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Warren Buffett of Berkshire Hathaway adjusts his results with unconventional accounting, just like Wall Street bankers and corporate CEOs who he often criticizes for adjusting standard earnings to give a better image.
The difference is that Buffett does not explicitly call the number, but rather that investors focus on an "adjusted EBITDA".
In his latest letter to shareholders, Buffett says his adjustment of the results is far removed from the presentations made by others. Too often, he writes, their presentations present an "adjusted EBITDA," a measure that redefines "profit" to exclude a variety of what Buffett calls "far too real" costs. In particular, Buffett opposes claims that stock-based compensation should not be accounted for as an expense. He adds that restructuring costs are common in companies – Berkshire shareholders see the impact.
However, Berkshire Hathaway
BRK.A, -0.26%
BRK.B, -0.20%
regularly uses certain non-GAAP financial measures. In each period in which it adjusts the losses and gains of its investment portfolio, a routine GAAP expense has become more important to Berkshire Hathaway, with businesses also recognizing the impact of unrealized gains and losses in their business. net profit.
For more information: Why Buffett will keep Berkshire Hathaway's results over the weekend
In its fourth quarter earnings release, Berkshire adjusts GAAP net income by a net loss on its investment portfolio of nearly $ 27.6 billion, as well as a $ 3 billion loss from its equity holdings. in the $ 15 billion reduction in Kraft Heinz's goodwill. intangible assets reflecting the deterioration of the brand value.
Kraft Heinz adjusted its $ 15 billion loss in earnings.
Lily: Why the devaluation of the $ 15.4 billion Kraft Heinz brand was unusual
Generally Accepted Accounting Principles, or GAAP, are the standard accounting rules that all publicly traded US companies must use to present their financial results. According to the SEC, the term "income" refers to the net income reported in the Statement of Income in accordance with generally accepted accounting principles (GAAP) in its updated guidance of May 2016 on the use of non-standard accounting parameters. Measures that are calculated differently from those described as EBIT and EBITDA are expected to be distinguished by a security such as "Adjusted EBITDA".
The SEC asked Berkshire Hathaway in 2017 why she did not disclose expenses related to the amortization of certain intangible assets. In his letter to shareholders, Buffett rationalized last year's move: "We present the data in this way because Charlie and I believe that the adjusted figures more accurately reflect the actual economic expenditures and benefits of the aggregated activities. in the table that the figures established under GAAP ". he said, referring to Charlie Munger, vice-chair of the board.
Berkshire will move away from a metric
For nearly three decades, Buffett opened his letters discussing another measure he loved to praise: Berkshire's book value per share. The carrying amount represents the assets of the corporation less its liabilities and is also referred to as "shareholders' equity" or simply "to have".
Buffett also claims a type of non-GAAP measure he calls "intrinsic value," which is defined as the "present value of money that can be withdrawn from a business for the rest of his life."
In the 2017 letter, Buffet said, "We are giving you the Berkshire book values, because today they serve as an approximate, albeit grossly underrated, measure of the intrinsic value of Berkshire. In other words, the percentage change in the book value in a given year will probably be close enough to the change in the intrinsic value of that year. "
However, Buffett and his partner Charlie Munger never reveal their estimates of the intrinsic value of Berkshire Hathaway, because, they say, this is a very subjective estimate.
"What our annual reports provide, however," wrote Buffett for the 2017 Annual Report, "are the facts we use ourselves to calculate this value."
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Berkshire Hathaway may refrain from disclosing estimates of intrinsic value because the SEC has stated that "free cash flow" statistics, which are non-GAAP, are liquidity measures. The SEC prohibits companies from disclosing per share amounts for liquidity measures.
"Perhaps the intrinsic value has never been criticized as a non-GAAP measure because it was not an input into a valuation model of a company." "It's a business, but of an output," said Ed Ketz, an accounting professor at Penn State University.
Marc Hamburg, Chief Financial Officer of Berkshire Hathaway, did not respond to a request for comment on the company's use of non-GAAP measures or its history of acquisitions.
For more, see: SEC asks companies to pay attention to how they talk about free cash flow
Read: Take-Two Interactive uses a revenue metric that SEC does not calculate bonuses.
"It is now time to abandon this practice," wrote Buffett in his letter this year, citing his discussion of the measurement of book value per share, as he felt that it was no longer relevant.
"Berkshire has gradually become a company whose assets are concentrated in marketable shares in a company whose main value lies in the operating activities," says the letter.
Buffett's previous interest in book value per share and intrinsic value was based on his belief that it was more useful for investors to focus on what he thought acquisitions were worth. But it's after paying a premium that has been accounted for in goodwill, rather than the value that the accounting rules had assigned to it.
Buffett regrets that "although our investments are valued at market prices, the accounting rules require that our collection of operating companies be included in the book value at a much lower level than their present value, an error that has increased in recent years" .
But the other half of his business is commercialized and he is not happy with that either. Indeed, given the size of the portfolio – close to $ 173 billion at the end of 2018 – and its concentration of financial services and technology companies, it "will often experience price fluctuations from one day $ 2 billion or more ". In the fourth quarter, Berkshire Hathaway lived for several days with a "profit" or "loss" of more than $ 4 billion, he writes.
This volatility is now immediately apparent in his results.
Redeem the redemptions
Buffett writes in this year's letter that Berkshire will be a major buyer of his own stock in the future. These transactions will be made at prices in excess of the book value but below its estimate of intrinsic value.
"Over time, however, the price of Berkshire shares will be the best measure of the company's performance," not the book value per share or the mysterious intrinsic value, he concludes.
Paul Zarowin, an accounting professor at New York University's Stern School of Business, told MarketWatch: "If Berkshire Hathaway owns many market-listed assets, it makes sense that it now focuses on price of # 39; action. A new focus on stock repurchases goes in this direction. "
Berkshire's common share buyback program was amended on July 17, 2018, allowing Buffett to redeem its shares for less than the intrinsic value of Berkshire, a "conservative" value determined by Buffett and Munger, the report states. annual. In 2018, Berkshire repurchased for $ 1.3 billion of common shares Classes A and B.
Last June, Buffett and JPMorgan Managing Director Jamie Dimon wrote an article in The Wall Street Journal, criticizing the "unhealthy interest in short-term profits at the expense of strategy, growth and sustainability. long-term ", advocated by companies earnings-per-share forecasts.
Despite his concerns over the excessive focus of the financial markets over the short term, Buffett said Berkshire Hathaway plans to focus on his share price, not his book value per share, in future financial results. .
Professor Zarowin says he tends to give Buffett the benefit of the doubt and not to consider these changes as egoism given his investor status and as a major player in many notable initiatives, such as advocating taxes. higher for the wealthy and make sure that Gates philanthropic foundation Giving Pledge.
"Even a Buffett record holder" can not fight the City Hall. "Everyone is focused on stock prices and Berkshire Hathaway will be lagging behind the market if he does not move with the trends." said Zarowin at MarketWatch.
Read now: The Sanders-Schumer buy-back test would block almost all of the company's stock repurchases
Offers and other offers
Buffett may prefer investors to ignore the volatility of the value of the equity investment portfolio, but he admits his influence should grow rather than diminish.
Berkshire's renowned prowess in making brilliant acquisitions that could distract from investing in equity securities is now a story.
Despite "the hope of transferring much of our excess cash into activities that Berkshire Hathaway will hold permanently," the immediate outlook for this, he writes in this year's letter, is "not good.
"Prices are exorbitant for companies with decent long-term prospects," he said.
The sudden announcement of bad news at Kraft Heinz also calls into question the information provided previously and the prospects for earlier acquisitions.
In 2007, for example, Berkshire Hathaway acquired a 60% stake in Marmon Holdings, the industrial holding company owned by the Pritzker family in Chicago, for $ 4.5 billion. Buffett now owns 99.75% of the company, with the exception of a family-owned fraction, after a series of transactions in which he also criticized the impact of GAAP accounting.
"Our deal was concluded exactly as Jay would have liked – no consultants or studies," Buffett said in a statement in 2007, citing Jay Pritzker, founder of the Hyatt hotel empire of the family and uncle of JB Pritzker, the current governor of Illinois and his sister Penny Pritzker, former trade secretary to President Barack Obama.
In 2012, Buffett was already complaining about the growing challenge of using book value and intrinsic value to measure his company's performance when he talked about accounting for the transaction.
The Marmon deal was one of Buffett's most important acquisitions in recent years. Marmon had more than 125 companies in a wide range of industries and had a turnover of about $ 7 billion at that time. According to Berkshire's latest annual report, it now includes 13 business lines and more than 100 independent manufacturing and service companies.
"Marmon provides an example of a clear and substantial difference between book value and intrinsic value. Last year, I told you that we had bought additional shares in Marmon, bringing our stake to 80% (versus 64% we acquired in 2008). I also told you that accounting under GAAP required us to immediately save the 2011 purchase in our books much cheaper than what we had paid. I now have a year to think about this strange accounting rule, but I have not found a logical explanation yet – and Charlie or Marc Hamburg, our CFO, can not come up with one, "Buffett wrote in 2012.
But Marmon has been struggling in recent years. Berkshire no longer discloses its individual profits, but says in its latest annual report that Marmon's pre-tax profit decreased 5.6% in 2018 compared to 2017, despite a 5.5% increase in revenues, to 8%. , $ 2 billion. Marmon's profit also decreased in 2017 by 3.5% from 2016, despite an increase of $ 305 million in revenues, or 4.1%, according to the publication of this year's annual report.
This is not what Berkshire reported in his 2017 annual report, in which it was said that Marmon's revenues had increased by $ 349 million, or 7%, in 2017 compared to 2016 and that the profit Combined before-tax of Marmon and international metallurgy companies increased in 2017 compared to 2016, due to a combination of increased sales, increased efficiency of manufacturing, the effects of acquisitions of the world's largest metals companies. businesses and ongoing efforts to control expenditures. "
Berkshire first invested significantly in HJ Heinz Holding Corporation in 2013. Berkshire Hathaway holds a 26.7% interest in Kraft Heinz, which is accounted for using the equity method because it is part of of the control group.
"I was wrong in many ways about Kraft Heinz," Buffett told Becky Quick of CNBC on Squawk Box on Monday. "We paid too much for Kraft," he said.
"The impairment of Kraft Heinz's goodwill tends to prove that goodwill is not an asset, but simply a comment on the amount that the acquirer tends to overpay for the acquired company," Ketz said. from Penn State. "If there were real synergies, these losses of value would not occur."
Another big deal
Buffett refuses to throw in the towel on acquisitions, though.
In his letter to the shareholders this year, he writes that Munger and he "continue to hope for an elephant-sized acquisition. Even at our ages of 88 and 95 – I am young – this prospect is what drives my heart and Charlie to beat faster. "
At 88 and 95, it may be better to play more bridge instead.
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