Buffett's 1998 Shareholder Letter: The Divergence Between Book Value and Intrinsic Value, and the Constraint of Scale on Returns

In his 1998 shareholder letter, Warren Buffett noted that although Berkshire's book value per share increased by 48.3%, this was primarily due to issuing stock for acquisitions. He emphasized that while such transactions instantly boost book figures, they do not result in an immediate increase in intrinsic value, because what is given up and what is received are essentially equal in nature.

This viewpoint reveals the deviation between accounting metrics and economic reality. Buffett reminded investors that what truly matters is the growth of intrinsic value per share, not the inflation of book value. When a company's stock price is significantly higher than its book value, acquiring other companies through additional stock issuance mechanically pushes up earnings per share or net assets, but this does not equate to creating new wealth for shareholders.

Furthermore, Buffett candidly discussed the constraint of scale on investment returns. He explicitly stated that as the capital base becomes excessively large, future yields will be far lower than in the past. He set a target of achieving an average annual growth rate of 15% in the future, frankly calling it "the peak that can be reached," and even acknowledged that years with negative returns could pull down the average.

For current readers, understanding how "scale effects" dilute returns is crucial. Many growth-oriented companies enjoy high compounding in their early stages, but as market capitalization expands, finding sufficiently large investment opportunities becomes difficult. Assuming a small fund achieves a 20% annualized return, its strategy may work when managing one billion dollars in assets, but become unsustainable at a ten-billion-dollar scale. This is not a degradation of ability, but a mathematical necessity.