In addition to all of the other things Warren Buffett is great at, he writes a pretty impressive Chairman's Letter. In it, he is known to reiterate a critical part of his investing strategy: Buy quality businesses that earn big returns at the right price -- even if they aren't publicly traded.

It's the returns, stupid
Berkshire Hathaway
(NYSE:BRK-A) is really a simple business, despite its complexities. The goal at Berkshire is to take low-cost (sometimes negative-cost) capital and allocate it intelligently to high return investments. If the spread is high and persists for a long time, every dollar allocated creates value. I think that's a big part of what Eddie Lampert learned from studying Buffett.

Buffett's success with stock-market investments is well known. We're not going down that road today; we've traveled it many times. A less publicized part of Berkshire's success comes from buying whole companies. Companies such as Dairy Queen, Nebraska Furniture Mart, Fruit of the Loom, and MiTek live in its manufacturing, service, and retailing-operations neighborhood.

These businesses are very different from each other. They serve different customers, make different products, and sell things in many different ways. Yet despite all of these differences, they tend to have one thing in common: They earn high returns on average net tangible worth, or RANTW.

Here's the equation for RANTW.

RANTW = Net Income/ (Average Equity - Average Goodwill)

What does RANTW measure? I am glad you asked. It measures the returns that managers create using the "real" assets to operate the business. Goodwill is not included in this measure. You can hold a piece of inventory or a receivable contract. I am not sure what goodwill would look like.

Being the nice guy that he is, Buffett provides all of the data needed to make the calculation. I've copied the data from the past Chairman's Letters and put them in the table below, with numbers in millions.















Net Income










Return on Equity





*Number supplied by Buffett; complete data not available.

Another day, another 20%
Two things from the table jump out at me.

First, I know my RANTW numbers for 2004 and 2006 are off by 0.1 as compared with Buffett's results. But I am confident that my calculations are correct.

Second, returns are increasing. Thus, it looks as though Buffett continues to find great places to put new capital. For those out there who think Buffett has lost his magic touch, this is a counterargument that Buffett may be actually getting better with age.

Finally, Berkshire's operating businesses create tons of value. Let's estimate that the cost of capital is 5%. I realize it is probably lower, but I just want to illustrate a point. If roughly $8.5 billion of average tangible assets generated a return of 25.1% at a cost of 5%, then they created $1.7 billion of value. If that value creation persists and grow, Berkshire shareholders will certainly be rewarded.

Looking at all the numbers, we see that returns have not been juiced with high levels of debt. Over the period in the table, the average debt-to-equity ratio is a modest 20%. With the cash these businesses generate, that number could be considerably higher, and a higher number would mean increased returns. Still, Buffett remains conservative with his debt use, since there doesn't appear to be a need to turbocharge returns. Buffett's got plenty of power.

Buffett has clearly honed his skills over the year, and his strategy works. Acquire some low-cost capital, allocate it to a business that earns high returns, and watch value increase. Lather, rinse, repeat.

This is where I have to control my envy.

Using Buffett's wisdom
I decided to create a simple screen to find other companies that meet the master's criteria: RANTW greater than 20% and a debt-to-equity ratio less than 30%.

The screen started with 6,581 companies and ended up with 36 names. Yes, 0.5% of the businesses in the screening universe made the cut. Some of the great ones included Johnson & Johnson (NYSE:JNJ), Nike (NYSE:NKE), Automatic Data Processing (NYSE:ADP), Coach (NYSE:COH), Lexmark (NYSE:LXK), and Biomet (NASDAQ:BMET). That's a pretty diverse group, too.

These are certainly great businesses, but they have not all made for great investments over that time period. That's because, as Buffett also reminds us, it takes more than just a great business to make a great investment. You have to buy it at the right price. That's what makes Buffett's Chairman's Letters so great. They give straightforward advice on investing, offer a deeper look into how great managers help great businesses fire on all cylinders, and make us laugh a bit along the way. So forget searching for quick changes in stock prices. Invest in great businesses that generate high returns, pay a smart price for a piece of the action, and watch your wealth grow.

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Retail editor David Meier loves learning from great investors. There's no sense reinventing the wheel. He owns shares of Nike but in none of the other companies mentioned. He is currently ranked 582 out of 24,488 investors in The Motley Fool's CAPS rating service. You can view his TMF profile here. Johnson & Johnson is an Income Investor recommendation. The Fool takes its disclosure policy very seriously.