During the period, the company run by Buffett reported $53.7 billion in unrealized gains on its equity investments.
“That $53.7 billion gain requires comment,” Buffett said. “It resulted from a new GAAP rule, imposed in 2018, that requires a company holding equity securities to include in earnings the net change in the unrealized gains and losses of those securities. As we stated in last year’s letter, neither Charlie Munger, my partner in managing Berkshire, nor I agree with that rule.”
A recent change to generally accepted accounting principles (GAAP) by the Financial Accounting Standards Board (FASB) requires companies to account for short-term swings of their equity investments in their quarterly and annual earnings. These are known as unrealized gains and losses — unrealized because these are paper losses, not actual losses (or realized gains and losses) that come from the sales of these securities.
“The adoption of the rule by the accounting profession, in fact, was a monumental shift in its own thinking,” Buffett said. “Now, Berkshire must enshrine in each quarter’s bottom line – a key item of news for many investors, analysts and commentators – every up and down movement of the stocks it owns, however capricious those fluctuations may be.”
Because of the accounting rule change, Berkshire Hathaway’s reported net earnings have become significantly more volatile because of fluctuations in the stock market, not because of major shifts in the company’s operations.
“Those market gyrations led to a crazy 1,900% increase in GAAP earnings!” Buffett exclaimed.
Instead, the “Oracle of Omaha” recommends investors focus on the company’s operating earnings, which account for revenue, costs and expenses but excludes noisier, non-operating items.
In 2019, Berkshire’s operating earnings came in at $23.9 billion, which was just slightly lower than the $24.8 billion earned in the year prior. The 2019 figures included Q4’s $4.4 billion of operating earnings, which was a bit lower than the $5.7 billion earning during the prior year period.
“Our advising that in no way diminishes the importance of these investments to Berkshire,” Buffett said. “Over time, [vice chair Charlie Munger] and I expect our equity holdings – as a group – to deliver major gains, albeit in an unpredictable and highly irregular manner. To see why we are optimistic, move on to the next discussion.”
Sam Ro is managing editor at Yahoo Finance. Follow him on Twitter: @SamRo