A company's ability to generate incremental returns on capital as well as returns on previously invested capital is what creates value.
Only when $1 is worth more to the company than to the shareholder should profits be kept by the business.
To reword this concept another way, companies need to generate returns on capital that are higher than their cost of capital.
In the 1984 shareholder letter, Buffett stated that he would assess the retained earnings and value creation over a five-year period.
An expert covered this topic in an old blog. He looked at an example of $GOOG between FY12 - FY16.
For every $1 of retained earnings during that period, Google created $4.88 of value, passing Buffett’s test.
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Some famous words of Buffett. I hope it's useful to you. : )
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whqqq : Interesting. But in terms of analysis. Wouldn’t you rather look at earnings than market cap. Google retained 67bn of earnings. How much incremental profit did that generate? That’s the ROIC we should focus on. Market cap is driven by Mr Market which can be all over.