The "Oracle of Omaha" uses his investor letter to once again bemoan the vagaries of accounting.
Warren Buffett used his annual shareholders letter released Saturday to not only explain Berkshire Hathaway’s stellar performance in 2013, but also as a pulpit to once again criticize what he considers a “nonsencical” accounting rules that dilute his company’s “intrinsic” value.
For Buffett, current rules around stock purchases and what is considered “capital in excess of par value” are a direct shot at Berkshire Hathaway’s much touted “intrinsic value.”
The “Oracle of Omaha” has long stated that Berkshire’s short-term book value per share (as measured under US GAAP standards) understates the company’s long-term “intrinsic value”, which is an economic concept that relies on subjective standards.
As an example, Buffett argued in the letter issued Saturday that a $3.5 billion share purchase program Berkshire initiated last year for two subsidiaries — Marmon Group and Iscar Metals — actually diluted Berkshire’s book value even though it increased the company’s intrinsic value.
The way Buffet explains in the letter in 2013 Berkshire purchased $3.5 billion additional shares of the two subsidiaries.
In the case of Marmon the purchase brought Berkshire’s ownership in the company to the 100% level that was agreed to during the 2008 acquisition. For Iscar, the share purchases were the result of a “put option” exercised in 2013 held by the subsidiary’s controlling family.
“These purchases added about $300 million pre-tax to our current earning power and also delivered us $800 million of cash,” Buffett said in the letter. “Meanwhile, the same nonsensical accounting rule that I described in last year’s letter required that we enter these purchases on our books at $1.8 billion less than we paid, a process that reduced Berkshire’s book value. (The charge was made to “capital in excess of par value”; figure that one out.)”
For Buffett the accounting method that decreased book value by $1.8 billion was made galling since he considers that the share purchases actually increased Berkshire’s intrinsic value to investors by the same amount.
“This weird accounting, you should understand, instantly increased Berkshire’s excess of intrinsic value over book value by the same $1.8 billion,”
This is the second year that Buffett has taken a swipe at GAAP accounting, with the world’s most notable investor arguing in last year’s investor letter that the same “bizzare accounting treatment” has stumped his executive team and is increasing the gap existing between book value and intrinsic value.
“I’ve now had a year to think about this weird accounting rule, but I’ve yet to find an explanation that makes any sense – nor can Charlie or Marc Hamburg, our CFO, come up with one,” he said in the 2012 letter.”My confusion increases when I am told that if we hadn’t already owned 64%, the 16% we purchased in 2011 would have been entered on our books at our cost.”
Despite his protests, Buffett admitted that book value is an acceptable “rough tracking indicator” even though the company’s intrinsic value “far exceeds” that measure.•