1980. Operating earnings increased 16% to $41.9 million, and Berkshire’s return on equity was 17.8%. Net earnings per share, including investment gains, jumped 24% to $51.72. Berkshire’s performance is reflected in its stock, which recently traded at $495 a share, a premium over book value. In 1977, the shares traded at $82. (Buffett owns nearly half of Berkshire’s 1 million shares.)

Buffett does not pretend to be an oracle. He writes: “Short-term forecasts of stock or bond prices are useless. The forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”

Berkshire’s stock portfolio

Thousands of dollars

<small>Data: Berkshire Hathaway Inc.’s 1980 annual report</small>

102 BUSINESS WEEK: April 20, 1981 FINANCE

Billionaire investor and former Chairman of Berkshire-Hathaway Warren Buffett has great advice for new investors:

“You have to have the attitude that you’re buying into a business. You’re not buying something that [just] wiggles around on a chart. And if you buy intelligently into a business, you’re going to make money.”

When you treat a stock ticker not as a flashing green or red light on a screen, but as a fractional ownership stake in a real-world business with factories, employees, and customer relationships, your entire framework changes. You stop worrying about daily price fluctuations and start focusing on what truly drives long-term wealth: economic moats and compounding power.

For an investor looking to buy a business intelligently, three foundational metrics serve as the ultimate operational health check:

1. Return on Invested Capital (ROIC)

ROIC tells you how efficiently a management team allocates capital to generate profits. A business that wiggles on a chart can look exciting, but if it requires ⁠$1.00⁠ of capital just to make ⁠$0.05⁠ of profit, it is a cash-burning machine. High-quality businesses consistently generate high double-digit ROIC, proving they can deploy cash efficiently and defend their market position against competitors.

2. Free Cash Flow (FCF) Growth

Net income can be manipulated by accounting tricks, but free cash flow—the actual cash left over after paying for operating expenses and capital expenditures—is the lifeblood of a company. A rising FCF trend ensures the business has the capital to reinvest in growth, pay down debt, buy back shares, or distribute dividends, all without relying on outside capital markets.

3. Sustainable CAGR

When looking at compound annual growth rates, consistency matters far more than a single explosive year. An intelligent business owner looks for a steady, predictable CAGR in both top-line revenue and bottom-line earnings. This indicates a growing market share or pricing power that can withstand economic downturns.

“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.” — Warren Buffett

When you analyze companies through this business-owner lens, short-term market volatility transforms from a source of anxiety into a source of opportunity. If the fundamental earnings power of the underlying business remains intact, a falling chart isn’t a failure—it’s a clearance sale on a great enterprise.

As the years roll by, it is incredibly easy to fall into the trap of letting go of habits under the guise of “slowing down” or “acting your age.” Often, society tells us that aging means stepping back, but biology and psychology tell us the exact opposite.

When people buy into the myth that aging requires a quiet, sedentary life, they often stop doing the very things that keep them vibrant. Here are the core things people frequently drop as they age—and exactly why they should keep doing them.

1. Lifting Relatively Heavy Weights
Many people swap out all resistance training for gentle walking as they get older. While walking is fantastic for cardiovascular health, it doesn’t stop **sarcopenia** (the natural loss of muscle mass and strength that accelerates after age 30).
The Risk:  Losing muscle mass directly impacts balance, metabolic rate, and joint stability.
The Fix:** Continuing to lift weights or perform bodyweightAs the years roll by, it is incredibly easy to fall into the trap of letting go of habits under the guise of “slowing down” or “acting your age.” Often, society tells us that aging means stepping back, but biology and psychology tell us the exact opposite.
When people buy into the myth that aging requires a quiet, sedentary life, they often stop doing the very things that keep them vibrant. Here are the core things people frequently drop as they age—and exactly why they should keep doing them.

1. Lifting Relatively Heavy Weights
Many people swap out all resistance training for gentle walking as they get older. While walking is fantastic for cardiovascular health, it doesn’t stop **sarcopenia** (the natural loss of muscle mass and strength that accelerates after age 30).
* **The Risk:** Losing muscle mass directly impacts balance, metabolic rate, and joint stability.
* **The Fix:** Continuing to lift weights or perform bodyweight resistance exercises signals the body to maintain bone density and muscle tissue. You don’t need to powerlift, but challenging your muscles is what keeps you independent.

2. Seeking Out New (and Frustrating) Challenges
It is comfortable to stick to what you are already good at. As a result, people often stop trying to learn complex, entirely new skills because the learning curve feels frustrating.
* **The Risk:** True **neuroplasticity**—the brain’s ability to form new neural pathways—is triggered by *struggle* and novelty. Doing the same crossword puzzles or reading the same genres keeps you in a comfortable groove, but it doesn’t build cognitive reserve.
* **The Fix:** Pick up things that make you feel like a beginner again. Learn a new language, take up an instrument, or master a complex piece of software. If it feels a little frustrating, it’s working.

3. Sitting on the Floor
Pay attention to how often you get down on the floor and back up again. For many adults, years can pass without them ever touching the ground unless they accidentally fall.
* **The Risk:** Losing the flexibility, core strength, and mobility required to get off the floor is a major predictor of long-term mortality and injury risk.
* **The Fix:** Make a habit of sitting on the floor to stretch, play with pets, or watch TV, and practice getting back up without using your hands if possible. It keeps your hips, knees, and core functional.
### 4. Expanding Their Social Circle
It’s natural for social circles to shrink over time as people move, retire, or pass away. The mistake is stopping the active pursuit of *new* relationships, particularly across different generations.
* **The Risk:** Chronic isolation has a health impact equivalent to smoking 15 cigarettes a day. Furthermore, only hanging out with peers of the exact same age can sometimes trap your perspective in a specific era.
* **The Fix:** Join clubs, volunteer, or engage in community groups where you interact with people of all ages. Younger generations provide fresh energy and perspectives, while older generations offer mentorship and wisdom.
### 5. Taking Calculated Physical Risks
As reflexes slow slightly, the instinct is to become hyper-cautious. People stop riding bikes, stop hiking uneven trails, or stop dancing because they are afraid of falling.
* **The Risk:** While avoiding catastrophic injury is smart, total avoidance of balance challenges actually degrades your **proprioception** (your body’s awareness of its position in space). If you don’t challenge your balance, you lose it.
* **The Fix:** Keep playing sports, dancing, or walking on uneven terrain like sand or hiking trails. Keeping your nervous system sharp is your best defense against future falls.
> **The Takeaway:** Aging isn’t a process of shutting down; it’s a process of adaptation. The phrase “use it or lose it” applies to your muscles, your brain cells, your balance, and your social life.
>
resistance exercises signals the body to maintain bone density and muscle tissue. You don’t need to powerlift, but challenging your muscles is what keeps you independent.
### 2. Seeking Out New (and Frustrating) Challenges
It is comfortable to stick to what you are already good at. As a result, people often stop trying to learn complex, entirely new skills because the learning curve feels frustrating.
* **The Risk:** True **neuroplasticity**—the brain’s ability to form new neural pathways—is triggered by *struggle* and novelty. Doing the same crossword puzzles or reading the same genres keeps you in a comfortable groove, but it doesn’t build cognitive reserve.
* **The Fix:** Pick up things that make you feel like a beginner again. Learn a new language, take up an instrument, or master a complex piece of software. If it feels a little frustrating, it’s working.
### 3. Sitting on the Floor
Pay attention to how often you get down on the floor and back up again. For many adults, years can pass without them ever touching the ground unless they accidentally fall.
* **The Risk:** Losing the flexibility, core strength, and mobility required to get off the floor is a major predictor of long-term mortality and injury risk.
* **The Fix:** Make a habit of sitting on the floor to stretch, play with pets, or watch TV, and practice getting back up without using your hands if possible. It keeps your hips, knees, and core functional.
### 4. Expanding Their Social Circle
It’s natural for social circles to shrink over time as people move, retire, or pass away. The mistake is stopping the active pursuit of *new* relationships, particularly across different generations.
* **The Risk:** Chronic isolation has a health impact equivalent to smoking 15 cigarettes a day. Furthermore, only hanging out with peers of the exact same age can sometimes trap your perspective in a specific era.
* **The Fix:** Join clubs, volunteer, or engage in community groups where you interact with people of all ages. Younger generations provide fresh energy and perspectives, while older generations offer mentorship and wisdom.
### 5. Taking Calculated Physical Risks
As reflexes slow slightly, the instinct is to become hyper-cautious. People stop riding bikes, stop hiking uneven trails, or stop dancing because they are afraid of falling.
* **The Risk:** While avoiding catastrophic injury is smart, total avoidance of balance challenges actually degrades your **proprioception** (your body’s awareness of its position in space). If you don’t challenge your balance, you lose it.
* **The Fix:** Keep playing sports, dancing, or walking on uneven terrain like sand or hiking trails. Keeping your nervous system sharp is your best defense against future falls.
> **The Takeaway:** Aging isn’t a process of shutting down; it’s a process of adaptation. The phrase “use it or lose it” applies to your muscles, your brain cells, your balance, and your social life.
>