BULLS & BEARS: Investing for the long term: Buffett does it; so can you

Have you dreamed of creating your own business empire? Well, if you have an investment portfolio that contains a group of stocks, congratulations. You and Jeffrey Immelt at General Electric Corp. have a lot in common.

GE is a company composed of a diverse group of separate businesses. And since stocks represent a fractional ownership of a business, the separate holdings in your portfolio, when combined, are analogous to running your own mini-conglomerate.

One technique you can use to track the progress of your business empire is to use a concept Warren Buffett introduced in Berkshire Hathaway’s 1989 annual report called “look-through” earnings.

You may receive dividends from some of the companies in your portfolio, which are paid from a portion of the profit these businesses generate. However, a large portion of your proportionate share of the earnings is usually retained by those companies to reinvest in their business.

As Buffett describes, Berkshire reports the dividends received from its stock holdings in its financial statements-just as you report dividends on your tax return. However, he suggests that investors should calculate the overall earnings that accrue to you as an investor.

For example, you may own 500 shares of Eli Lilly and Co. In 2004, you received $177.50 in dividends. Now let’s “lookthrough” and determine your share of Lilly’s total earnings based on your ownership percentage. In 2004, this would have amounted to $830, calculated by multiplying your 500 shares by the $1.66 per share in earnings Lilly reported in 2004.

Writing in Berkshire’s 1991 annual letter, Buffett says, “We also believe that investors can benefit by focusing on their own lookthrough earnings. To calculate these, they should determine the underlying earnings attributable to the shares they hold in their portfolio and total these.

“The goal of each investor should be to create a portfolio (in effect, a ‘company’) that will deliver him or her the highest possible look-through earnings a decade or so from now. An approach of this kind will force the investor to think about long-term business prospects rather than short-term stock market prospects, a perspective likely to improve results.”

Maybe you own 700 shares of Indianapolis-based Celadon Group Inc. representing ownership of $27,349 worth of the firm’s 2005 revenue (700 times $39.07 sales per share), and $861 in earnings (700 times $1.23 earnings per share).

Add these to the numbers attributable to your 500 shares of Lilly, and so forth, for each of your stock holdings. You could even write your own annual letter-to yourself-that candidly discusses both the positives and negatives from the past year.

This method of calculating look-through earnings takes the focus off short-term movements in stock prices and drives home the point that your portfolio represents partial ownership in a group of companies. And it is the operating results of these businesses in your empire that will eventually determine your investment results.

So in a way, you and Jeff Immelt at GE run in the same circles-you are both managing an empire composed of a diverse group of businesses. There may be a few zeroes missing from the end of the market value of your conglomerate relative to that of GE, but the idea is the same.