1988
Click here to read the letter.🧠 Key Takeaways
While standardized accounting rules are beneficial, they can sometimes be restrictive and may not fully capture a company's financial situation. It's crucial for a company's management team to provide a comprehensive view to investors.
When investors (even those who consider themselves sophisticated and well-versed in the craft) place high valuations on consistently rising earnings, some managers may get tempted to manipulate GAAP numbers to meet these expectations, regardless of the true financial health of the company.
Investors need to dive deep into research, and need to really get to know the facts about their potential investments. It's crucial to stay disciplined, and to stick to a well-thought-out plan while avoiding making decisions based on knee-jerk reactions or other emotions.
As investors take more risks without regard for that risk, you should proceed with even more vigilance and caution. Be fearful when others are greedy.
✍️ Memorable Quotes
“First, I’ll offer my customary disclaimer: Despite the shortcomings of generally accepted accounting principles (GAAP), I would hate to have the job of devising a better set of rules. The limitations of the existing set, however, need not be inhibiting: CEOs are free to treat GAAP statements as a beginning rather than an end to their obligation to inform owners and creditors - and indeed they should. After all, any manager of a subsidiary company would find himself in hot water if he reported barebones GAAP numbers that omitted key information needed by his boss, the parent corporation’s CEO. Why, then, should the CEO himself withhold information vitally useful to his bosses - the shareholder-owners of the corporation?”
While standardized accounting rules are beneficial, they can sometimes be restrictive and may not fully capture a company's financial situation. It's crucial for a company's management team to provide a comprehensive view to investors.
Therefore, alongside the required GAAP statements, companies should also present non-standardized, non-GAAP statements. These additional reports can offer a clearer and more complete financial picture for shareholders.
“As long as investors - including supposedly sophisticated institutions - place fancy valuations on reported “earnings” that march steadily upward, you can be sure that some managers and promoters will exploit GAAP to produce such numbers, no matter what the truth may be. Charlie and I have observed many accounting-based frauds of staggering size. Few of the perpetrators have been punished; many have not even been censured. It has been far safer to steal large sums with a pen than small sums with a gun.”
When investors (even those who consider themselves sophisticated and well-versed in the craft) place high valuations on consistently rising earnings, some managers may get tempted to manipulate GAAP numbers to meet these expectations, regardless of the true financial health of the company.
This manipulation can lead to significant accounting frauds, which typically go unpunished. Presenting non-GAAP statements can provide a more accurate and transparent financial picture, helping to deter management from engaging in any funny business.
With that said, it's important to be cautious with too many non-GAAP adjustments. An abundance of adjustments in the earnings results can significantly skew reported figures, and can also be a sign of potential financial tomfoolery.
“An investor cannot obtain superior profits from stocks by simply committing to a specific investment category or style. He can earn them only by carefully evaluating facts and continuously exercising discipline.”
Achieving superior profits isn't just about luck or following a trendy strategy. It takes a lot of hard work and self-control.
Investors need to dive deep into research, and need to really get to know the facts about their potential investments. It's crucial to stay disciplined, and to stick to a well-thought-out plan while avoiding making decisions based on knee-jerk reactions or other emotions.
“We have no idea how long the excesses will last, nor do we know what will change the attitudes of government, lender and buyer that fuel them. But we do know that the less the prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”
Markets are obviously unpredictable, and it's impossible to know how long periods of excess, like bubbles or long-lasting bull markets, will last or what might change the attitudes of the market participants.
Because of that, when others are acting recklessly or without caution in the market (when the “greed” factor is high), you’d best be extra careful and prudent with your own investments and decisions.
In other words, as others take more risks without regard for that risk, you should proceed with even more vigilance and caution. Be fearful when others are greedy.