Capital Allocation
Definition & Origin
Capital allocation is the most important responsibility of a CEO - deciding how the money earned by the company should be spent. Buffett believes that most CEOs are experts in operations, but often lack training in capital allocation. This concept was systematically elaborated in the 1983 shareholder letter.
Key Points
- Five options: Reinvest in existing business, acquire new business, pay down debt, buy back shares, issue dividends
- Opportunity cost thinking: Every dollar should be allocated where the return is highest
- Don’t grow for growth’s sake: Rather return capital to shareholders than make low-return investments
- Patiently waiting for a good opportunity: It is more rational to wait for the “fat ball” with a lot of cash than to blindly take action.
Case Studies
- Berkshire’s Capital Allocation: Leverage Float and operating cash flow to continue acquisitions and investments
- Share Repurchases: Large-scale buyback of Berkshire shares after 2018
- Conservative Debt: Always maintain ample cash reserves
Quotes from Buffett
“A CEO who only does well in operations but poorly in capital allocation during his tenure is still an unqualified CEO.” - 1987 Shareholder Letter
Related Concepts
- Compounding — The goal of capital allocation is to maximize compound interest
- Opportunity Cost — Judgment criteria for capital allocation
- Share Repurchases — One of the means of capital allocation
Letters Mentioned
Since the systematic elaboration in 1983, it has been mentioned in almost every shareholder letter since then.