Warren Buffett is a legendary investor widely recognized for his ability to consistently deliver massive returns to Berkshire Hathaway (BRK.A) (BRK.B) shareholders. His reputation isn’t built on chasing the latest market obsessions, but on a signature investment style: identifying value stocks that offer high dividends and hold durable competitive advantages.
However, as the modern market grapples with high valuations and the “growth at any cost” mentality of the artificial intelligence era, one of Buffett’s most important warnings — stated over four decades ago — has never been more relevant.
In his 1981 shareholder letter, Buffett identified a fundamental flaw in how corporations measure success, warning that managers and investors alike often prioritize the wrong metrics.
Buffett observed that most organizations, whether business-oriented or otherwise, tend to measure themselves and compensate their managers by the “yardstick of size.” He noted that if you ask a Fortune 500 manager where their company stands on that prestigious list, they will almost certainly give you a number based on sales volume.
For the modern investor, the “yardstick of size” is a deceptive measurement. It focuses on how big a company can get or how much its revenue is growing. While high growth looks impressive on a chart, it often hides a grim reality. If a company is spending a fortune on capital expenditure just to maintain those sales, the overall fundamentals of the company may be weak. Growth that eats up all available cash is not growth, it is simply expansion without value.
In contrast to the obsession with size, Buffett’s philosophy centers on companies with sustained profitability. To Buffett, a truly strong company isn’t just large; it is resilient. While at the helm of Berkshire Hathaway, he notoriously avoided overhyped stocks, instead placing capital into companies that are highly profitable. He often looked for “oversold” companies, those that the market has temporarily soured on but which possess strong fundamentals and are likely to return to their fair value.
According to Buffett’s criteria, a profitable winner typically demonstrates strong fundamentals, consistent returns, dividend growth, and controlled volatility.
The AI Dilemma and the Modern Market
Buffett’s 1981 warning is particularly striking when looking at today’s market, which is characterized by high price-earnings ratios and a heavy reliance on artificial intelligence (AI) as a bullish momentum factor.
Currently, most of the Magnificent 7 tech giants have underperformed the broader market year-to-date. Many of these companies are caught in an “AI arms race,” continuously expanding their capex to remain ahead of the competition. This creates a significant risk for investors: If the massive investments in AI do not result in a proportionate increase in profitability, these companies may become risky to invest in.
Berkshire appears to be proceeding with caution. While Buffett made a few recent investments that fit his strict criteria before he stepped down as CEO, Berkshire is currently sitting on a massive cash pile. Perhaps the conglomerate is waiting for the market to move past the hype of “size” and return to the reality of “profit.”
The Bottom Line
As Buffett noted in 1981, “yardsticks seldom are discarded while yielding favorable readings.” When sales are up, managers rarely want to talk about margins. But for the investor, the “yardstick of size” is a distraction. By focusing on fundamental profitability and cutting ties with companies that value expansion over earnings, you can align your portfolio with the logic that made Buffett the Oracle of Omaha.
On the date of publication, Oscar Cierpial did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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