Learning from Warren Buffett Shareholders Letters - Year 1982 - Fine Art of Business Valuations

6th September 2024

Learning from Warren Buffett Shareholders Letters – Year 1982 – Fine art of Business Valuations


Dear Investors,

Namaste! Today we will deal with the fine art of business valuations from the Master. We mostly look at the accounting value as per the Accounting rules from time to time. Master looks at the economic value which the business has and can generate over a period of time.


Master says: -

We prefer a concept of “economic” earnings that includes all undistributed earnings, regardless of ownership percentage. In our view, the value to all owners of the retained earnings of a business enterprise is determined by the effectiveness with which those earnings are used - and not by the size of one’s ownership percentage. If you have owned .01 of 1% of Berkshire during the past decade, you have benefited economically in full measure from your share of our retained earnings, no matter what your accounting system. 

Our explanation: -

In 1981 – as per the accounting rules – company can reflect accounting benefits of earning to the extent of their holding in the other corporations as long as it is 20% or more. Say a company ABC is holding 20% shares of XYZ and the company XYZ makes Rs.100 Crs profit – the company ABC can show Rs.20 Crs profit in its balance-sheet. 

However, if the holding is below 20% - then only dividend received is reflected. If the company does not pay the dividend than the retained earnings can’t be shown in the Balance-Sheet of the ABC. 

Master shares an example of GEICO: - 

There are a few exceptions to this rule; e.g., we own about 35% of GEICO Corporation but, because we have assigned our voting rights, the company is treated for accounting purposes as a less-than-20% holding. Thus, dividends received from GEICO in 1982 of $3.5 million after tax are the only item included in our “accounting” earnings. An additional $23 million that represents our share of GEICO’s undistributed operating earnings for 1982 is totally excluded from our reported operating earnings. If GEICO had earned less money in 1982 but had paid an additional $1 million in dividends, our reported earnings would have been larger despite the poorer business results. Conversely, if GEICO had earned an additional $100 million - and retained it all - our reported earnings would have been unchanged. Clearly “accounting” earnings can seriously misrepresent economic reality. 

(This is to be followed while we study the any investment idea). 

Master Says: -

Accounting numbers are the beginning, not the end, of business valuation. Message is clear – consider the economic value for meaningful investment analysis and likely future gains.

Wish you all a happy investing.

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Hitesh Parikh.