Brian Gongol
It's typically his pattern to spend a page or two explaining some detail about economics, accounting, or management to his readers, whom he imagines to be "highly intelligent...[but] not experts in accounting or finance." Last year, he spent a couple of pages on intrinsic value and how that influences the decision to repurchase shares.
This year, there is a very good chance that he's going to write at some length about "look-through earnings" -- the equivalent earnings of the companies in which Berkshire has a large ownership stake, but that don't show up in standard accounting statements.
He hasn't written explicitly about look-through earnings since the letter to shareholders issued in 2001, so it's time for a review. Moreover, companies are retaining colossal amounts in earnings right now -- which is why their balance sheets are getting healthier while politicians are complaining that they aren't hiring. Retaining earnings instead of paying dividends depresses the cash received by Berkshire in the short run, but it may pay off handsomely in the long run. And, especially since Berkshire hasn't announced a big "elephant" acquisition since the last letter came out (the Heinz purchase was very large, but it's only a 50% stake and leaves lots of cash still in the company's treasury), he'll probably want to explain why it's a perfectly fine substitute for the company to take large, permanent stakes in companies like Coca-Cola.
Just for reference, here's what the look-through earnings chart would tell us about just the four biggest "permanent" holdings (some figures are rounded or estimated from partial-year reports, but they're going to be in the ballpark):
| Company | Berkshire control | 2012 earnings (est.) | Berkshire's share of earnings |
| American Express | 13.6% | $5 billion | $0.7 billion |
| Coca-Cola | 8.9% | $9 billion | $0.8 billion |
| IBM | 6.0% | $15 billion | $0.9 billion |
| Wells Fargo | 8.0% | $19 billion | $1.5 billion |
| total | $3.9 billion | ||
| Company | Payout ratio (percent of earnings paid as dividends) | Dividends paid to Berkshire | Earnings retained for Berkshire |
| American Express | 18% | $126 million | $574 million |
| Coca-Cola | 52% | $416 million | $384 million |
| IBM | 23% | $207 million | $693 million |
| Wells Fargo | 25% | $375 million | $1,125 million |
| totals | $1.124 billion | $2.776 billion |
So, in other words, for every dollar that Berkshire will receive in dividends from just these four companies, another $2.47 will be retained and (presumably) reinvested to promote future growth.
As you can imagine, that nearly $2.8 billion in what he calls "look-through earnings" is (a) included in Buffett's mental calculation of Berkshire's intrinsic value, (b) a huge asset that conventional accounting overlooks, (c) tax-advantaged to Berkshire, and (d) the kind of thing that almost nobody pays attention to, even though it's huge.
He wouldn't consider these companies "permanent" holdings if he didn't expect them to be smarter users of the retained earnings than most of the other companies in the stock market. And, by the way, it would take an "elephant" in the $20 to $30 billion range to produce real, on-the-books earnings equal to those $2.8 billion in phantom earnings.
Of course he still wants to bag another "elephant", but we shouldn't overlook what he's getting from the huge holdings that Berkshire appears to be slowly and quietly expanding.