I Can’t See Berkshire’s Bottom Line

A new accounting rule makes it difficult for investors to make sense of annual reports.

 

Berkshire Hathaway-branded Heinz mustard.
Berkshire Hathaway-branded Heinz mustard. PHOTO: DAVID WILLIAMS/BLOOMBERG NEWS

At each quarter’s end, investors depend on accurate, straightforward corporate reports. Yet this year Berkshire Hathaway , one of the largest and most closely followed companies in the market, suddenly boasts one of the least comprehensible reports, after decades of close-to-perfect clarity. Berkshire isn’t to blame—the fault lies with federal regulators and the national accountants board. With a single change of the reporting rules for earnings, investors like me have tougher time than ever evaluating complicated companies.

The rule change affects all companies that hold large amounts of stock. A multinational holding company, Berkshire is the sole owner of Geico, the BNSF railway system and dozens of other subsidiaries, but it also owns stocks and bonds—more than $200 billion as of the third quarter of this year. The value of its equity holdings is always on its balance sheet, on the first page of Berkshire’s quarterly reports—the first stop for shareholders who want to know how much stock, bonds and cash the company holds. CEO Warren Buffett discusses the largest shareholdings in his annual letters.

But this year, the Financial Accounting Standards Board joined with the Securities and Exchange Commission to decree that stock gains or losses must be reported as earnings every quarter. So Berkshire’s reported pretax earnings jumped from $5.3 billion in the third quarter of 2017 to $23 billion in the same quarter of 2018. Did its earnings quadruple? No, the FASB’s new accounting rules forced Berkshire to record $14.6 billion in gains on its stocks.

On paper, these fluctuations in stock value dwarf Berkshire’s actual business profits. In reality they merely record short-term changes in the prices of stocks that may be held for decades before they are sold. Berkshire and all other companies already report gains and losses on stocks at the time of sale. Interim fluctuations shouldn’t be allowed to fuzz up reported earnings. Quarter after quarter, Berkshire will be forced to record gains or losses of tens of billions in its stocks.

The meaningful portion of Berkshire’s reports is the actual profits of its businesses. They had a good third quarter on that basis, rising to nearly $3 billion above the previous year. But to arrive at that number, I had to look at Berkshire’s operation report and calculate it myself. Next year, I would have to do two such calculations, deducting stock-market gains from earnings for both this year’s third quarter and last year’s.

Why did the FASB and SEC insist on the change? Perhaps accounting perfectionists believed that recording stock gains and losses gave a better definition of a company’s value. Voltaire, who said that the best was the enemy of the good, didn’t live long enough to see his maxim validated by the SEC and the accountants.

At Berkshire’s annual meeting in May, a perfectionist type asked Mr. Buffett if the new reporting format didn’t give a clearer idea of the company’s value. Mr. Buffett pointed out that the value of the company’s other holdings—Geico, for instance—also could be said to change from quarter to quarter. Likewise its land, and its bonds. But none of these are earnings, and neither are changes in Berkshire’s stock portfolio.

Instead of providing clarity, the new rules effectively have made Berkshire’s reported numbers meaningless. Mr. Buffett said as much in this year’s annual report: “For analytical purposes, Berkshire’s ‘bottom-line’ will be useless.”

The rule change is a rare step backward in the history of accounting standards, which generally have become more helpful to investors over time. When my grandfather Eugene Meyer bought a seat on the New York Stock Exchange in 1905, there was no federal regulator to ensure that the accuracy of the financial information his staff scrutinized. But by the mid-1950s, when Mr. Buffett began investing, the SEC could guarantee accurate reporting from all public companies.

With the quarterly-reporting mandate for stock value, the SEC and accountants board failed in their duty to provide clarity to investors. The new rule inhibits investors’ understanding of companies’ real performance, and it should be done away with.

Mr. Graham is CEO of Graham Holdings Co.

Appeared in the November 8, 2018, print edition.

Leave a Reply

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

This site uses Akismet to reduce spam. Learn how your comment data is processed.