Investment Performance

In the Berkshire Hathaway Annual Letters, “investment performance” is something Buffett works hard to define correctly before measuring. His primary test of managerial economic performance is a high earnings rate on equity capital employed (without undue leverage or accounting gimmickry) — explicitly not consistent gains in earnings per share. He notes that even a “totally dormant savings account will produce steadily rising interest earnings each year because of compounding,” so EPS growth alone signals nothing about management quality. He recommends judging performance over a five-year rough yardstick, not a single year (“why should the time required for a planet to circle the sun synchronize precisely with the time required for business actions to pay off?”), with red lights flashing if the five-year average gain falls much below the return on equity earned by American industry in aggregate.

The letters also warn about how performance gets mismeasured and gamed. Buffett’s recurring image: managers who “shoot the arrow of business performance into a blank canvas and then carefully draw the bullseye around the implanted arrow” — yardsticks get discarded when readings turn unfavorable. He stresses that competitive moats and capital efficiency are not the same as financial performance, that performance must be defined relative to the business’s underlying economics (tailwinds vs. headwinds), and that incentive pay should reward genuine performance whether the stock rises or falls. The throughline is a discipline of honest, long-horizon, return-on-capital measurement resistant to the flattering yardsticks managers reach for when results deteriorate.

Where this appears

• Berkshire Hathaway Annual Letters — return on equity capital as the primary test of performance (not EPS); the five-year yardstick; the “draw the bullseye around the arrow” critique of self-serving measurement; performance defined relative to a business’s tailwinds vs. headwinds