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Warren Buffett issued his always highly anticipated annual letter to Berkshire Hathaway stockholders over the weekend. While the media has focused primarily on his advice to Donald Trump, his aversion to foreign stocks & his defense of Berkshire’s cash hoard, it’s his continuing distaste for what compliance with GAAP does to Berkshire’s operating income that caught my eye.

As we’ve pointed out in blogs about his 2023 and 2020 letters, railing against GAAP’s impact on Berkshire’s operating income has become a bit of a hobby horse for Warren Buffett. His problem is ASC 321, which requires Berkshire Hathaway to run fluctuations in the value of its public company equity investments through its income statement. Buffett thinks that results in a misleading presentation, and this excerpt from this year’s letter explains why:

Our measure excludes capital gains or losses on the stocks and bonds we own, whether realized or unrealized. Over time, we think it highly likely that gains will prevail – why else would we buy these securities? – though the year-by-year numbers will swing wildly and unpredictably. Our horizon for such commitments is almost always far longer than a single year. In many, our thinking involves decades. These long-termers are the purchases that sometimes make the cash register ring like church bells.

Fair enough, but here’s the thing – Berkshire made a business decision to take multi-billion-dollar minority stakes in enormous companies. What if it had to sell one or more of those positions? That’s what ASC 321 is getting at – it shows users of the financial statements the market risk to which Berkshire is exposed. Interestingly, despite his preference for reporting Berkshire’s non-GAAP operating earnings, he acknowledges the magnitude of this risk a few pages later:

With marketable equities, it is easier to change course when I make a mistake. Berkshire’s present size, it should be underscored, diminishes this valuable option. We can’t come and go on a dime. Sometimes a year or more is required to establish or divest an investment. Additionally, with ownership of minority positions we can’t change management if that action is needed or control what is done with capital flows if we are unhappy with the decisions being made.

As I said in my blog about Buffett’s 2020 letter, GAAP does have a conservative bias, but the disclosures it requires usually provide insights into a business that shouldn’t be ignored, and when people complain that GAAP’s distorting their company’s financial statements, it’s usually a sign that the GAAP requirements are highlighting something that makes them uncomfortable. To Warren Buffett’s credit, he acknowledges what that something is in this year’s letter.

– John Jenkins