1999: Does Buffett still think American corporations will average 13% ROE?

AUDIENCE MEMBER: My name is Jonathan Brandt. I’m from New York City.

Warren, you wrote in 1977 that the return on equity and growth of book value for corporate America tended towards, and averaged, about 13 percent, no matter the inflation environment.

After properly expensing options and so-called non-recurring charges and taking into account the high price-earnings ratio paid for increasingly frequent acquisitions, do you think that 13 percent figure is still roughly correct?

Also, what quantitative method would you suggest that investors use for expensing the option grants of publicly traded firms where there is no realistic prospect for the substitution of such an options program with a cash-based performance incentive plan?

In other words, how do you derive the five to 10 percent earnings dilution referred to in this year’s Berkshire’s annual report? And is it possible that the dilution figure could be even higher than that? Thank you.

WARREN BUFFETT: OK. Thanks, John. Just like Martin Wiegand, Jon Brandt is the son of a very good friend of mine, where we worked together for decades. And Jon is now an analyst with Ruane Cunniff and a very good one.

He also — he says it didn’t happen this way. But when he was about four years old, I was at his house for dinner with the parents. And he suggested to me, after dinner, he said, “How about a game of chess?”

I looked at this four-year-old. I thought, you know, “This is the kind of guy —”

I said, “Should we play for money?” (Laughter)

And he said, “Name your stakes.” So, I backed off, and — (laughter) — we sat down.

And after about 12 moves, I could see I was in mortal trouble. So, I suggested it was time for him to get to bed. (Laughter)

The question about return on equity, it’s true. Back in 1977, I believe, I wrote an article for Fortune and talked about this, more or less, this figure of 12 or 13 percent that return on equity kept coming back to, and explained why I didn’t think it was affected by inflation, which was a hot topic of the day very much.

And it wasn’t. But in recent — in the last few years, earnings have been reported at very high figures on the S&P, although you’ve had these very substantial restructuring charges, which every management likes to tell you doesn’t count.

I love that, when they, you know, they say, “Well, you know, we earned a dollar a share in total last year, but look at the two dollars a share that we tell you we really earned. The other dollar a share doesn’t count.” And then they throw in mistakes of the past or mistakes of the future. And every three or four years, ask you to forget this as if it doesn’t mean anything.

We’ve never had a charge like that that we’ve set forth in Berkshire and we never will.

It isn’t that we don’t have things we do that cost us money in moving around. But we do not ask you to forget about those costs.

The report — even allowing for options costs and restructuring charge and everything, return on equity has been surprisingly — to me — surprisingly high in the last few years.

And there’s a real question in a capitalistic society whether if long-term rates are 5 1/2 percent, whether return on equity can be, across the board, some number like 18 or 20 percent.

There’re an awful lot of companies out there that are implicitly promising you, either by what they say their growth in earnings will be, or various other ways, that they’re going to earn at these rates of 20 percent-plus. And, you know, I’m dubious about those claims. But we will see.