Warren Buffett’s Berkshire Hathaway just published its annual letter to shareholders, and he took a moment to take aim at the practice of reporting adjusted earnings.
Earnings adjustments are common on Wall Street. Companies can, for example, back out certain costs by saying they’re not likely to be repeated or not part of the “core” business. While businesses have to report unadjusted earnings, Wall Street analysts typically focus on the adjusted number.
To Buffett, adjusted earnings create wiggle room — potentially for misleading reporting of results.
“Too many managements — and the number seems to grow every year — are looking for any means to report, and indeed feature, “adjusted earnings” that are higher than their company’s GAAP earnings. There are many ways for practitioners to perform this legerdemain. Two of their favourites are the omission of “restructuring costs” and “stock-based compensation” as expenses.”
He said, for example, that Berkshire Hathaway had been restructuring since Buffett acquired it in 1965, and “we have never, however, singled out restructuring charges and told you to ignore them in estimating our normal earning power.”
“To say ‘stock-based compensation’ is not an expense is even more cavalier,” he added. He provided an example of the way in which Berkshire could report “adjusted earnings” by making certain compensation costs disappear, but chooses not to.
He said (emphasis added):
“Charlie and I want managements, in their commentary, to describe unusual items — good or bad — 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 “adjusted per-share earnings” makes us nervous. That’s because bad behaviour is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” 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 “make the numbers.” 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.
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