Buffet on Capex

In light of Exxon Mobil’s earnings announcement and continued capital expenditure cuts due to the sinking price of crude oil, I thought it would be a good time to revisit the subject of capex.

Warren Buffett in his 1989 Chairman’s Letter, stated the importance of ongoing re-investment in a business in order for it to continue to grow and remain competitive.

Capital outlays at a business can be skipped, of course, in 
any given month, just as a human can skip a day or even a week of 
eating. But if the skipping becomes routine and is not made up, 
the body weakens and eventually dies. Furthermore, a start-and-
stop feeding policy will over time produce a less healthy 
organism, human or corporate, than that produced by a steady 
diet. As businessmen, Charlie and I relish having competitors who 
are unable to fund capital expenditures.

I’ve heard capital expenditures referred to as the seed corn of future profits and the importance of investing an amount roughly equal to a company’s depreciation on an ongoing basis is vital to the long-term health of that enterprise.

Earnings this year for the S&P 500 are expected to decline approximately 8%, but one way to earn more in a flat or declining revenue year is to curtail the amount of spending necessary to maintain and replace plant and equipment.  Short-term decision making that helps the company meet quarterly expectations can ultimately hurt shareholders the long-run.

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