Short Story
Too many managements â and the number seems to grow every year â are looking for any means to report, and indeed feature, âadjusted earningsâ that are higher than their companyâs GAAP earnings. There are many ways for practitioners to perform this legerdemain. Two of their favorites are the omission of ârestructuring costsâ and âstock-based compensationâ as expenses.
Charlie and I want managements, in their commentary, to describe unusual items â good or bad â that affect the GAAP numbers. After all, the reason we look at these numbers of the past is to make estimates of the future. But a management that regularly attempts to wave away very real costs by highlighting âadjusted per-share earningsâ makes us nervous. Thatâs because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be âhelpfulâ as well. Goals like that can lead, for example, to insurers underestimating their loss reserves, a practice that has destroyed many industry participants.
Charlie and I cringe when we hear analysts talk admiringly about managements who always âmake the numbers.â In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers.
Letâs get back to the two favorites of âdonât-count-thisâ managers, starting with ârestructuring.â Berkshire, I would say, has been restructuring from the first day we took over in 1965. Owning only a northern textile business then gave us no other choice. And today a fair amount of restructuring occurs every year at Berkshire. Thatâs because there are always things that need to change in our hundreds of businesses. Last year, as I mentioned earlier, we spent significant sums getting Duracell in shape for the decades ahead.
We have never, however, singled out restructuring charges and told you to ignore them in estimating our normal earning power. If there were to be some truly major expenses in a single year, I would, of course, mention it in my commentary. Indeed, when there is a total rebasing of a business, such as occurred when Kraft and Heinz merged, it is imperative that for several years the huge one-time costs of rationalizing the combined operations be explained clearly to owners. Thatâs precisely what the CEO of Kraft Heinz has done, in a manner approved by the companyâs directors (who include me). But, to tell owners year after year, âDonât count this,â when management is simply making business adjustments that are necessary, is misleading. And too many analysts and journalists fall for this baloney.
To say âstock-based compensationâ is not an expense is even more cavalier. CEOs who go down that road are, in effect, saying to shareholders, âIf you pay me a bundle in options or restricted stock, donât worry about its effect on earnings. Iâll âadjustâ it away.â
To explore this maneuver further, join me for a moment in a visit to a make-believe accounting laboratory whose sole mission is to juice Berkshireâs reported earnings. Imaginative technicians await us, eager to show their stuff
Question:
Discuss Buffettâs specific views on âadjusted earningsâ
