I am hugely indebted to Jim Fink’s Investing Daily newsletter for picking up on an absolutely daft confrontation between Warren Buffett’s Berkshire Hathaway and SEC accounting branch chief Gus Rodriguez. The nub of the matter concerns an obscure Financial Accounting Standards Board (FASB) ruling; namely Accounting Standards Codification (ASC) Section 320-10-35-33. Here I quote Fink: “This arcane rule states that under U.S. generally accepted accounting principles (GAAP), a company must take a charge against earnings if it determines that one of its stocks has suffered an “other-than-temporary” impairment of value. An impairment of value means that the current market price of the stock is less than the original price that the investor paid for it.”
The reason why it is so much easier to write rules than it is to follow them is that the rule writer can paper over elephant traps with a phrase, leaving it to everyone else to either fall into or tiptoe round the trap. The black hole in question here, of course, concerns the “common sense” definition to be applied to “other-than-temporary”. One of the sad facts about living in a contingent universe is that much can happen and probably will, so deciding whether a particular stock price, at a particular moment, represents a temporary fall from a previous high, or a new high that is unlikely to be exceeded again until hell freezes over, is a tough call.
The way in which a value investor with a proven pedigree, such as Buffett, makes this call is by analysing the company and its management and its strategy and markets and deciding, perhaps, that the company is currently undervalued, because it will go on to do better things and that its potential to do these astonishing things has not yet been grasped by the market and written in to the current stock price. Occasionally, or not so occasionally, given the vagaries of markets, even a world class investor like Buffett places a bet without foreseeing that the stock is going to tank a bit, and that if they’d waited a while longer, they could have bought that same stock more cheaply. When this happens the investor, be it Buffett or anyone else, faces a choice: dump the stock and take the hit, or reanalyse the company, convince themselves that it was a sound investment after all, and then sit tight and wait for the price to recover, which may take a year or three.
Which brings us to FASB (ASC) Section 320-10-35-33. (Spare a thought here for the complexities hinted at by this numbering scheme: if this point delineates such a tasty elephant trap, one can only marvel at what else may lie in mini sections 0-33 of sub section 35, and that’s before we work back a further 35 points to get to 320-10-00 – the mind boggles at trying to count back to 320-00-00-00, and the heart positively quails at the thought of trying to push further back to, say, 318-0-0.) Anyway, pressing on, we find Buffett and the SEC bean counter colliding on precisely when a charge is logically due because a stock has suffered an “other-than-temporary” impairment.
Buffett’s logic is simple. If he expects the stock to at least return to its purchase price in a reasonable time frame, say within a year or two (his phrase), and if he intends to hang on to the stock, then no impairment charge should be due. Nothing daunted by the illustrious reputation of his adversary, the SEC’s Gus Rodriguez takes a look at the calendar, has a sniff of the stocks in question, detects a whiff of permanence about their pricing and decides, yes, an impairment charge is in order.
The wonderful beauty of his decision, however, is that he bases it on the assumption that, hey, markets are efficient so the price must be right, so what’s Buffett on about? At which point one wants to take the man aside and explain that no, far from being 100% efficient 100% of the time, markets actually quite often get things wildly wrong. They undershoot, they overshoot, they bounce, they dive, they meander all over the bloody place, but look, they do find their way back to underlying fundamentals over time. And moreover, this is why you can have value investing in the first place. Having had this urge to council the good Mr. Rodriguez, one then looks again at his position. Chief accountant with the, what? The SEC? But that’s the market regulator. They’re supposed to know this stuff... Oh dear...
Further reading on the impairment charge, valuations, and asset price bubbles:
- Fair Value Accounting: SFAS 157 and IAS 39, by Kevin Ow Yong
- A One-in-Fifty-Year Event, by Leigh Skene
- Inverse Stagflation and the Global Economy: When Real Assets and Paper Assets Part Company, by Renée Haugerud
Tags: ASC , Berkshire Hathaway , chief accountant , fair value , FASB , impairment charge , SEC , Warren Buffett