Feb 11th, 2007 by Martin Lee
Look Through Earnings
Warren Buffett continues to use the concept of look through earnings to discuss about the earnings of Berkshire Hathaway. This is the fourth year in a row that he has done so.
For the definition, you can refer to my previous posts on this topic.
Note that the “operating earnings” which is referred to exclude capital gains, special accounting items and major restructuring charges.
Over time, Berkshire’s look-through earnings need to increase at about 15% annually for their intrinsic value to grow at that rate. In the previous year’s letter, Buffett had explained that to meet the 15% goal, these earnings will have to increase to $1.8 billion in the year 2000. Because of the issuance of additional shares in 1993, the amount required has now risen to $1.85 billion.
One managerial practice that Buffett has criticized in the past is that of shooting the arrow of performance and then painting the target. Buffett makes himself accountable to shareholders and boldly paints his target (of 15% goal) first. However, for the target to be achieved, he will need markets that allow the purchase of businesses on sensible terms. If prices are high, there is no need to do something just because there is excess cash.
Over time, Buffett expects the look through earnings to be a conservative estimate of Berkshire’s true economic strength.
For example, in 1986 they bought 3 million shares of Capital Cities/ABC for $172.50/share. When 1/3 of the stake was sold years in 1993, there was a realized profit of $297 after deducting a 35% capital gains tax. If the look through earnings of Cap Cities during those 8 years were distributed to Berkshire after deducting a tax of 14% (this is the tax rate that Berkshire pays for dividends), it would be only $152 million in gains.