Berkshire Annual Letter 1996 (Part 5)
At Berkshire, reported earnings are a poor measure of the economic performance because the numbers represent only the dividends received from investees (which is a small fraction of the earnings attributable to their ownership).
Instead, the concept of “look-through” earnings is used. This consists of:
1) The reported operating earnings, plus;
2) Berkshire’s share of the retained earnings of major investees that are not reflected in their profits under GAAP, less;
3) An allowance for tax that would be paid by Berkshire if these retained earnings have been distributed.
Can we apply this concept to our own portfolio?
consider that you own a 1% stake of a company X which has a market value of $100 million.
Last year, the company made $10 million and paid out $1 million in (assume tax-free) dividends.
If you look at only the dividends, your earnings would only be $10,000.
Using the concept of look-through earnings, your actual earnings would be $100,000 before tax. This consists of $10,000 dividends which were paid to you and $90,000 retained profits (attributable to you) which will increase the future economic value of the company.