Buffett on Retained Earnings and Capital Allocation

Buffett explains why CEOs must learn to be excellent capital allocators: (1) Profitable companies generate cash that must be deployed, and (2) seeking outside assistance generally makes matter worse. From a 1987 letter to shareholders:

The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.

CEOs who recognize their lack of capital-allocation skills (which not all do) will often try to compensate by turning to their staffs, management consultants, or investment bankers. Charlie and I have frequently observed the consequences of such “help.” On balance, we feel it is more likely to accentuate the capital allocation problem than to solve it.

retained earnings Warren Buffett
Source: Warren Buffett | "Chairman's Letter" | Berkshire Hathaway Annual Letter | 12/31/1987 | Visit