GAAP Earnings vs Operating Earnings

Overview

A core tenet of Buffett's financial communication is distinguishing between mandated GAAP (Generally Accepted Accounting Principles) net income and "Operating Earnings" (or Economic Earnings). Buffett considers GAAP net income often misleading due to arbitrary inclusion of non-economic items.

The 2018 GAAP Rule Change

The distinction became critical following a 2018 change to GAAP rules requiring companies to include unrealized capital gains and losses in their bottom-line net income. Because Berkshire holds a massive portfolio of marketable securities (like Apple), normal market fluctuations cause multi-billion dollar swings in GAAP earnings that have nothing to do with Berkshire's operating businesses.

Chronological Evolution

• 2019 Letter: Buffett forcefully criticized the new GAAP rule. In 2019, a $53.7 billion unrealized gain drove GAAP profit to a staggering $81.4 billion, which Buffett called a "crazy 1,900% increase" over the previous year. He urged shareholders to focus on the $24 billion in operating earnings, characterizing the GAAP bottom line as "capricious" and disconnected from the real world.

🔗 Connections

• Concepts: Retained Earnings, Economic Earnings
• Sources: 2019 Letter