Warren Buffett Thinks Berkshire Hathaway's Earnings Figures Are "Worse Than Useless." So What Should Investors Focus On?

Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) reported a profit of $96.2 billion last year. The result reflected an impressive improvement over the net loss of nearly $22.8 billion in 2022. Or did it?

Warren Buffett doesn't think highly of his company's bottom line. In his latest letter to Berkshire Hathaway shareholders, Buffett wrote that the conglomerate's earnings figures are "worse than useless." Why is he so negative about earnings? And what should investors focus on instead?

Why Buffett dislikes Berkshire's earnings numbers

It didn't take long for Buffett to bring up Berkshire's financial results for 2023 in his recent shareholder letter. He acknowledged that many people gravitate to the bottom-line numbers on the company's income statement. The legendary investor specifically called attention to the big swings from 2021 (with net earnings of nearly $90 billion) to the loss posted in 2022 to the huge aforementioned profit in 2023.

With Buffett's famous acerbic wit, he wrote:

You seek guidance and are told the procedures for calculating these "earnings" are promulgated by a sober and credentialed Financial Accounting Standards Board ("FASB"), mandated by a dedicated and hard-working Securities and Exchange Commission ("SEC") and audited by the world-class professionals at Deloitte & Touche ("D&T").

He added, "So sanctified, this worse-than-useless 'net income' figure quickly gets transmitted throughout the world via the internet and media. All parties believe they have done their job -- and legally, they have."

Why does Buffett dislike Berkshire's earnings numbers so much? Because the figures must adhere to generally accepted accounting principles (GAAP), they include unrealized capital gains and losses. He noted that Berkshire's unrealized capital gains and losses can sometimes top $5 billion in just one day.

Buffett believes that capital gains are important. He emphasized that Berkshire wouldn't invest so heavily in stocks if they weren't. However, including capital gains and losses in the conglomerate's bottom line doesn't provide shareholders the information they need to truly gauge how well Berkshire is performing. In Buffett's words: "It is more than silly, however, to make judgments about Berkshire's investment value based on 'earnings' that incorporate the capricious day-by-day and, yes, even year-by-year movements of the stock market."

The metric Buffett recommends investors watch

Since Berkshire's GAAP earnings aren't especially helpful, another metric is needed to evaluate how the company is performing. Buffett recommended that investors pay attention instead to Berkshire's operating earnings.

The main difference between GAAP earnings and operating earnings is that the latter excludes the volatile unrealized capital gains and losses. Unsurprisingly, the year-to-year changes with operating earnings aren't nearly as big as the swings with GAAP earnings.

In 2021, Berkshire generated operating earnings of $27.6 billion. Operating earnings rose to $30.9 billion in 2022. The company delivered operating earnings of $37.4 billion last year. The trend is steadily upward, just as Buffett likes to see.

You won't find Berkshire's operating earnings in its 10-K filings. However, the company has included them in its annual report to shareholders since 2018 when GAAP reporting was changed to reflect unrealized capital gains and losses in earnings as well as realized gains and losses.

What about companies other than Berkshire?

It's important to note that Buffett's disparagement of GAAP earnings was limited to Berkshire's case. He didn't argue that investors should disregard the GAAP earnings of other publicly traded companies in evaluating their performance.

However, any company with a significant investment portfolio faces the same issues with GAAP earnings as Berkshire does. For example, Markel, which was in Berkshire's portfolio for a while, invests a lot of money in other stocks. As a result, its GAAP earnings are more likely to fluctuate quite a bit.

There are also some drawbacks to GAAP earnings even with companies that don't have large investment portfolios. Non-cash items such as depreciation and amortization can distort earnings. One-time events can make a company's earnings look much better or worse as well.

Perhaps the best advice for investors concerning using GAAP earnings comes from Buffett himself. He wrote to Berkshire Hathaway shareholders that the GAAP metric should be only "a starting point" in evaluating businesses.