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Long-term reading3 min readDisconfirmAI Editorial

Berkshire Hathaway Shareholder Letter 1977: Why Return on Equity Is More Important Than Earnings Per Share?

In the 1977 Berkshire Hathaway shareholder letter, Warren Buffett delves into the correct standards for measuring management's economic performance.

Verified 2026-11-03 00:06 GMT+8

In the 1977 Berkshire Hathaway shareholder letter, Warren Buffett delves into the correct standards for measuring management's economic performance. He criticized most companies for simply defining "record" earnings as a new high in earnings per share (EPS). Buffett pointed out that because companies typically increase their equity base year after year, if a company's equity capital increases by 10% while EPS grows by only 5%, such management performance is not particularly noteworthy. He argued that a more appropriate measure is the return on equity capital (Return on Equity). In 1977, Berkshire's operating return on beginning-of-year equity capital was 19%; although EPS grew by 37%, the beginning capital also increased by 24%, making the EPS growth appear less impressive than it seemed on the surface. This viewpoint emphasizes that investors should focus on the efficiency of capital usage rather than merely the growth of absolute profit figures.

Additionally, Buffett elaborated on the philosophy of insurance business operations in the letter, particularly regarding the importance of "tailwinds" versus "headwinds." He noted that in the insurance industry, even if some major mistakes are made, overall performance can still be quite satisfactory; whereas in the textile industry, even exceptionally excellent management yields only meager profits on average. This reveals a core investment principle: choosing businesses in favorable industry environments (tailwinds) is more critical than relying solely on superior management capabilities. He cited an example where the entire industry raised prices significantly in 1976 to offset disastrous underwriting results from 1974-75, making 1977 a beneficiary year. However, he also warned that as inflation and social inflation cause costs to rise by approximately 1% monthly, if rates cannot increase at the same pace, underwriting profits will shrink. Therefore, identifying turning points in industry cycles and adjusting strategies accordingly is crucial.

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Finally, Buffett discussed the advantages of indirectly holding quality businesses through stocks. Using his investment in Capital Cities Communications as an example, he pointed out that directly purchasing the assets owned by the company might cost twice as much as the stock market investment and would not provide the same level of management. Through non-controlling stock investments, Berkshire could obtain the operational results brought by excellent management while avoiding the burden of control responsibilities. This strategy of "non-controlling interests" allows investors to enjoy long-term value created by outstanding management without interfering in daily operations. This concept challenges the traditional assumption that control inevitably leads to better outcomes, demonstrating that minority equity investments can be an effective way to obtain high-quality commercial returns at the right price.

For instance, suppose an investor is evaluating two technology companies. Company A has had an average annual EPS growth of 15% over the past five years, but its net asset scale expanded by 20%; Company B has an average annual EPS growth of 8%, but its net assets expanded by only 2%. According to Buffett's logic, despite Company A's faster EPS growth, Company B has higher capital efficiency, and its improvement in return on equity better reflects the true economic performance of management. Investors should be wary of companies that drive EPS growth by issuing large amounts of new shares or accumulating retained earnings, and instead look for enterprises that generate higher returns on a smaller capital base.

For readers hoping to understand the underlying logic of value investing, rereading the Berkshire Hathaway 1977 Shareholder Letter has extremely high reference value. It not only clarifies misconceptions about financial indicators but also provides profound insights into judging industry cycles and selecting equity structures. It is recommended to start reading with the sections on "return on equity" and "insurance underwriting cycles," which best reflect the mature form of Buffett's early investment philosophy.

Sources

  • berkshirehathaway.com《Berkshire Hathaway Shareholder Letter 1977》（1977）↗
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