Warren Buffett Torches Corporate America, Spells Doom for Stock Market announces the headline of a recent CCN.com commentary
The article says: “Buffett’s 2019 letter is soaked through with his conviction that much of corporate America’s numbers are fake. He begins with the same admonition in his 2018 letter against the new Generally Accepted Accounting Principles (GAAP) rule for reporting unrealized capital gains and losses. He thinks this causes companies to report faulty numbers.”
I don’t think though that this accurately represents the key passage in question:
- Now, Berkshire must enshrine in each quarter’s bottom line – a key item of news for many investors, analysts and commentators – every up and down movement of the stocks it owns, however capricious those fluctuations may be.
- Berkshire’s 2018 and 2019 years glaringly illustrate the argument we have with the new rule. In 2018, a down year for the stock market, our net unrealized gains decreased by $20.6 billion, and we therefore reported GAAP earnings of only $4 billion. In 2019, rising stock prices increased net unrealized gains by the aforementioned $53.7 billion, pushing GAAP earnings to the $81.4 billion reported at the beginning of this letter. Those market gyrations led to a crazy 1,900% increase in GAAP earnings!
- Meanwhile, in what we might call the real world, as opposed to accounting-land, Berkshire’s equity holdings averaged about $200 billion during the two years, and the intrinsic value of the stocks we own grew steadily and substantially throughout the period.
- Charlie (Munger, Buffet’s long-time partner) and I urge you to focus on operating earnings – which were little changed in 2019 – and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized.
Buffett’s displeasure at the new rule is plain enough (and one Twitter user commented that “if he dislikes GAAP, IFRS must be affront to his sensibilities”), but there’s a difference between “fake” and “capricious.” Indeed, if you take another CCN-cited passage from his letter:
- Audit committees now work much harder than they once did and almost always view the job with appropriate seriousness. Nevertheless, these committees remain no match for managers who wish to game numbers, an offense that has been encouraged by the scourge of earnings “guidance” and the desire of CEOs to “hit the number.” My direct experience (limited, thankfully) with CEOs who have played with a company’s numbers indicates that they were more often prompted by ego than by a desire for financial gain.
…it seems clear that these “game playing” exercises would be more successfully applied (if at all) to the various components of operating earnings than to the fair value remeasurement of investment holdings (for which, in case of “level 1” holdings such as Berkshire’s, a clear external reference point exists). Anyway, you could plausibly argue that Buffett’s commentary implicitly endorses this aspect of accounting standards even as it damns it. Berkshire’s income statement prominently presents a total for “Investment and derivative contract gains (losses),” making it easy for those who regard this aspect of the accounting as “faulty” to adjust overall net earnings accordingly, and nothing is stopping anyone (evidently!) from encouraging users to do exactly that. One slight imperfection comes from his advice to “focus on operating earnings” – Berkshire’s income statement doesn’t provide a caption with such a label, so that users might be uncertain about what exactly they should be focusing on (that is, whether “operating earnings” is simply what’s arrived at after that one adjustment, or whether he has something else in mind).
But that aside, there’s nothing here to prompt outraged name-calling, much less the kind of sky-is-falling reaction associated with our old friend Al Rosen. Unfortunately, as has often been pointed out, we’re living in a time where ambiguity and complexity are increasingly regarded as suspect, and discarded for solutions which are “authentic” only in their simplistic, often mean-spirited inadequacy. In this case, that would seemingly involve a retreat from fair value accounting to a cost-less-impairment type model, but the idea that such a change would result overall in more relevant financial information seems fanciful at best.
As for Buffett’s point about CEOs who play with numbers, well, he also remarks in his letter that “I have yet to see a CEO who craves an acquisition bring in an informed and articulate critic to argue against it,” and that “when seeking directors, CEOs don’t look for pit bulls. It’s the cocker spaniel that gets taken home.” Many of the directors he’s met over the years, he says, despite being “good souls,” “are people whom I would never have chosen to handle money or business matters. It simply was not their game.” Berkshire, in contrast, searches for directors guided by “thought and principles, not robot-like ‘process.’” It seems clear enough that the perceived enemy here is mediocrity (although he doesn’t use that word) and weakness rather than corruption as such, better countered through positive rather than negative actions (for example, through more informed, critical governance processes). Does the man who talks of finding “managers whose goals include delighting their customers, cherishing their associates and acting as good citizens of both their communities and our country” sound like CCN’s bile-spewing prophet of doom? Why would you even want to colour him that way…?
The opinions expressed are solely those of the author