Don’t lose sight of the long term. It’s a core message from the eighth edition of Valuation: Measuring and Managing the Value of Companies, McKinsey’s seminal guide for corporate-finance professionals. It also describes the unique investment approach of the legendary investor Warren Buffett, who will step down as CEO of Berkshire Hathaway at the end of 2025. In this episode of The McKinsey Podcast, we hear an excerpt from our Author Talks series featuring Valuation coauthor and McKinsey Partner Tim Koller and Editorial Director Roberta Fusaro. They talk about what’s changed in the business world since the first edition of Valuation was published, some 35 years ago, and touch on Buffett’s approach to investing, including why it worked and whether it can be replicated.
The McKinsey Podcast is cohosted by Lucia Rahilly and Roberta Fusaro.
The following transcript has been edited for clarity and length.
What’s new on McKinsey.com
Lucia Rahilly: We have a couple of timely podcasts on McKinsey.com. The first relates to the ongoing uncertainty about current geopolitical dynamics and the tariff landscape and explores how leaders can navigate global trade shifts. The second is a piece of research from the McKinsey Institute for Economic Mobility and covers innovative solutions to the affordable-housing crisis. That’s obviously always a relevant and serious topic, but it’s particularly interesting right now given the recent news that, for the second straight year, Los Angeles has reported a decline in the number of people who are unhoused.
The tried-and-true long-term view of Warren Buffett
Roberta Fusaro: Warren Buffet recently announced that, after 60 years, he’s stepping down as CEO of Berkshire Hathaway at the end of the year. Talk to me about his legacy. What impact has he had on the business world?
Tim Koller: His legacy is more about his courage to think independently and to invest that way, not necessarily in the latest trend or fad. He took a very long-term view and thought about the long-term economics of a particular business and whether they were based on facts and analysis, and about the ability of a business to generate cash flow.
Roberta Fusaro: Why did this long-term view work for Warren Buffett?
Tim Koller: It’s successful not only for him. We studied this and found that companies that take a long-term approach outperform over a longer period. When we look at well-known companies, we see that a lot of them fall into a short-term trap. They do well for a while, and then they find that to keep their profits and cash flow growing, they must focus on short-term cost cutting, which customers notice and which is eventually bad for the long-term growth of the business. These are well-known, well-respected companies that eventually run into difficulties because they don’t adjust to the times and to what the long-term trends are.
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Roberta Fusaro: Buffett spoke out against the situation going on with global trade. How does that jibe with his investing approach?
Tim Koller: That is an unusual circumstance, where he’s commenting on policy issues and talking about the economy. Usually, when he does that, like when he’s talking about global trade, he’s reinforcing what many thoughtful economists would be saying.
Very few economists would say that free trade—or mostly free trade—is a bad thing and that tariffs and other things distort. He’s not saying something unique, he’s just making it more visible than it would be otherwise.
Roberta Fusaro: Tim, what’s the one key takeaway for you from Warren Buffett’s career?
Tim Koller: The one key takeaway is being an independent thinker. What I mean by that is looking at the facts objectively and looking very dispassionately at what’s going to happen in the longer term in terms of the quality of a company’s products, the trends in the industry, and so on. Whether you’re an investor or an executive, make decisions based on that and not on trying to go against the market. If consumers are changing their behavior, you can’t pretend it’s not happening. You need to move more quickly than most companies are willing to move.
Valuation—then and now
Roberta Fusaro: Tim, this is the eighth edition of Valuation. Looking back to the first edition, why did you and your coauthors want to write this book originally?
Tim Koller: We never set out to write a book. In the late ’80s, we started the McKinsey Corporate Finance Practice, and we wanted to ensure that McKinsey consultants around the world were doing rigorous, high-quality financial analysis the same way. There were no books or materials of the standard that we felt was important, given the level of detail and rigor needed. So we wrote a manual for McKinsey consultants on how to do valuations.
It was a three-ring binder—I still have a copy of it. We never intended it to be a textbook, but it’s now become a textbook at leading business schools, and we keep adding more content as we learn more.
Roberta Fusaro: You’ve said many times that the principles of valuation don’t really change, the world does. How does this book help business leaders deal with that change?
Tim Koller: We found that when people overly focus on what’s going on in the world and forget about the principles of valuation, they make poor decisions. I remember back around 1999 and the dot-com bubble, people were talking about a new economy where principles—not just of valuation but of economics—wouldn’t apply anymore.
There was a so-called new economy at the time and a belief that if you just got big fast, you would eventually make big profits, regardless of the industry. Electric utilities were buying power plants around the world with no synergies.
Almost all companies that did that went out of business because there was no economic logic to any of the actions. Size did not bring any benefits. Sometimes size leads to complexity. Whenever we’ve been in those kinds of situations, I find that looking back to valuation principles helps me better understand what’s going on and where the future may lead us.
Right now, for example, there are a handful of companies with enormous valuations—well over a trillion dollars. One of the things I’ve learned over the years is to ask, “What do you have to believe in order for those values to be justified?”
We can then analyze and say, “OK, are these numbers reasonable? What might be driving those valuations up, and are they sustainable?” These principles really do help me understand the world. Whatever geography it is, whatever time it is, I always go back to these valuation principles to help me understand what’s going on and to think about how that might play out in the future.
Looking longer term
Roberta Fusaro: What is the most misunderstood concept of valuation?
Tim Koller: What business leaders most often get wrong—today and 35 years ago, when we wrote the first edition of our book—is that they believe the stock market is focused only on short-term earnings, and they look at accounting earnings or earnings per share as a primary metric when making strategic decisions. They are often too short-term oriented because they believe the market demands that.
Our research has shown that there are a lot of long-term investors out there. In fact, if you add together index funds, retail investors, and long-term institutional investors, they probably account for 75 percent of the market, yet it’s these short-term investors who are very noisy. They ask lots of questions. They’re looking for what’s going to move the share prices in the short term. Executives and boards of directors often think they’re the ones who drive the market. But the evidence shows that’s not the case.
We encourage companies to be more long-term oriented—to focus on growth and innovation, for example, rather than trying to increase profits by cutting costs. The focus on earnings, in particular short-term earnings, is still the biggest misconception that we battle with all the time.
Managing through uncertainty
Roberta Fusaro: What are the top two or three issues facing business leaders today?
Tim Koller: If I’m an executive, the right way to think about that question is to ask, “What is out there that’s going to affect my company and over what time frame?” For example, I was talking to a senior executive of a large grocery retail chain. This was a couple years ago, when there was a lot of concern about a recession, and they were considering cutting back capital expenditures. Through our conversations, we found out it typically takes two to three years to build a new store, and yet the typical recession lasts only 12 months or less. Turns out the time frame of many investments is longer than a recession. So if you don’t make that investment today, two or three years from now you may be behind. And all our research says that recessions are often the best time to make investments.
Another thing in the case of the grocery chain—once again, it’s a question of, “Do we think about it at the aggregate level, or do we think about it more at a micro market level?” One of the big issues, for the US and for many other countries in Europe and Asia, is the growth of the federal debt, which keeps growing. We’re almost at a point where we’re spending more on interest than on defense. And eventually, that’s not sustainable. The typical solution most countries resort to as a way of reducing the value of the debt is to print money, which leads to inflation. So thinking about how to deal with inflation is certainly one of the issues I would be concerned about if I were a senior executive.
The other one is sustainability, or climate change. But, once again, it’s a matter of how it affects my company and my industry. What are the issues that I’m going to face? Some companies are big emitters of carbon, so they have more direct concerns. Some have indirect concerns, and some have other types of concerns. Figure out what really matters and what the magnitude is for you instead of trying to do the same thing that everyone else is doing.
Companies don’t always do a good job of communicating to investors about how these issues affect their company specifically and what they’re doing about it. Instead, they panic or try to deal with—or talk about—every single thing under the sun instead of focusing on what’s relevant to their company.
Making better decisions
Roberta Fusaro: You and your coauthors have written a lot about biases in decision-making. How should executives think about bias and its effect on their decisions?
Tim Koller: About ten years ago, I became interested in cognitive biases and how they affect decision-making because I observed that companies were not doing a very good job of executing against their strategies. There’s a massive body of literature now on cognitive biases in decision-making, but almost all of it deals with individual decision-making, not organizational decision-making.
I had the opportunity to have dinner with Daniel Kahneman. He and his partner Amos Tversky were the pioneers in this whole area. I asked Daniel, who had won the Nobel Prize in economics, how we can overcome these biases. He said he didn’t have any confidence in the ability to change people’s biases, but he said organizations can put rules and processes in place to help overcome those biases.
I found that striking, and that’s how we’ve been trying to think about biases: “How do you overcome biases?” For example, one of the biases that many large companies have is loss aversion. They weigh losses much more than gains. As a result, they’re unwilling to undertake investments that are risky but that may have massive payoffs. One of the techniques you can use is to look at investments as part of a portfolio, rather than the risk of an individual investment. You find that when you look at your portfolio projects, the overall risk is a lot lower.
Another example is group thinking. A lot of companies don’t have a very strong debate culture. As a result, you have to take some actions to almost force a debate. You can do things like assigning someone to be a devil’s advocate. You can ask people at the beginning of a meeting to have a secret ballot so you can get a sense of where they are leaning and if others are leaning in the same direction, which gives people the confidence to speak up.
Another big bias that companies have is confirmation bias, which involves looking for data that confirms what they want to believe rather than disconfirming it. You need techniques to help overcome that. One technique is called a premortem, which involves forcing yourself to analyze all the things that could go wrong.
I recently had a conversation with someone about AI and whether it can help with this. Some experts have said, “Yes, you could have AI listening in on a meeting and identifying biases.” Maybe the head of the meeting is dominating the discussion and not getting input from other people. AI could identify confirmation bias in real time. The biggest roadblock is whether companies or executives are willing to let a technology tool tell them they’re doing something wrong.
Weighing geopolitical threats
Roberta Fusaro: Geopolitics is very much in the news today. How can it affect valuations?
Tim Koller: It’s all about digging underneath the surface. Yes, geopolitics does enter into valuations, but investors are smart enough to figure out how material those issues are to a specific company.
If a company is particularly vulnerable to, say, its supply chain in China, the market does reflect that investors will pressure managers to diversify their supply chain. Investors know what’s going on, but they try to be as specific as possible in understanding what the risks are and how they will affect individual companies, what companies might do about that, and how companies can better prepare for those risks.
Do they have contingency plans? Do they take action ahead of time? So, yes, there is an impact, but it is very focused on individual companies or industries and not a massive discount in the market because of geopolitical concerns.
Roberta Fusaro: Tim, this is a perennial issue, and I know you’ve talked a lot about it: How can companies balance shareholder expectations for the short and long term?
Tim Koller: It’s important to understand that, once again, it’s a question of short-term versus long-term value creation. I can do things to pump up my share price in the short term— I can cut costs, for example. And let’s suppose that I cut costs. I fire a bunch of employees who are maybe important in the long term, but if you reduce the quality of the product or the quality of the service, and so on, you might boost your short-term profits, but eventually, everybody will lose.
The market may not understand it, because it’s sort of hidden from them, but a couple of years down the road, customers will be unhappy, employees will be unhappy, and shareholders will be unhappy. I’ve seen it happen.
Cutting costs is never a way to succeed. In all my years, I’ve never seen a company that has successfully cut costs. They can do it for four, five, six years sometimes, but eventually it comes back to haunt them, and they find their growth is below their market. Then they must scramble to figure out how to fix the issue, if they can even fix it.
We need to shift the conversation away from short-term share price to, “How do I balance the needs of different stakeholders over the long term?”
Roberta Fusaro: How does it work, then, if companies keep those employees who are important for the long term?
Tim Koller: It doesn’t mean you need to overpay your employees at the expense of shareholders. You want to pay them enough so that they are loyal to you and they’re satisfied, but you don’t need to go beyond that. Same thing with the prices you charge your customers. You could always provide more benefits to customers by lowering prices and lowering profits and returns to shareholders. But if they’re satisfied and they’re happy and they’re buying your products, you don’t need to lower the price more than the amount that helps you to maximize shareholder value. You need to get the balance right.
Another area where it’s important to get the balance right in terms of the environment and stakeholders is with the broader community. The decisions there, once again, are difficult because they are not always straightforward. Who is responsible? What is the role of the government versus companies? An example of that might be in the chemical world. People are concerned about the impact of plastics on the environment, and yet, if I’m a chemical company, should I just stop making certain plastics?
People have analyzed this and found that certain plastics, for example, are essential for food preservation. Right now, we don’t have many alternatives, so the negative impact of plastics on food preservation should be weighed against the positive impacts, one of which is that it’s important for feeding people around the world.
It’s a tough balancing act to be undertaken by executives. It’s never a good thing to purposely pollute. As an economy, we mitigate pollution or greenhouse gas emissions at the level where the costs are the least. And we need to figure out ways to do that.
Timeless traits of effective CEOs
Roberta Fusaro: Would a great CFO or CEO from 1990, when the first edition of Valuation was published, be a great CFO or CEO today? Or are there too many uncertainties in the world for them to thrive?
Tim Koller: First of all, I’m not convinced that the uncertainty level today is much higher than it’s always been. We’ve always thought that whatever time we are in is the highest level of uncertainty. If I look back over my career, the highest level of uncertainty I ever experienced was before my career started, in the late ’70s, when we had both inflation and unemployment in the US, and there was tremendous uncertainty about how we were going to fix that.
It was painful, probably more painful than anything we’re experiencing right now. But that said, I don’t think the characteristics of a great CEO have changed. Great CEOs have to be good strategists, which means understanding in detail the economics of their businesses and being able to make courageous, long-term decisions about what to do.
“If a business is declining, should I shut it down? Should I sell it? If there’s a new opportunity, should I invest in it? How much do I invest in it?” A lot of companies see opportunities, but they don’t invest enough to really be winners.
The winners are often the small companies that don’t have any baggage. Be confident enough to be a contrarian at times. If we look back at Warren Buffett, he’s successful because he’s been a contrarian. If I look at the banks that survived the financial crisis more successfully, they didn’t jump on the mortgage-backed-securities bandwagon. They pulled back because they said, “This doesn’t make sense.” They were courageous enough to go against conventional wisdom. Talent management is another big skill; how to motivate people. Those are all skills that have always been important for CEOs.
Roberta Fusaro: What’s been most surprising about your work on this project?
Tim Koller: I came out of the University of Chicago with an MBA in 1981. I was a firm believer in market efficiency, almost to the extent of market perfection, that the stock markets couldn’t do any wrong. What I’ve learned over the years is that the stock market is very good at valuing companies for the most part, but there are times when the stock market gets it wrong.
Now I know why it gets it wrong. And the reason is because when you learn about the theory, you think people can buy and sell just as easily. So you have buyers and sellers balancing each other out. What we find in real life is that there are times in certain stocks—not for the market as a whole—where a group of investors might be buying without doing any of the numbers. They’re excited because the company is in the news. Well, that pushes up the share price. Then you’ve got professional traders who trade on momentum pushing up the share price. Then you’ve got big funds that are concerned they don’t have those hot stocks in their portfolios, so they buy the shares.
All these things push up the share price. And it’s very difficult—or risky—to be a short seller, to move in the opposite direction. There aren’t enough of them, and it’s very expensive and risky. So that’s how we end up with bubbles in stocks from time to time.
They always go away, but now I understand why they come about. For example, right now if you look at the seven largest companies by market cap, you see that the ownership of their shares is very different from that of the rest of the 500 companies.
They have about twice as many retail investors, individual investors, as most other companies. To me, retail investors typically don’t get their computers out and build a spreadsheet to figure out whether they should buy a company’s shares or not.
They buy it based on what people are saying, what the news says, or whether it’s going up or not. So when you have a lot of retail investors in a stock, that’s typically a sign that maybe there’s an imbalance in the way the stock is being traded and to be cautious about that. One of the things I’ve learned: Markets are not as perfect as I thought they were.
