§
197.]
1997]
THE ESSAYS OF WARREN BUFFETT
179
I made a similar statement in our 1983 Annual Report about
the Goodwill attributed to See's Candy, when I used that company
as an example in a discussion of Goodwill accounting. At that
time, our balance sheet carried about $36 million of See's Good-
will. We have since been charging about $1 million against earn-
ings every year in order to amortize the asset, and the See's
Goodwill on our balance sheet is now down to about $23 million.
In other words, from an accounting standpoint, See's is now
presented as having lost a good deal of goodwill since 1983.
The economic facts could not be more different. In 1983, See's
earned about $27 million pre-tax on $11 million of net operating
assets; in 1995 it earned $50 million on only $5 million of net oper-
ating assets. Clearly See's economic Goodwill has increased dra-
matically during the interval rather than decreased. Just as clearly,
See's is worth many hundreds of millions of dollars more than its
stated value on our books.
We could, of course, be wrong, but we expect GEICO's grad-
ual loss of accounting value to be paired with increases in its eco-
nomic value. Certainly that has been the pattern at most of our
subsidiaries, not just See's. That is why we regularly present our
operating earnings in a way that allows you to ignore all purchase-
accounting adjustments.
In the future, also, we will adopt a similar policy for look-
through earnings, moving to a form of presentation that rids these
earnings of the major purchase-accounting adjustments of inves-
tees. We will not apply this policy to companies that have only
small amounts of goodwill on their books, such as Coca-Cola or
Gillette. We will extend it, however, to Wells Fargo and Disney,
which have both recently made huge acquisitions and are conse-
quently dealing with exceptionally large goodwill charges.
Before leaving this subject, we should issue an important
warning: Investors are often led astray by CEOs and Wall Street
analysts who equate depreciation charges with the amortization
charges we have just discussed. In no way are the two the same:
With rare exceptions, depreciation is an economic cost every bit as
real as wages, materials, or taxes. Certainly that is true at Berk-
shire and at virtually all the other businesses we have studied. Fur-
thermore, we do
not think so-called EBITDA (earnings before
interest, taxes, depreciation and amortization) is a meaningful
measure of performance. Managements that dismiss the impor-
tance of depreciation-and emphasize "cash flow" or EBITDA-
180
CARDOZO LAW REVIEW
[Vol. 19:1
are apt to make faulty decisions, and you should keep that in mind
as you make your own investment decisions.
D.
Owner Earnings and the Cash Flow Fallacy
50
[Many business acquisitions require] major purchase-price ac-
counting adjustments, as prescribed by generally accepted account-
ing principles (GAAP). The GAAP figures, of course, are the ones
used in our consolidated financial statements. But, in our view, the
GAAP figures are not necessarily the most useful ones for inves-
tors or managers. Therefore, the figures shown for specific operat-
ing units are earnings before purchase-price adjustments are taken
into account. In effect, these are the earnings that would have been
reported by the businesses if we had not purchased them.
A discussion of our reasons for preferring this form of presen-
tation [follows.
It]
will never substitute for a steamy novel and def-
initely is not required reading. However, I know that among our
6,000
shareholders there are those who are thrilled by my essays on
accounting-and I hope that both of you enjoy [it].
First a short quiz: below are abbreviated
1986
statements of
earnings for two companies. Which business is the more valuable?
50
[Divided
by
hash lines: 1986; 1986 Appendix]
1997]
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