Berkshire Hathaway Letters to Shareholders: 1965-2024

by Warren Buffett

Merging with public companies presents a special problem for us. If we are to offer any premium to the acquiree, one of two conditions must be present: Either our own stock must be overvalued relative to the acquiree’s, or the two companies together must be expected to earn more than they would if operated separately. Historically, Berkshire has seldom been overvalued. In this market, moreover, undervalued acquirees are almost impossible to find. That other possibility—synergy gains—is usually unrealistic, since we expect acquirees to operate after we’ve bought them just as they did before. Joining with Berkshire does not normally raise their revenues nor cut their costs. Indeed, their reported costs (but not their true ones) will rise after they are bought by Berkshire if the acquiree has been granting options as part of its compensation packages. In these cases, “earnings” of the acquiree have been overstated because they have followed the standard—but, in our view, dead wrong—accounting practice of ignoring the cost to a business of issuing options. When Berkshire acquires an option-issuing company, we promptly substitute a cash compensation plan having an economic value equivalent to that of the previous option plan. The acquiree’s true compensation cost is thereby brought out of the closet and charged, as it should be, against earnings.