This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Warren Buffett Challenges Wall Street's Thinking

NEW YORK ( TheStreet) --  Berkshire Hathaway  (BRK.A - Get Report) chief Warren Buffett challenged Wall Street's most commonly used valuation metric in his annual letter to shareholders, as corporate merger and private equity buyout activity rises to levels not seen since the before the financial crisis.

Buffett criticized bankers' reliance on earnings before interest, taxes, depreciation and amortization (EBITDA) and said that the metric excludes real costs like depreciation expense. Those comments came as Buffett sought to explain the operating performance of Berkshire Hathaway subsidiaries like BNSF Railways and MidAmerican Energy, and their ability to handle debt.

"Every dime of depreciation expense we report, however, is a real cost. And that's true at almost all other companies as well. When Wall Streeters tout EBITDA as a valuation guide, button your wallet," Buffett said. In particular, Buffett said, adding back depreciation expense for businesses with long-lived assets would understate a company's costs.

Berkshire Hathaway, one of the most prolific acquirers of companies, uses different ways to calculate debt-service ratios. Instead of EBITDA, Buffett said Berkshire's definition of coverage is the company's pre-tax earnings divided by interest expense and "not EBITDA/interest, a commonly-used measure we view as seriously flawed."

Must Read: Berkshire Hathaway Outperforms S&P 500, Signaling Little Change for Buffett

At BNSF, Buffett said, pretax earnings were nine times interest expense, leading to a 9:1 coverage ratio.

Buffett did say that some of Berkshire's amortization expense may overstate the company's actual costs, especially given its acquisitive nature. When speaking about Berkshire's Manufacturing, Service and Retailing Operations, Buffett said the following:

With software, for example, amortization charges are very real expenses. Charges against other intangibles such as the amortization of customer relationships, however, arise through purchase-accounting rules and are clearly not real costs. GAAP accounting draws no distinction between the two types of charges. Both, that is, are recorded as expenses when earnings are calculated -- even though from an investor's viewpoint they could not be more different. 

In the GAAP-compliant figures we show on page 29, amortization charges of $648 million for the companies included in this section are deducted as expenses. We would call about 20% of these "real," the rest not. This difference has become significant because of the many acquisitions we have made. It will almost certainly rise further as we acquire more companies. 

Eventually, of course, the non-real charges disappear when the assets to which they're related become fully amortized. But this usually takes 15 years and -- alas -- it will be my successor whose reported earnings get the benefit of their expiration.

-- Written by Antoine Gara in New York

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
BRK.A $219,000.00 0.00%
BRK.B $145.48 0.00%
AAPL $93.74 0.00%
FB $117.58 0.00%
GOOG $693.01 0.00%


Chart of I:DJI
DOW 17,773.64 -57.12 -0.32%
S&P 500 2,065.30 -10.51 -0.51%
NASDAQ 4,775.3580 -29.9330 -0.62%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs