Cuts to US taxes boost profits at Berkshire Hathaway as Buffett warns on misleading GAAP rules
Warren Buffett’s Berkshire Hathaway, which owns substantial insurance and reinsurance operations, posted record quarterly and annual results for 2017 – mainly fuelled by the big cuts to US corporate income tax, signed in by President Donald Trump last year.
Fourth-quarter net income increased to $32.55 billion from $6.29 billion, or $3,823 per share, a year earlier – but some $29 billion of this was attributed to this tax change which reduced the corporate tax rate to 21 percent from 35 percent.
The change also meant that Berkshire’s gain in net worth during 2017 was $65.3 billion, which increased the per-share book value of both its Class A and Class B stock by 23 percent.
But chairman Buffett was keen to be clear on the extent to which the company had benefitted from the tax changes. “A large portion of our gain did not come from anything we accomplished at Berkshire,” he stated in his letter to shareholders. “The $65 billion gain is nonetheless real – rest assured of that. But only $36 billion came from Berkshire’s operations. The remaining $29 billion was delivered to us in December when Congress rewrote the U.S. Tax Code.”
He also used the letter to highlight changes in accounting rules that he claims has the potential to “mislead” commentators and investors examining the company’s results in the future.
He noted that new rules, under generally accepted accounting principles (GAAP), mean that the net change in unrealized investment gains and losses in stocks the company holds must be included in all net income figures it reports.
“That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period,” Buffett said.
“Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire’s “bottom-line” will be useless.
“The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.
“That’s largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse).”
He said the company would make every effort to explain the adjustments you need in order to make sense of our numbers.
“But televised commentary on earnings releases is often instantaneous with their receipt, and newspaper headlines almost always focus on the year-over-year change in GAAP net income. Consequently, media reports sometimes highlight figures that unnecessarily frighten or encourage many readers or viewers,” he noted.
“We will attempt to alleviate this problem by continuing our practice of publishing financial reports late on Friday, well after the markets close, or early on Saturday morning. That will allow you maximum time for analysis and give investment professionals the opportunity to deliver informed commentary before markets open on Monday. Nevertheless, I expect considerable confusion among shareholders for whom accounting is a foreign language.”
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