Look-Through Earnings
high confidence — compiled with source citation from the investment brain.
Look-Through Earnings
Look-Through Earnings
Look-through earnings are warren-buffett's correction to the way consolidated accounting reports a holding company that owns big minority stakes. Under GAAP, the retained profits of investees such as Coca-Cola or GEICO never appear in berkshire-hathaway's income statement; look-through earnings add them back, because a part-owner of a good business shares in all of its economic profit, not just the dividend that happens to be mailed.
The definition
Buffett defines the concept directly in the 1992 letter:
We've previously discussed look-through earnings, which consist of: (1) the operating earnings reported in the previous section, plus; (2) the retained operating earnings of major investees that, under GAAP accounting, are not reflected in our profits, less; (3) an allowance for the tax that would be paid by Berkshire if these retained earnings of investees had instead been distributed to us.
The tax adjustment is the subtle piece: retained investee earnings are worth less than distributed ones, because if they had been paid out Berkshire would owe tax on the dividend. Buffett's verdict on the metric as a whole: "Though no single figure can be perfect, we believe that the look-through number more accurately portrays the earnings of Berkshire than does the GAAP number."
Why it is the right yardstick
The purpose is to give owners the number Buffett himself uses to judge the business. He ties the metric to value directly: "I've told you that over time look-through earnings must increase at about 15% annually if our intrinsic business value is to grow at that rate." In 1992 the figure was $604 million, and Buffett wrote that it would need to grow to more than $1.8 billion by 2000 to hit the 15% goal — a target he said guided capital-allocation: "When we allocate capital today, we are thinking about what will maximize look-through earnings in 2000."
A rough number, honestly disclosed
Buffett never pretends the figure is precise. Presenting the 1997 table he warns: "The following table sets forth our 1997 look-through earnings, though I warn you that the figures can be no more than approximate, since they are based on a number of judgment calls." That table added Berkshire's share of each major investee's undistributed operating earnings to reported operating earnings, netted out the hypothetical tax, and arrived at total look-through earnings of $1,930 million against $1,292 million of reported operating earnings.
The cyclical distinction
Look-through earnings track current economics, but they are not the same thing as intrinsic value. When media earnings sagged, Buffett drew the line explicitly: "Cyclical factors have also hurt our current look-through earnings, but these factors do not reduce intrinsic value." A cyclical dip in the metric is a reporting artifact of the year, not a loss of intrinsic-value.
Relationship to other concepts
Look-through earnings sit squarely inside the broader problem of accounting-quality — the distance between what reported statements say and the economic reality of ownership. The metric assumes, as insurance-float does, that the accounting presentation must be translated before it can be used to value. It is Buffett's answer to the question what did our businesses actually earn for us this year? — answered by looking through the legal ownership structure at the underlying operating earnings of everything Berkshire partly owns.
Sources
berkshire-hathaway/Letters-Markdown/1992 - Letter to Shareholders.mdberkshire-hathaway/Letters-Markdown/1997 - Letter to Shareholders.mdberkshire-hathaway/Letters-Markdown/1991 - Letter to Shareholders.md