Different companies, depending on their cash flows, can manage different levels of debt. What Buffett does tell us is that a good business should be able to earn a good return on equity without the aid of leverage. Investors should be wary of companies that can earn good returns on equity only by employing significant debt. Coca-Cola In Strategy for the 1980s, his plan for revitalizing the company, Goizueta pointed out that Coca-Cola would divest any business that no longer generated acceptable returns on equity. Any new business venture must have sufficient real growth potential to justify an investment. Coca-Cola was no longer interested in battling for share in a stagnant market. Increasing earnings per share and effecting increased return on equity are still the name of the game, Goizueta announced.3 His words were followed by actions. Coca-Colas wine business was sold to Se

Although the company earned a respectable 20 percent return on equity during the 1970s, Goizueta was not impressed. He demanded better returns and the company obliged. By 1988, Coca-Colas return on equity had increased to 31.8 percent (see Figure 7.1). Figure 7.1 The Coca-Cola Company return on equity and pretax margins. 112 THE INVESTOR WAY By any measurement, Goizuetas Coca-Cola was doubling and tripling the financial accomplishments of the previous CEO. The results could be seen in the market value of the company. In 1980, Coca-Cola had a market value of $4.1 billion. By the end of 1987, even after the stock market crash in October, the market value had risen to $14.1 billion (see Figure 7.2). In seven years, Coca-Colas market value rose at an average annual rate of 19.3 percent. The Washington Post Company When Buffett purchased stock in the Washington Post in 1973, its return on equity was 15.7 percent. This was an average return for most newspapers and only slight

But within five years, the Posts return on equity doubled. By then, it was twice as high as the S&P Industrials and 50 percent higher than the average newspaper. Over the next ten years, the Post Company maintained its supremacy, reaching

3 percent return on equity in 1988. These above-average returns are more impressive when you observe that the company has, over time, purposely reduced its debt. In 1973, long-term debt to shareholders equity stood at 37.2 percent, the second highest ratio in the newspaper group. Astonishingly, by 1978, Katherine Figure 7.2 The Coca-Cola Company market value. Investing Guidelines: Financial Tenets 113 Graham had reduced the companys debt by 70 percent. In 1983, longterm debt to equity was a low 2.7 percentone-tenth the newspaper group averageyet the Post generated a return on equity 10 percent higher than these same companies. OWNER EARNINGS Investors, Buffett warns, should be aware that accounting earnings per share represent the starting point for determining the economic value of a business, not the ending point. The first point to understand, he says, is that not all earnings are created equal.4 Companies with high assets to profits, he points out, tend to report ersat