Jan 18th, 2007 by Martin Lee
Look Through Earnings
For the 3rd year in a row, Warren Buffett talks about the concept of look through earnings. As explained by Warren, look through earnings consists of:
(1) the reported operating earnings, plus;
(2) the retained operating earnings of major investees that, under GAAP accounting, are not reflected in our profits, less;
(3) an allowance for the tax that would be paid by Berkshire if these retained earnings of investees had instead been distributed to us.
Warren believed that the look-through number more accurately portrays the earnings of Berkshire than the GAAP number.
For Berkshire’s intrinsic value to grow at 15% annually, the look through earnings also has to grow at that rate.
This means that not only does Berkshire’s operating subsidiaries and investees have to deliver excellent operating results, the skill of capital allocation will also be very important as well.
When capital is allocated today, it is with the thought of how that allocation will maximize look through earnings many years in the future.
However, this long-term focus does not eliminating the need for Berkshire to achieve decent short-term performance. After all, today’s performance is also the result of “long term” thinking made many years ago.
If a company fails to deliver for extended periods of time and blames it for their long time focus, then there is reason to be suspicious of their management.
Similarly, you should be suspicious of managers who increase their short-term earnings using tricks like accounting maneuvers, asset sales, etc.