Warren Buffett: Beyond the Numbers: Unveiling the True Value of Businesses with Intangible Assets

Johnny HopkinsWarren BuffettLeave a Comment

In his 1983 Berkshire Hathaway Annual Letter, Warren Buffett explained why a profitable business might not be a wise acquisition. While good businesses are good places to seek acquisitions, focusing purely on operating performance without considering true acquisition cost can lead to misjudgments. Here’s an excerpt from the letter:

We believe managers and investors alike should view intangible assets from two perspectives:

  1. In analysis of operating results—that is, in evaluating the underlying economics of a business unit—amortization charges should be ignored. What a business can be expected to earn on unleveraged net tangible assets, excluding any charges against earnings for amortization of Goodwill, is the best guide to the economic attractiveness of the operation. It is also the best guide to the current value of the operation’s economic Goodwill.
  1. In evaluating the wisdom of business acquisitions, amortization charges should be ignored also. They should be deducted neither from earnings nor from the cost of the business. This means forever viewing purchased Goodwill at its full cost, before any amortization. Furthermore, cost should be defined as including the full intrinsic business value—not just the recorded accounting value—of all consideration given, irrespective of market prices of the securities involved at the time of merger and irrespective of whether pooling treatment was allowed. For example, what we truly paid in the Blue Chip merger for 40% of the Goodwill of See’s and the News was considerably more than the $51.7 million entered on our books. This disparity exists because the market value of the Berkshire shares given up in the merger was less than their intrinsic business value, which is the value that defines the true cost to us.

Operations that appear to be winners based upon perspective (1) may pale when viewed from perspective (2). A good business is not always a good purchase—although it’s a good place to look for one.

You can find the entire letter here:

1983 Berkshire Hathaway Annual Letter

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