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Collection: Warren Buffett - #285 'EBITDA, the Bullshit Earnings'



Good afternoon, gentlemen. Andy Marino of Chapel Hill, by way of Boston.

You have argued against the use of alternate measures of profitability, such as earnings before interest, tax, depreciation, and amortization, as measures of business performance.

At the same time, you have frequently cited the incompleteness of generally accepted accounting in reflecting economic reality for some businesses, implying that there are some necessary and proper adjustments.

Beyond what you recently described in the annual report as the folly of omitting depreciation, could you elaborate on your thoughts on other pitfalls of alternative financial presentations?

Is EBITDA, in your view, just too often used as a shorthand for cash flow, or is the entire concept of recasting accounting data a suspect exercise?

And which revisions might be appropriate, if any? And what might be viewed as red flags? And does it matter to you who is making those adjustments? Analysts, investors for their own purposes, or company managements, in terms of how that information should be viewed?


Yeah. We regularly told you, for some years before the accounting change was made here a year or so ago — we told you, you should not count goodwill amortization.

You know, it was required under GAAP, and we, obviously, complied with GAAP, but we told you every year, virtually, that I can remember, we said, “This is not really an economic expense.”

And we ignore it in our own calculations of earnings, in terms of what we will pay for businesses. We don’t care whether there’s a goodwill item or not, because it’s immaterial to economic reality.

So, we have been quite willing, at Berkshire, to tell our own owners to ignore certain things. And if they disagreed with us, they could look at the GAAP figures. But we felt they were getting misled by looking at the amortization of intangibles.

That doesn’t mean we think all intangibles were good, but we just — we did feel that that was a — that was an arbitrary decision that didn’t make any sense at all.

And we felt — obviously, as we’ve talked about — we felt the crazy pension assumptions have caused people to record phantom earnings, in many cases.

So we’re willing to tell you when we think there is data that is more important in economic analysis than GAAP figures. We’ll talk to you about it.

Not thinking of depreciation as an expense, though, strikes us as absolutely crazy.

I can think of very few businesses — I can think of a couple — but I think of very few businesses where depreciation is not a real expense.

Even at our gas pipelines, I mean, you know, at some point, A, they’ll need repairs, but beyond that, at some point they become obsolete. I mean there won’t be gas there 200 years from now, we know that.

So, it — depreciation is real, and it’s the worst kind of expense. It’s reverse float. You know, you lay out the money before you get revenue. And you are out cash with nothing coming in.

And depreciation — any management that doesn’t regard depreciation as an expense, you know, is living in a dream world, but of course they’re encouraged to do that, you know, by investment bankers who talk to them about EBITDA.

And then, you know, certain people have built fortunes on misleading investors by convincing them that EBITDA was a big deal.

And when we see companies that say, “Hey, we don’t pay any taxes, you know, because we don’t have any earnings for tax purposes, and don’t count depreciation and all of that,” you know, that’s coming — in our view, many times that’s coming very close to a flimflam game.

You know, I get these people that show me — you know, they want to send me books with EBITDA in it, and I just tell them, you know, “I’ll look at that figure when you tell me you’ll make all the capital expenditures.”

If I’m going to make the capital expenditures, there’s very few businesses where I think I can spend a whole lot less than depreciation year after year and maintain the economic strength of the business.

So I think the EBITDA has been a term that has cost a lot of investors a lot of money.

You saw it in the telecom field. I mean the idea — they were spending money so damn fast, you know, I mean they couldn’t have it coming in the door fast enough from investors.

And then they pretended the depreciation was not a real expense. That’s nonsense. I mean it couldn’t be worse. And a generation of investors where sort of brought up to believe in that.

We, at Berkshire, will spend more than our depreciation this year. We spent more than our depreciation last year. We spent more than our depreciation the year before that. You know, depreciation is a real expense, just as much as, you know, the expenditure for lights.

It’s not a non-cash expense. It’s a cash expense. You just spend it first, you know. I mean the cash is gone, and it’s a delayed recording of cash. How anybody can turn that into something they use as a metric that talks about earnings is beyond me.



Yeah, I think you would understand any presentation using the word EBITDA, if every time you saw that word you just substituted the phrase, “bullshit earnings.” (Laughter and applause)


I knew he’d do it sooner or later, folks.


And the man —


He made it through the morning, but never all day. (Laughter)


And the man asked the question also, says, “What remaining big accounting troubles exist?”

The real lollapalooza is pension fund accounting, and, to some extent, post-retirement medical liabilities. Those are horribly understated now in America, and they’re very big numbers.


I’ve looked at financial statements, and you’ve seen them too in the last few months, where companies are recording pension income in the hundreds of millions, while at the same time being underfunded in their pension plan in the many billions.

And, you know, they just aren’t facing up to reality at all, and they don’t want to because they want to take the hit. And they’re this — you know, it’s the same mentality as stock option expenses.

And they are paying people with stock options. But, you know, we pay people with cash bonuses, and I suppose, you know — well, it isn’t really true, but we might like it if we didn’t have to record cash bonuses as an expense. I mean it’s a way we pay people.

And you can say, “Well, why don’t you put it in the footnotes and leave it out of the income account like they do with option expenses,” which is a form of compensation, too.

But the — you know, the answer is that a bunch of people who cared very much about having their stocks float to unreasonable prices, at least in our view, found they could do it a lot easier if they didn’t count compensation expenses.

And, you know, why not put all expenses in footnotes? Just have an item there that says “sales” and then have the same figure for net profit. And then just have all the — (laughter) — expenses in the footnotes, you know.

And people with a straight face, you know, say, “Well, it’s in the footnotes, so therefore everybody knows about it and we don’t have to count it — put it in the income account.”

It’s amazing what people with high IQs will do to rationalize their own, you know, their own pocketbooks.

And Charlie has another explanation for why there’s been this denial of the reality of expense — option expense — in terms of people’s ego getting involved with their own records.

You want to elaborate on that, Charlie? Don’t name names. (Laughter)


No, I’m so tiresome on this subject, and I’ve been on it for so many decades.

It’s such a rotten way to run a civilization. To make the basic accounting wrong is very much like making the engineering wrong when you’re building a bridge.

And when I see reputable people making these perfectly ridiculous arguments to the effect that it’s unthinkable that options be expensed.


Or it’s too difficult to value them.


Well, because it’s too difficult to value, or God knows what reason.

And a lot of them are people you’d be glad to have marry your daughter. (Laughter)


Yeah, because they’re rich, for one thing. (Laughter)


Yet, the truth of the matter is they’re somewhere between crazy and crooked. (Laughter)


Put him down as undecided. (Laughter)

It’s really astounding. The interesting thing is, of course, now, is that the four auditing firms left, what they call the Final Four now in the auditing — (Laughter)

They have now — and listen, I’m glad they did it, too. And I tip my hat to them for doing it. But they’ve now said that they really do think options are an expense. So this is —

You know, it kind of reminds of you what happened during the Reformation, isn’t it? You know, when you’d have these places sway back and forward, you know, as they get carried by one argument or the other.

In fact, I think there was that famous vicar of Bray who would swing from Catholicism to Luther, back and forth, as this little town went back and forth in Germany.

And finally, the townspeople gathered and they said to the vicar — they said, “It’s understandable that we’re confused by all that’s going on in theology, and we really don’t know much about it, and so we swing back and forth.”

But they said, “We find it a little disgusting that you, a man of the cloth, would also keep swaying back and forth.” And they said, “Have you no principle?” “And he said, “Yes, I have one principle.” He says, “It’s to remain the vicar of Bray.” (Laughter)

I think we’ve seen a little of that in the auditing profession, but I think they’ve actually found the true religion now, so I don’t want to sit here and criticize them.

But, you know, you now have four firms that lobbied against options being counted as an expense in 1993 that have written the FASB and say that options should be an expense.

And I don’t know how in the world something could have not been an expense in 1993 and be an expense in 2003.

Certainly didn’t apply to utility bills or, you know, raw materials or anything of the sort. But that’s the human condition.

Number 2.


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