Warren Buffett's Secret of Success

Since Oct. 1, 1964, which was the beginning of the fiscal year in which he took control, Warren Buffett (Trades, Portfolio) has increased Berkshire Hathaway’s book value per share from $19.46 to $146,186. This is an absolutely staggering gain of 751,113%. Amazingly, this represents a compounded return of “only” about 19.4% per year.

Berkshire’s market price per share has risen even faster than its book value and has increased by over one million per cent in those 50 years. A $1,000 investment in early 1965 would be worth over $15 million today.

Buffett’s success with Berkshire was achieved in part by earning (counting capital gains on its marketable securities as earnings) an average of almost 20% on equity for 50 years. But the real key was the fact that all earnings were retained, and that Buffett somehow found ways to earn that average 19.4% return on equity (ROE) despite the fact that the capital with which he was working was growing at an average of 19.4% annually, because of the retained earnings. Given a time span of decades, that is explosive exponential growth. The retaining of all earnings combined with the 19.4% ROE allowed the original book value or capital per share to continue to compound at an average of 19.4% for 50 years.

In the absence of high leverage, the way to achieve a high return on equity is to realize a high return on assets. It is therefore clear that Buffett and Berkshire Hathaway achieved a relatively high return on assets compared to most companies and that its return on assets was far higher than that of most insurance companies (which had far lower ROEs despite their much higher leverage).