Buffett on How Earnings and Assets Can Be Misstated



As I said last year, Warren Buffett’s annual letter to Berkshire Hathaway (BRK.B) shareholders is on my must-read list, and I suggest adding it to yours as well. His letters always provide investing insights written in Buffett’s folksy but outspoken manner. This year’s letter was no different. Though the media focused on the what the “Oracle of Omaha” said about productivity and the U.S. economy, a significant portion of the commentary was devoted to how earnings and assets can be misstated.

This may sound like heady accounting stuff, but it has implications for how you view a company’s earnings and its balance sheet. An understanding of how assets, shareholder equity and earnings can be overstated (or understated) will help to you know when to be skeptical of the metrics a CEO wants you to focus on.

There are two big types of noncash charges you will see. I’ll start with depreciation and then move onto amortization. Depreciation is a charge taken to reflect the decrease in value a physical asset incurs. For example, say a firm buys one of its new employees (Jimmy) a cocobolo desk. Accounting rules require that a certain percentage of that desk’s value be deducted each year. These charges count against earnings, but because checks are not being written to cover the charge, the charges do not count against cash flow. Depending on how gentle or tough Jimmy is on the desk, it may retain or lose more value than the depreciation charges imply. I’ve seen fully depreciated assets that could be still be sold. On the other hand, depreciation can understate the amount a company has to truly spend on equipment and machinery. As Buffett observed: “The depreciation charge we record in our railroad business falls far short of the capital outlays needed to merely keep the railroad running properly.”

Read more »

 More on AAII.com

Not an AAII member? Join today

AAII Sentiment Survey

Optimism about the short-term direction of stock prices rose above 30% for the first time since Thanksgiving. Pessimism, meanwhile, fell to its lowest level of 2016. More about this week’s results.

AAII Asset Allocation Survey

Stock and stock fund allocations declined to a three-year low as investors boosted their cash allocations to a three-year high. More about the latest results.

What’s Trending on AAII

  1. 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses
  2. Six Questions With John Bogle
  3. The 10 Myths of Retirement Planning

The Week Ahead

Just two members of the S&P 500 are scheduled to report earnings next week: Urban Outfitters (URBN) on Monday and Dollar General (DG) on Thursday.

There isn’t much on the economic calendar. Beyond February import and export prices (which will be released on Friday), the only reports of note will be weekly oil inventories and weekly initial jobless claims. The latter two are released every Wednesday and Thursday, respectively.

Federal Reserve Vice Chair Stanley Fischer will speak on Monday.

The Treasury Department will auction $24 billion of three-year notes on Tuesday, $20 billion of 10-year notes on Wednesday and $12 billion of 30-year notes on Thursday.

Read more »

AAII is a nonprofit association that provides you with member benefits, tools and services all designed to help increase your investment wealth. With membership, you’ll receive the monthly AAII Journal—our most popular benefit. Topics covered include financial planning, retirement issues, taxation, fund and stock selection, stock screening and a host of timely investment ideas and concepts that you’re certain to benefit from. Forbes Magazine says, “The AAII Journal is a thoughtful mix of investment professionals’ views” and that “the $29 a year it costs to belong to AAII is a bargain.” Join AAII and See the New March Issue!



Leave a Reply

Your email address will not be published. Required fields are marked *