Buffett 2021 — "Bull markets breed bloviated bull"

Buried inside a passage about BNSF Railway's record 2021 performance is the sharpest sentence Buffett wrote that year. He had just described BNSF's earnings — $6 billion — and insisted on defining what "earnings" actually means before moving on. 1

The definition he offered was deliberately old-fashioned: earnings after interest, taxes, depreciation, and amortization — and after all forms of compensation, including stock-based awards. Then came the aside:

One sentence. No chart required. Buffett had identified a structural pattern — that the incentive to inflate reported numbers intensifies exactly when investors are least suspicious of it.

The phrase "old-fashioned earnings" is doing more work than it appears. When Buffett says BNSF earned $6 billion, he is specifically not using any of the adjustments that have become standard in corporate earnings presentations over the past two decades.

EBITDA — earnings before interest, taxes, depreciation, and amortization — is perhaps the most widely cited proxy for operating performance. It excludes depreciation on the grounds that it is a non-cash charge. But for a company like BNSF, which operates 143 million track-miles annually and hauls 535 million tons of freight, the physical infrastructure — locomotives, rail lines, bridges, rolling stock — wears out and must be replaced. 1 Treating the cost of that replacement as not real is a choice that can only be sustained by someone with access to fresh capital. Buffett's point is that it is not a choice Berkshire makes.

Stock-based compensation is the second exclusion many companies apply. The logic — that it does not consume cash — has the same flaw: the shares that employees receive represent real dilution of existing shareholders. The dilution may not appear as a line item in a cash flow statement, but the economic cost is borne by the people who already own the company. Buffett includes it in BNSF's reported $6 billion as a matter of principle.

The result is a number that bears little resemblance to the headline figures many publicly traded competitors report for comparable operations.

BNSF and Berkshire Hathaway Energy (BHE) record earnings in 2021, measured on Buffett's "old-fashioned" definition — after interest, taxes, depreciation, amortization, and all forms of compensation. BHE's $4 billion was up more than 30-fold from $122 million when Berkshire first purchased a stake in 2000. 1

Buffett's observation — that deceptive adjustments become "more frequent and more fanciful as stocks have risen" — points to a feedback loop that is worth understanding precisely.

When stock prices are rising and companies are valued on forward earnings multiples, the numerator of that equation (reported earnings) has enormous economic value. A company that can add $1 billion to reported earnings through a definitional adjustment — reclassifying a recurring cost as "one-time," excluding stock compensation, adding back amortization on acquired intangibles — may add several billion dollars to its market capitalization at a typical earnings multiple. The marginal dollar of accounting creativity is highly rewarded in a bull market.

At the same time, scrutiny relaxes. Analysts covering strong performers are rewarded for coverage that supports prevailing narratives. Institutional investors generating strong returns are not motivated to introduce friction with management teams. Auditors operating in a period of minimal enforcement action face limited downside for approving aggressive but defensible positions. The entire system of checks weakens when the market is going up.

Buffett has been making versions of this argument since the 1990s. What makes the 2021 letter notable is the directness of the phrasing. "Bloviated bull" is not the language of a diplomatically-worded annual letter; it is the language of someone who has watched a specific pattern repeat enough times to be done with polite circumlocution.

The passage on earnings quality sits inside a section that also contains Buffett's most explicit statement of conviction about BNSF as a long-duration holding:

And then, about an acquisition consummated in 2009–2010 at the depths of the post-crisis downturn: 1

A century. It is a prediction that is structurally immune from short-term performance reviews, quarterly comparisons, or management guidance calls. It is also the context in which the earnings-quality argument makes most sense: Buffett is not managing BNSF to meet a next-quarter consensus estimate. He is running it for the owners who will be there in 2122.

That time horizon changes the calculus for what "real earnings" means. The accumulated depreciation on BNSF's rolling stock will eventually need to be funded. Deferred capital expenditure that makes this year's reported number look better makes next decade's maintenance burden larger. A manager who owns an asset for a century cannot hide from the physics of wear.

All figures from the 2021 Annual Report. 1

The 2021 letter offers no explicit checklist for separating real earnings from manufactured ones. But Buffett's argument implies a few tests any investor can apply when reviewing a company's reported results.

First: does the company reconcile from GAAP earnings to its preferred metric, or does it lead with the preferred metric and treat GAAP as the footnote? The direction of the disclosure matters. A company that starts with GAAP and explains its adjustments is making a different argument than one that leads with "adjusted EBITDA" and buries GAAP in a supplemental table.

Second: is stock-based compensation excluded from the headline metric? If so, by how much? This is increasingly a material number for technology and growth companies. A company reporting $1 billion in "adjusted" earnings while issuing $400 million in annual stock compensation is reporting economic reality differently from how it is actually deploying resources.

Third: does the frequency of "one-time" or "non-recurring" charges suggest that the recurring business is generating something the headline metric never shows? When restructuring charges, impairments, and write-downs appear in every annual report, the recurring/non-recurring classification has lost its meaning.

None of these tests is new. Buffett has been making the underlying arguments for thirty years. What the 2021 letter adds is the observation that the incentive to apply them varies inversely with how well the market is doing — meaning the period when investors are most comfortable is often the period when the adjustments are most aggressively constructed.

"Bull markets breed bloviated bull" is less a verdict on any specific company than it is a description of an environment. The question it puts to any investor reading an earnings release in a rising market is: am I seeing the number that describes the economics of this business, or the number that was constructed to be seen?

The 2021 letter was published February 26, 2022, covering a year in which Berkshire's per-share market value rose 29.6% against the S&P 500's 28.7% total return — a rare year of outperformance. 1 The 57-year compounded annual gain stood at 20.1% versus 10.5% for the S&P. Insurance float ended the year at $147 billion, up $9 billion from 2020. Berkshire's 15 largest equity holdings totaled $350.7 billion at market value against a cost basis of $104.6 billion. Over 2020 and 2021 combined, Berkshire repurchased 9% of its shares outstanding at a total cost of $51.7 billion, leaving continuing shareholders owning roughly 10% more of every Berkshire business than they did at the end of 2019. The cash position stood at $144 billion — which Buffett described, with characteristic understatement, as "not some deranged expression of patriotism."