Why Warren Buffett is Suspicious of CEOs who Always “Make the Numbers”

You’d think that consistently hitting or exceeding earnings targets would be an achievement that one of the world’s richest investors would applaud.

Not so for Berkshire Hathaway CEO Warren Buffett, who is very wary about the type of forecasts that companies are actually hitting.

If they’re “adjusted”, he’s not impressed.

Nevertheless, it’s become increasingly common for companies—and the analysts and journalists who cover them—to focus on numbers that differ from bottom line results based on Generally Accepted Accounting Principals (GAAP). The reasoning is that one-off expenses won’t be repeated in future years, so it’s OK for them to be excluded to paint a more accurate comparison of a organization’s continuing performance.

That can be misleading, according to Buffett and Berkshire Hathaway vice-chairman Charlie Munger, who fear that real costs are a little too conveniently excluded from consideration.

“Too many managements—and the number seems to grow every year—are looking for any means to report, and indeed feature, “adjusted earnings” that are higher than their company’s GAAP earnings,” Buffett wrote Saturday in his closely-watched annual letter to shareholders.

Two adjustments that rankle the billionaire most are the omission of “restructuring costs” and “stock-based compensation” from expenses.

And his concerns go much deeper than what such disclosure practices mean for interpreting financial results. They also, he fears, can say something about the corporate culture engendered by CEOs.

“A management that regularly attempts to wave away very real costs by highlighting “adjusted per-share earnings” makes us nervous,” Buffet wrote.” That’s because bad behavior is contagious: CEOs who overtly look for ways to report high numbers tend to foster a culture in which subordinates strive to be “helpful” as well.”

That’s why he and Munger both “cringe” when they hear analysts praise managers who always make the numbers.

“In truth, business is too unpredictable for the numbers always to be met,” Buffett said. “Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers.”

Berkshire Hathaway reported a 15% rise in fourth-quarter profit to $6.29 billion. In his letter, Buffett also took aim at investment managers who charge additional fees for trying to outperform the market.

He estimated that investors had wasted more than $100 billion on Wall Street fees over the past decade. “The bottom line: when trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients,” Buffett said. “Both large and small investors should stick with low-cost index funds.”