GAAP Volatility - Explained
A beginner-friendly explanation of GAAP Volatility in value investing.
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GAAP Volatility Explained
The requirement to mark investment portfolios to market each quarter causes wild swings in reported earnings, which Buffett argues distorts true business performance.
What It Means for Investors
The Problem
New GAAP Rule
In 2016, a new accounting rule required:
- All equity securities must be marked to market each quarter
- Unrealized gains/losses flow directly through the income statement
- This applies to Berkshire's ~$300B equity portfolio
The Distortion
| Quarter | GAAP Earnings Impact |
|---|---|
| Q1 2018 | $1.1B loss |
| Q2 2018 | $12.0B profit |
| Q3 2018 | $18.5B profit |
| Q4 2018 | $25.4B loss |
| Full Year | $4.0B (but operating earnings: $24.8B) |
Why Buffett Objects
Focuses on the Wrong Thing
- The quarterly swings are meaningless to long-term value
- They distract from operating business performance
- Market prices are temporary, business value is durable
Timing Mismatch
- Unrealized gains/losses are just paper changes
- Only realized gains/losses represent actual transactions
- Market prices can be wildly wrong in short term
"A new GAAP rule requires us to include that last item in earnings... we both have consistently thought that at Berksh
Key Takeaway
The requirement to mark investment portfolios to market each quarter causes wild swings in reported earnings, which Buffett argues distorts true business performance.