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Buffett thought about his portfolio of shares in terms of look-through earnings. In most cases the actual income received from a holding for the year – dividends – is far smaller than the profit after tax for that holding. Most of those earnings are retained within the business, but as part owner of that business you should have a keen interest in what is attributable to you, i.e. both dividends paid to you and your share of earnings that management keep to invest.
So, if you own 5% of a company (460,000 shares) that had profits after tax of £400,000 and paid a 2p per share dividend it would pay to you 460,000 x 0.02 = £9,200. Overall earnings attributable to you are 0.05 x 400,000 = £20,000 (the look-through earnings), so the company is keeping $10,800 of look-through earnings.
Having observed past look-through earnings try to think of where look-through earnings are going for each company in the portfolio. Try to construct a portfolio that will have the highest look-through earnings in ten years from now.
The accounting and tax background for Berkshire Hathaway is somewhat different than it is for us today so Berkshire’s look-through earnings calculation is a little more complicated. Nevertheless we can understand the example Buffett presents for his Capital Cities/ABC holding.
Look-through earnings consist of,
(1) the cash dividend paid to Berkshire, plus;
(2) Berkshire’s share of the retained operating earnings that, under GAAP accounting, are not reflected in Berkshire’s profits, less;
(3) an allowance for the tax that would be paid by Berkshire if these retained earnings of investees had instead been distributed to Berkshire
Capital Cities Inc. owner earnings attributable to Berkshire Hathaway
| £m | Dividends | Berkshire’s share of undistributed operating earnings | Tax | Total look-through earnings | |||
| 1990 | 0.5 | 85 | -11.2 | 74.3 | |||
| 1991 | 0.5 | 61 | -8.0 | 53.5 | |||
| 1992 | 0.5 | 70 | -9.9 | 60.6 | |||
| 1993 | 0.5 | 83 | -11.5 | 72.0 | |||
| 1994 | 0.5 | 85 | -11.7 | 73.8 |
Thus, an original investment of…..
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