Notes : Berkshire Annual Letters – 1982/83— October 12, 2013
Operating Earnings / Equity Capital is a good measure of single-year performance of a company / management, however it’s not a accurate measure of performance for a company like Berkshire which has significant capital invested in non-controlled companies and hence cannot include their earnings in their income statement.
( This is similar to how you would calculate the rate of return in your investment in a rental property, total value of the home / ( rent – expenses ) )
Earning Reporting as per GAAP –
- Companies report earnings of companies they own more than 20% of outstanding shares proportionately
- Companies report dividends only if they own less than 20% of companies in their income stmt
Look Carefully : for companies which have good stakes in companies , but have less than 20% , as they might have hidden earnings others are not seeing . However from a tax standpoint, the advantage of such earnings is immense, since we don’t have to pay taxes and should not pay taxes on earnings we did not receive.
Managers & Investors should understand that the accounting numbers are the beginning not the end of valuation
Focus on “economic earnings” not “account earnings”, which is dividends
Pascal – All men’s misfortunes are due to their inability to stay quietly in one room
We should think about this quote form Warren Buffet, when ever we are trading anything including our time for money or other stuff, also when we are buying stuff… we are always giving something when we get something.
In a trade what you are giving is just as important as what you are getting.
When a company A acquires Company B for stocks, you should translate the transaction as , shareholders of Company B own part of Company A, by giving up their complete ownership of company B. The winner in this deal is the shareholder of the company who’s company was selling below fair value. Add to this the fact that a majority of acquisitions (specially large ones ) fail to produce the desired outcome for it’s shareholders… you will start being very skeptical about acquisitions.
Buffet’s checklist for buying businesses :
- Demonstrated consistent earning power ( future projections are of little use and we don’t believe in turn-around situations )
- Earning good returns on equity (ROE) with little or no debt ( i.e ROIC )
- Good & trustworthy management
- Simple business
- Good Price
- Can I compete and win with the business under consideration, assuming I had capital and personal needed.
Economic , Social Goodwill & Intangibles:
- Any business that requires some tangible assets to operate ( almost all do) is hurt by inflation. Businesses needing little in the way of tangible assets are simply hurt the least. – Hence look for business with durable intangible assets ( example patents, strong brands, products etc )
- Asset-heavy businesses generally earn low rates of interest and barely provide enough capital to fund inflationary needs.
- During inflation “intangible” assets are a gift that keeps giving. True Intangibles = Economic Goodwill
Valuation of Business based on GoodWill / Intangibles :
- Analysis of Operating Results : What a business can be expected to earn on unleveraged net intangible assets , excluding any charges against earnings for amortization of goodwill is the best guide to economic attractiveness of the operations & current value of economic goodwill
- Wisdom of business acquisition : Amortization of goodwill should be ignored. They should be neither deducted from earnings not from the cost of the business.
A good Business is not always a good purchase.
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