Benel Lagua l October 26, 2023 l Manila Bulletin
This writer has picked up gems of wisdom from Warren Buffet’s annual letter to Berkshire Hathaway stockholders. The regular reader may not have access to these letters, so this column can serve as an echo board.
In a discussion on the topic of full and fair disclosures, Buffet calls caution to the way company CEOs provide disclosures on financial information. He laments that corporations have practiced “selective disclosure” which he characterized as a concern in information reporting. He is suspicious of accounting methodology that is vague or unclear, an indication that management wishes to hide something.
“Three suggestions for investors: First, beware of companies displaying weak accounting. If a company still does not expense options, or if its pension assumptions are fanciful, watch out. When managements take the low road in aspects that are visible, it is likely they are following a similar path behind the scenes. There is seldom just one cockroach in the kitchen.”
“Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice. Doing so implies that depreciation is not truly an expense, given that it is a “non-cash” charge. That’s nonsense. In truth, depreciation is a particularly unattractive expenses because the cash outlay it represents is paid up front before the asset acquired has delivered any benefits to the business. Imagine, if you will, that at the beginning of this year a company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed asset to be useful for ten years). In the following nine years, compensation would be a “non-cash” expense – a reduction of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years two through ten would be simply a bookkeeping formality?”
“Second, unintelligible footnotes usually indicate untrustworthy management. If you can’t understand a footnote or other managerial explanation, it’s usually because the CEO doesn’t want you to. Enron’s descriptions of certain transactions still baffle me.”
“Finally, be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no-surprise environment, and earnings simply don’t advance smoothly (except, of course, in the offering books of investment bankers).”
Buffet makes several bible references when he writes about governance. “Both the ability and fidelity of managers have long needed monitoring. Indeed, nearly 2,000 years ago, Jesus Christ addressed this subject, speaking (Luke 16:2) approvingly of a certain rich man who told his manager, “Give an account of thy stewardship; for thou mayest no longer be steward.” Accountability and stewardship withered in the last decade, becoming qualities deemed of little importance.”
He asserted that director’s independence means being not subject to control by others. An interesting anecdote he shared was about how some advisors questioned his alleged lack of independence in his role as director of Coca-Cola. Apparently, this was because among others, Berkshire Hathaway owned large shares in other companies that buys lots of Coke products. One group wanted to remove him from the board, and another simply wanted him booted from the audit committee. I can relate to Buffet’s reaction, as this writer is often assigned chair of the audit committees in his directorships.
“My first impulse was to secretly fund the group behind the second idea. Why anyone would wish to be on an audit committee is beyond me. But since directors must be assigned to one committee or another, and since no CEO wants me on his compensation committee, it’s often been my lot to get an audit committee assignment. As it turned out, the institutions that opposed me failed and I was re-elected to the audit job. (I fought off the urge to ask for a re-cast).”
Here’s his bible take on the idea of independence. “I can’t resist mentioning that Jesus understood the calibrations of independence far more clearly than do the protesting institutions. In Matthew 6:21 He observed: “For where your treasure is, there will your heart be also.” Buffet reflects that elementary arithmetic shows his heart and mind belong to the owners of Coke, not to its management. The $8 Billion investment of Berkshire Hathaway in Coca Cola should qualify as a treasure that dwarfs any profit Berkshire might earn on its routine transactions with Coke.
The interested reader who wants more has a valuable reference in “The Essays of Warren Buffet” by Lawrence Cunningham. It’s a good read and learning from Buffet is one worthwhile investment.
*** (Benel Dela Paz Lagua was previously EVP and Chief Development Officer at the Development Bank of the Philippines. He is an active FINEX member and an advocate of risk-based lending for SMEs. Today, he is independent director in progressive banks and in some NGOs. The views expressed herein are his own and does not necessarily reflect the opinion of his office as well as FINEX.)