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1982 Shareholder Letter

Buffett's 1982 letter introduces 'economic earnings' vs 'accounting earnings', using GEICO's $23M excluded earnings to demonstrate how accounting distorts reality.

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1982 Shareholder Letter

Date: March 3, 1983 Author: Warren Buffett Company: Berkshire Hathaway

Overview

1982 operating earnings were only 9.8% of beginning equity capital, down sharply from 15.2% in 1981 and far below the 1978 high of 19.4%. This decline resulted from insurance deterioration, capital expansion without operational growth, and increasing investments in partially-owned businesses.

Key Points

Why ROE Is No Longer the Right Metric

"It was only a few years ago that we told you that the operating earnings/equity capital percentage was the most important yardstick of single-year managerial performance. While we still believe this to be the case with the vast majority of companies, we believe its utility in our own case has greatly diminished."

The Problem with "Accounting Earnings"

Buffett used GEICO to illustrate:

"We own about 35% of GEICO Corporation but... only $3.5 million in dividends received from GEICO in 1982 after tax are the only item included in our 'accounting' earnings. An additional $23 million that represents our share of GEICO's undistributed operating earnings for 1982 is totally excluded from our reported operating earnings."

"Clearly 'accounting' earnings can seriously misrepresent economic reality."

"Economic Earnings" Concept

"We prefer a concept of 'economic' earnings that includes all undistributed earnings, regardless of ownership percentage. In our view, the value to all owners of the retained earnings of a business enterprise is determined by the effectiveness with which those earnings are used."

Undistributed Earnings > Reported Earnings

"This number - not reflected at all in our earnings - is greater than our total reported earnings, which include only the $14 million in dividends received from these companies."

Famous Quotes

"Managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation."

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