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1997: How do you calculate maintenance capex?
AUDIENCE MEMBER: Gentlemen, my name is Richard Sercer from Tucson, Arizona.
WARREN BUFFETT: Let’s give him a hand. This is the gentleman that led to the FlightSafety purchase. (Applause)
AUDIENCE MEMBER: My question relates to owner earnings. What guidance can you give us as to the calculation of item (c), which is maintenance capital spending and working capital requirements?
WARREN BUFFETT: Item (c)? Richard, I was going to ask you a question. How about another company? (Laughter)
Richard and his wife Alma have attended, what, maybe eight or so meetings, and what he did is covered in the annual report. But if it had not been for Richard we would not have merged with FlightSafety. And for that we owe him a lot of thanks.
Now, the item (c), I don’t remember item (c).
CHARLIE MUNGER: He’s talking about maintenance expenditures and working capital —
WARREN BUFFETT: Yeah, I know.
CHARLIE MUNGER: — and so forth. The compulsory reinvestment.
WARREN BUFFETT: Oh, oh, back on the — goes back some years on that description. Yeah.
In the case of the businesses that we’re in, both wholly owned and major investee companies, we regard the reported earnings — with the exception of the — some major purchase accounting adjustment, which will usually be an amortization of intangibles item — we regard the reported earnings — actually the reported earnings plus — plus or minus, but usually plus — purchase accounting adjustments, to be a pretty good representation of the real earnings of the business.
Now you can make the argument that when Coca-Cola’s spending a ton of money each year in marketing and advertising that they’re expensing, that really a portion of that’s creating an asset just as if they were building a factory, because it is creating more value for the company in the future, in addition to doing something for them in the present. And I wouldn’t argue with that.
But of course, that was true in the past, too. And if you’d capitalized those expenditures in those earlier years, you’d be amortizing the cost of them at the present time.
I think with a relatively low inflation situation, with the kind of businesses we own, I think that reported earnings plus amortization of any — well, it’s really amortization of intangibles. Other purchase accounting adjustments usually aren’t that important. I would say that they give a good representation to us of owner earnings.
Can you think of any exceptions in our businesses particularly, Charlie?
CHARLIE MUNGER: No. We have — after some unpleasant early experience, we have tried to avoid places where there was a lot of compulsory reinvestment just in order to stand still.
But there are businesses out there that are still like that. It’s just that we don’t have any.
WARREN BUFFETT: Yeah. I would say that in the case of GEICO, for example, the earnings — the gain in intrinsic value — will be substantially greater than represented by the annual earnings.
Whether you want to call that extra amount owner earnings or not is another question. But as we build float from that business, as long as it’s represented by the same kind of policyholders that we’ve had in the past, there is an added element to the gain in intrinsic value that goes well beyond the reported earnings for the year.
But whether you want to really think of that as earnings, or whether you just want to think of that as an increment to intrinsic value, you know, I sort of leave to you.
But I would say that there’s no question that in our insurance business, where our float was $20 million or so when we went into it in 1967, and where it is now, that there have been earnings, in effect, through the buildup of the float that have been above and beyond the reported earnings that we’ve given to you.
I think our look-through earnings are — they’re very rough. And we don’t try to — we don’t believe in carrying things out to four decimal places where, you know, we really don’t know what the first digit is very well.
So, I don’t want — I never want you to think of them as too precise, but I think they give a good rough indication of the actual earnings that are taking place, attributable to our situation every year.
And I think the pace at which they move gives you a good idea as to the progress, or the lack of progress, that we’ve made. The only big adjustment I would make in those is in the super-cat insurance business, we’re going to have a really bad year occasionally. And you probably should take something off all of the good years, and you probably should not regard — when the bad year comes — you should not regard that as something to be projected into the future.
CHARLIE MUNGER: No more.
WARREN BUFFETT: No more.