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Berkshire's Bottom Line More Relevant Than Ever Before, The Rest Of The Story

Jun. 04, 2020 7:59 AM ETBerkshire Hathaway Inc. (BRK.A), BRK.B20 Comments


  • Graham argued that Berkshire Hathaway's income statement is no longer relevant because of the requirement, beginning in 2018, that the change in the fair value of equity securities be reflected in net income rather than equity (i.e. other comprehensive).
  • During the Berkshire Annual meeting Buffett again notes, they are seeking to own companies - not the stocks - and they are doing it through the public purchase of shares, because rarely can you own 100% of good companies.
  • The accounting Buffett prefers - historical cost - is only available to him when share or security ownership exceeds 20% (i.e. the equity method or consolidation when ownership exceeds 50%).

By Sandy Peters, CPA, CFA

Buffett's sale of airline stocks validates FASB'S new accounting for equity securities

In a December 2018 piece, Berkshire's Bottom Line More Relevant Than Ever Before, I refute the claims made in a Wall Street Journal (subscription required) opinion piece, I Can't See Berkshire's Bottom Line: A New Accounting Rule Makes It Difficult For Investors to Make Sense of Annual Reports, by Donald E. Graham - chair of the board of Graham Holdings Co. (formerly Washington Post Co. and previously an investee company of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B)). In his opinion piece Graham echo's Warren Buffett's criticisms regarding a recently implemented accounting standard on the recognition and measurement of equity securities.

Recent Berkshire actions related to the sale of airline stocks shows Graham's analysis was incorrect.

Graham argued that Berkshire Hathaway's income statement is no longer relevant because of the requirement, beginning in 2018, that the change in the fair value of equity securities be reflected in net income rather than equity (i.e. other comprehensive). In very simple terms, Graham argued that reflecting the changes in equity security values - and the resulting volatility - made Berkshire's income statement irrelevant because Berkshire holds these investments for the long term and doesn't intend to sell them.

In April 2020, however, Buffett sold Berkshire's airline stocks. He told investors so at the Berkshire Annual Meeting in Omaha. By selling the stocks he transformed the unrealized losses in the March 31 income statement to realized losses - which we will see reflected in the June 30 income statement. In making the sale, Buffett refuted his earlier premise that the investments are held for the long-term and that the accounting, the bottom line, is not reflective of the economics.

During the Berkshire Annual meeting Buffett again notes, they are seeking to

This article was written by

The Standards and Financial Market Integrity division of CFA Institute is a policy authority on ethics in the global capital markets. We advocate for fair and transparent markets for all investors.

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Comments (20)

It’s a great time to start buying airlines for long term buy and hold. Buffett made a mistake. Instead if selling, he should have added to his positions using all that cash
mpmassey profile picture
Buffett bought high, sold low and within a month of selling low, watched his former holdings skyrocket. His loss on Delta to take one example, was huge but if he had held it another month to 6 weeks, he would have gotten almost back to even.
Yep a very rare case of what looks like panic selling at the bottom. Even more foolish because the combined value of all of his airline stocks would have barely mattered to the portfolio or the company.
It might have been a great time to buy them back when Buffett was selling, I disagree that now is a great time to buy airlines for a long term hold. They've been a great short term trade but I think they're over done at this point, still a lot of pain ahead for the airlines and they're low PE unloved stocks even in the best of times.
bengalesq profile picture
Buffett has not played this Covid crisis well at all. I don’t agree 100% with your thesis, but I think it’s a serious analysis with some good points and I respect your opinion. Like most things in life, the truth is somewhere in the middle.
I am honestly shocked that Buffett has done nothing but sell stocks, looking like at their lows. And share buybacks in Q1 were paltry. I don't know what it takes to get him to make a significant move but if a global pandemic isn't it, I don't know what is.

He doesn't have to be super clever. All he has to do is buy the S&P index or add to existing positions where he can.

If we get to the end of Q2 and find that he has done nothing but sit on cash and has bought back only another $1-2 billion of stock then shareholders should really start to become seriously concerned.
Ján Mazák profile picture
It typically takes several months for the best opportunities to appear after the initial drop. This market recovery is thus rather exceptional (probably caused by swift and extensive actions of central banks). It would be nice to do more buybacks, but there is not much against Buffett -- who has actually done much more? Even alternative asset managers and PE players, which typically have lower thresholds and less capital to invest than Buffett, have not done much. Many boast tens of billions in dry powder, but invested barely a tenth of it, not much more than a year ago.

With hindsight, it looks like he could have avoided selling or should have bought more, but we are kind of lucky the market recovered like this; the range of reasonable possibilities was much wider. If instead of recovery the stocks slid another 10-30%, allowing Buffett some extensive buying, he would get praised for his actions.
Under the old method the loss would have been recognized in the p&l upon the sales of shares in the second quarter. I would argue that treatment much more closely reflects economic reality than running it through earnings prior to the losses being realized Berkshire had a $50 billion dollar loss in the first quarter, they're likely going to have a huge gain in the second quarter. They've had multiple swings from quarter to quarter like that since the new rule was adopted. To me that pretty much proves the point that Buffett is making, the temporary swings are pretty much meaningless until you actually sell a position and realize that loss.

I agree that the losses on the airline stocks were not meaningless to shareholders once they were realized, but under the new system realizing the loss actually had no impact on the p&l at all. This is because the losses were recognized before they were actually taken. So my takeaway would be that the new rule makes it harder to understand which gains & losses are meaningful rather than provide more clarity. Berkshire would have shown much larger losses on positions like Coke and BOA in the fist quarter, but were those actually meaningful? In the second quarter they will show huge gains when the reality is they realized some meaningful losses on the airline stocks. Again does that reflect reality, does that make it more clear for those looking at the financial statements?

Also please understand the old method required you to mark your positions to market every quarter, the balance sheet correctly and clearly stated the values of the assets at all times. The only change is under the old system you ran the change in value through the OCI (equity) portion of the balance sheet rather than through the Income Statement. The way the values of the assets are reported in the asset portion of the balance sheet has not changed at all. I would argue it adds no clarity at all to the fair value of these positions and only blurs the income statement.
Buffett's "favorite holding period is forever" quip is constantly and completely misunderstood. He does not mean that he never sells investments. Clearly he does, not just the airline stocks but throughout his career he's sold hundreds of investments. All he means is that he hopes that when he buys an investment, it continues to perform so well that he never has to sell it. This is true, rarely, but it does sometimes happen.

The accounting treatment muddies Berkshire's quarterly numbers and a lot of people don't like it for that reason. It doesn't make Berkshire's reporting more "conservative" or "safe" but just more variable. Most informed investors will simply back out or ignore the portion of the results that are based on this new required disclosure.
The criticism of the new accounting rules has nothing to do with whether they are accurate reflection of TODAYs reality - they are! And that’s the problem. These assets can fluctuate madly from day to day - look at the markets lately - this volatility can supersize quarterly gains (BRK had 60B in gains last year) or losses (1Q 2020) to such an extent that operating results become dwarfed and lost in the wild asset fluctuations, making quarterly reports meaningless to the long term shareholder who is trying to gauge health of the underlying business (not gauge the health of the stock market which is already reported through other avenues). The new accounting is not a problem due to accuracy, but rather to it’s distortion of a companies operational “income/loss” for the past 90 days...
FASB has a tough job -- in a world of global conglomerates with no end of variations in structure, it is impossible to create one set of standards that work equally well for everyone. So they do the best they can and try to create reporting rules that give the most transparency. They aren't always right, but they aren't stupid either.

It is the investor's job to untangle it and figure out what is important for determining current and future equity values. All the data is there, and with a little time and Excel you can model it out to your heart's content.

When I look at BRK, I separate the companies they own from the stocks they own. I just assume that the stock portfolio is going to mirror the SP500, so the emphasis is on projecting the owned companies.

If someone is going to just look at PEs to make investing decisions, and then complain about all the flaws in the accounting standards, they should just buy SPY and focus their energies elsewhere.
Fearful when others are greedy, as this mkt runs up, even as people are still being laid off, I wonder when the mkt will realize this economy is going to take a while to get back to operating where it was before COVID. Raising Cash and waiting, this will need to have a retest of the lows much like 2011. As for the airlines, I can't believe Buffett got burned by that business.
the stock market is a mechanism for transferring wealth from the impatient to the patient
Ján Mazák profile picture
A single anecdote does not refute anything. Participation in the dot-com bubble via public securities would lead to tons of earnings (according to the new rule) that would not reflect reality.

I'm no expert on various accounting standards, but saying that one should account for a wholly (privately) owned business' earnings in a markedly different way than a portion of earnings owned via public shares does not seem right at all. (Why should an opinion of random strangers, i.e. markets, matter for the way I account for the earnings? If others want to pay twice as much as before, my privately held earnings stream is also worth twice as much, but no one bothers to reflect this in an income statement under GAAP.)
There is one option that remains: Berkshire sold the airline stocks in order buy an airline. Buffett has long desired an airline for Berkshire. And when a Buffett target becomes distressed, he acts. Stay tuned.
Doesn’t sound right. Sitting like a sardine in a sardine can when shaking hands may become obsolete is the problem going forward. Warren will not be buying an airline.
BRK owns an "airline" -- Net Jet.

That was the right choice to own. Their mistake was buying into the ones whose customers won't pay for luxury.
Over time Net Jets has been a stinker too. It’s probably barely broken even and certainly underperformed its cost of capital
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