- “EBITDA is a poor investment metric” Buffet does not believe that so-called EBITDA (earnings before interest, taxes, depreciation and amortisation) is a meaningful measure of performance.
- He warns that managers and/or investors that dismiss the importance of depreciation - and emphasise "cash flow" or EBITDA - are apt to make faulty decisions.
- In his books, depreciation is an economic cost every bit as real as wages, materials, or taxes.
Every once in a while, I like to share some nuggets from legendary investor Warren Buffet. Few investors have the reputation that he has.
In today’s article, we dig from his owner’s manual - a compilation of 13 owner-related principles - that would help investors understand his managerial approach. Although they’re now 37 years old, Buffett still values them as much as ever. I highlight five with a brief commentary.
One, use debt sparingly. On this point, Buffet states that he will reject interesting opportunities rather than over-leverage Berkshire’s balance sheet. Although he admits that this sort of conservatism has penalised the group’s results, he believes that it is the only way that leaves him comfortable, considering his fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to his care.
Two: “EBITDA is a poor investment metric” Buffet does not believe that so-called EBITDA (earnings before interest, taxes, depreciation and amortisation) is a meaningful measure of performance.
He warns that managers and/or investors that dismiss the importance of depreciation - and emphasise "cash flow" or EBITDA - are apt to make faulty decisions. In his books, depreciation is an economic cost every bit as real as wages, materials, or taxes.
Buffet thus warns that investors are often led astray by CEOs and analysts who equate depreciation charges with the amortisation charges.
Three: Beware of the undervaluation lie. Buffett cautions investors that managers that say or imply during an initial public offering or a rights issue that their stock is undervalued are usually being economical with the truth or uneconomical with their existing shareholders' money: Owners unfairly lose if their managers deliberately sell assets for less than their full price.
Four: Buy and hold. On this point, the oracle of Omaha firmly states that regardless of price, he has no interest in selling any good businesses that Berkshire owns. He’s also very reluctant to sell any sub-par businesses as long as he expects them to generate at least some cash and as long as he feels good about their managers. He hopes not to repeat the capital-allocation mistakes that led Berkshire into such sub- par businesses.
Five: Find a cheap source of cash. Berkshire has access to two low-cost sources of leverage that allow it to safely own far more assets than its equity capital alone would permit: deferred taxes and "insurance float" - the funds of others that its insurance business holds because it receives premiums before needing to pay out losses.
To explain further, deferred tax liabilities bear no interest and since its insurance underwriting business breaks even, it means the cost of the insurance float is zero. On the insurance float, Buffett is reportedly quoted as saying, “it's the engine that has propelled its expansion since 1967.” Both of these funding sources have grown rapidly and now total about Sh15 trillion as of 2020.
These five principles have served Warren Buffett well over the years, and even after he’s gone, Berkshire Hathaway shareholders can count on them lasting for years to come. You can count on them too.
Mr Mwanyasi is managing director at Canaan Capital