1998: What is the quality of earnings in the US right now?

AUDIENCE MEMBER: Nat Chase (PH), Houston, Texas. My first question’s on the quality of earnings and your evaluation of quality of earnings in the U.S. right now.

WARREN BUFFETT: Now, as to quality of earnings, Charlie and I feel that, in several respects, but in one important respect, that the quality of earnings has gone down. Not because the policy has changed, but because it’s just become more significant. And that’s in the case of stock options.

We have — there are certain companies that we’ve evaluated for possible purchase where, in our calculation of earnings, the earnings are maybe 10 percent less per year per share than reported. And that isn’t necessarily the end of the world, but it is a difference in valuation that is significant and is not reported under standard accounting.

So we think the quality of earnings as reported by a company with significant stock option grants every year, we think is dramatically poorer than for one where that doesn’t exist. And there are a lot of companies that fall in that category.

Coca-Cola’s earnings are very easy to figure out. Just figure out what they’re, you know, what they’re earning per case from operations, and you’ll see over the years the earnings per case go up. And the cases go up and the shares go down. And it doesn’t get much more complicated than that.

Charlie?

CHARLIE MUNGER: You’ve said it wonderfully. (Laughter)

I just wish we had more like that.

WARREN BUFFETT: Yeah.

GEICO, the key — I mean the same way. It’s policies in force and underwriting experience per policy. And that is exactly the way, as noted in the annual report, we pay people there. We pay them, from the bottom to the very top, based on what happens with those two variables.

And we don’t talk about earnings per share at GEICO, and we don’t talk about investment income. We don’t get off the track, because there are two things that are going to determine what kind of business that GEICO is over a long period of time. And policies at GEICO are unit cases at Coca-Cola.