💵 There's a common theme in the recent letters of Warren Buffett to the shareholders of Berkshire Hathaway, $BRK.B the profits according to GAAP (Generally Accepted Accounting Principles) are not accurate. The problem with the GAAP earnings of Berkshire Hathaway is that it takes into consideration unrealized capital gains. But these are not real profits as only when you sell the stocks, you make an actual profit. 𝙃𝙤𝙬 𝙙𝙤 𝙬𝙚 𝙘𝙖𝙡𝙘𝙪𝙡𝙖𝙩𝙚 𝙩𝙝𝙚 𝙧𝙚𝙖𝙡 𝙥𝙧𝙤𝙛𝙞𝙩𝙨 𝙤𝙛 𝙖 𝙘𝙤𝙢𝙥𝙖𝙣𝙮?
📰 Usually, two numbers are often mentioned in the news about how a company is doing, 𝙧𝙚𝙫𝙚𝙣𝙪𝙚𝙨 𝙖𝙣𝙙 𝙀𝙋𝙎 (Earnings Per Share). While revenues are important, what really matters are profits. Here also, accounting rules are very important. In recent years, the revenues of McDonald's $MCD have been going down. It is because they are changing their business model. But as long as profits are increasing, we should not worry.
🎮 𝙏𝙤 𝙘𝙖𝙡𝙘𝙪𝙡𝙖𝙩𝙚 𝙣𝙚𝙩 𝙞𝙣𝙘𝙤𝙢𝙚 (𝙂𝘼𝘼𝙋 𝙥𝙧𝙤𝙛𝙞𝙩𝙨), non-cash expenses such as amortization are also included. But in reality, these expenses don't take cash away from the business. This is what I saw with GameStop $GME when I invested in the company. Most of their expenses were from impairment of goodwill, which did not affect the operations of the business at all. A better way to calculate the actual profits of a company is to look at cash flows.
💰 Warren Buffett goes a step further, from the cash flows, he calculates the actual cash flows which the company can return to shareholders through dividends or buybacks or reinvestments, and calls it 𝙤𝙬𝙣𝙚𝙧'𝙨 𝙚𝙖𝙧𝙣𝙞𝙣𝙜𝙨. For example, owner's earnings should ignore stock compensation unlike free cash flow.
🚚 There is 𝙣𝙤 𝙚𝙭𝙖𝙘𝙩 𝙛𝙤𝙧𝙢𝙪𝙡𝙖 to calculate the owner's earnings of a company. For example, most of the time, non-recurring incomes such as divestitures should be ignored according to Security Analysis of Benjamin Graham. But when I calculated the earnings of UNFI $UNFI I added them since they are using this cash to repay a debt which they took to make these acquisitions.
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