Warren Buffett on Accounting and Valuation

"Managers sometimes have to choose between reporting the truth and reporting financial results that meet expectations. Too many choose the latter."

"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed, not consistent gains in EPS."

"Businesses logically are worth far more than net tangible assets when they produce earnings in excess of market rates of return. The capitalised value of this excess return is economic goodwill."

"We suggest that you ignore a portion of GAAP amortization costs. But it is with some trepidation that we say that, knowing that managers tell owners to ignore real expense items."

"The shortcoming of book value as a guide to intrinsic value has always been significant but is now overwhelming. Accounting rules require operating businesses to be carried at cost, less depreciation."

"You can gain insight into the difference between book value and intrinsic value by looking at a college education. Think of the education's cost as its book value."

"Our views on capital gains: we regard them as fully as important as earnings realized in a more routine manner through operations."

"When we look at a business, we focus on the cash that will be generated, not the reported earnings."

"My wealth has come from a combination of living in America, some lucky genes, and compound interest."

"Leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. Any series of positive numbers evaporates when multiplied by a single zero."

"Depreciation is a real cost, even though it doesn't require cash. A business that requires heavy capital investment will see its cash earnings fall far short of reported earnings."

"Reported earnings tell you very little about a business's true economics. You must understand the nature of the business."

"Many businesses would be better understood if managements modified the primary emphasis they place upon earnings per share and yearly changes in that figure."

"We cringe when we hear about EBITDA. Does management think the tooth fairy pays for capital expenditures?"

"Economic goodwill tends to grow over time. Unlike accounting goodwill, it reflects real competitive advantages that create value."

"It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently."

"We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value."

"The most valuable assets in many businesses — brand equity, customer relationships, and distribution networks — are intangible and often invisible on GAAP statements."

"GAAP rules are designed to produce consistency, not truth. Investors must look through GAAP numbers to understand economic reality."

"Unquestionably, some people have become very rich through the use of borrowed money. However, that's also been a way to get very poor."

"Liquidation value is rarely realized. The gap between book value and liquidation value can be enormous."

"Our look-through earnings include the retained earnings of our investee companies. Over time, these retained earnings must translate into market value."

"Owner earnings represent reported earnings plus non-cash charges less the average annual amount of capitalised expenditures required to maintain long-term competitive position."

"A low P/E ratio alone is not enough. You must understand the quality and sustainability of the earnings."

"When management says 'our real earnings are better understood by excluding X,' and X is large and recurring, the investor should ask why."

"Capital gains or losses, either realized or unrealized, are fully as important to shareholders over a period of years as earnings realized through operations."

"We test the wisdom of retaining earnings by assessing whether retention delivers shareholders at least $1 of market value for each $1 retained."

"The primary test of managerial economic performance: a high earnings rate on equity capital employed."

"If return on capital is ordinary, an earn-more-by-putting-up-more record is no great managerial achievement."

"Intrinsic value is an estimate rather than a precise figure. It must be changed if interest rates move or forecasts are revised."