What we read from the Berkshire Hathaway quarterly report?

7 Nov 2023 , 11:01 AM

LOSSES FOR BERKSHIRE IN Q3, BUT OPERATING PROFITS HIGHER

The third quarter ended September 2023 was a tough quarter for Berkshire Hathaway with the company reporting net loss of $12.8 billion. This is more than 4 times the net loss of $2.8 billion reported in the year ago quarter. But why is Berkshire Hathaway bleeding? Actually, it is not bleeding. It follows the principle of writing off any MTM losses on its equity portfolio in the same quarter and this is a practice it has followed diligently over the last many years, as that is more of an accounting necessity than a business reality. Berkshire reports its net profits the same way as a mutual fund would report MTM losses on its portfolio. The only difference is that, Berkshire Hathaway is a listed company where the legendary equity portfolio is a smaller part of its business as compared to core businesses like insurance, railroads, petroleum etc. But, why are we looking at Berkshire earnings?

Berkshire Hathaway is no ordinary company. It is among the 10 most valuable companies in the world by market cap, but that is more the outcome. What makes Berkshire Hathaway special is that it is the holding company of the world’s greatest investor, Warren Buffett. Neither Buffett at 93, nor his partner Charlie Munger at 98, are getting any younger. However, their performance has been so stellar that nobody really worries about things like change in management, succession plan etc. That is not surprising considering that over the last 55 years, Berkshire Hathaway has outperformed the S&P 500 index by nearly 100% in terms of CAGR returns. Here is the story of Berkshire Hathaway in numbers for Q3-2023.

What we read from the Q3-2023 earnings report of Berkshire Hathaway

The quarterly results may not be as big an even as the Oracle of Omaha delivered his famous “Letter to Shareholders” in February each year, along with the annual accounts. Amidst investment wisdom and trout fishing; the annual meeting of Berkshire Hathaway has been the pilgrimage for every aspiring investor. For now, here is what we gather from the quarterly numbers of the company for the September 2023 quarter.

1. Berkshire Hathaway reported net loss of $12.8 billion in the September quarter. However, as stated earlier, these losses are not actual losses but substantially notional losses. Notional losses may not mean much in a long term investment like equities, but Berkshire has generally preferred to err on the side of caution. These numbers include the gains or losses from the investment portfolio, including unrealized losses from their portfolio. In this quarter, the biggest contributor to the net loss has been MTM losses in Apple Inc. Incidentally, Apple is the largest portfolio holding of Berkshire Hathaway and has powered its portfolio performance in the last 5 years.

    

2. It is 3 full years since the end of the pandemic and it is time to look at whether current numbers are outperforming the pre-COVID levels. According to the quarterly report, Berkshire Hathaway has operating earnings for the third quarter of 2023 by 46% over the corresponding 2019 levels. YTD earnings in 2023 are 65% higher than 2019 and that shows that Berkshire Hathaway not only survived the pandemic crisis, but came out much stronger. 

    

3. As Buffett himself says, investors must look beyond the net losses and focus on the operating income across various segments. At a macro company level, the operating income has grown by 41% yoy. However, this has been powered by a 165% growth in operating income in the insurance and reinsurance business. As a result, the operating income excluding insurance fell by 12%. Let us, therefore, delve a little deeper into the insurance story of Berkshire Hathaway. 

    

4. What triggered such a sharp growth in the operating income of the insurance business of Berkshire Hathaway? For starters, the investment income was 75% higher driven by higher interest income from short-term investments. With the bond yields rebounding from lows, investment income has recovered from extremely low levels. However, the underwriting losses were quite prominent in the September quarter, largely driven by its main holding in GEICO due to Hurricane Ian. However, the primary group and the reinsurance group saw underwriting gains in the quarter. GEICO has been largely hit by rising claims severity on account of higher valuation of used vehicles. For Berkshire, the main factor continues to be that they earning underwriting profits, so the float from premiums paid in advance, costs them next to nothing.

    

5. Another major business line of Berkshire Hathaway is the railroads business. It owns Burlington Northern Santa Fe (BNSF), the largest operating railroad in the US and Canada. Railroads business saw operating earnings lower by 15% due to lower overall freight volumes and higher non-fuel operating costs. However, this was partially compensated by lower fuel costs.

    

6. The other major business vertical of Berkshire Hathaway is the Utilities business. Generally, the utilities business is supposed to be steady and a growing business. Incidentally, Berkshire owns 92% of Berkshire Hathaway Energy (BHE). Most of the pressure on earnings has come from losses from the wildfires involving PacifiCorp, although it does get the benefit of extensive tax credits to a substantial wind power franchise in its power portfolio. 

    

7. There are other sectors also that Berkshire operates in, like manufacturing, retailing and real estate broking. But, now we move to the non-controlled businesses or the portfolio investments of Berkshire Hathaway. This includes companies, where the profits must be accounted for under the equity method due to the size of ownership and influence on management. This includes some of the blue chips names in the US industry like Kraft Heinz, Occidental Petroleum, and Berkadia. Incidentally, Berkshire Hathaway holds a 25.8% stake in Occidental Petroleum

Apart from the business side of Berkshire Hathaway, the 2 things that people are most interested in about the company is its Buyback volumes and the cash held by the company. 

Buybacks and the Berkshire cash stash

Just to recap, for the September 2023 quarter, Berkshire Hathaway reported $12.8 billion in net loss but the operating profits were higher by 40.6% in the quarter. Here are some interesting points about the quarterly numbers. As of the close of September 2023, Berkshire was sitting on a cash stash of $157.20 billion. In the entire globe, only Apple sits on more cash with Alphabet and Microsoft also holding more than $100 billion in cash. According to Buffett, the company has been making a lot of money on its debt investments at the short end of the  yield curve due to rising bond yields. However, Buffett still remains sceptical about investing big money at these levels and feels that the margin of safety is still not too convincing. 

Buffett has a simple logic for a Buyback. When the company does not have too many exciting opportunities in the market, the best way to add value to shareholders is to use the cash in the balance sheet to buy back its own shares. That means, with no additional investment, the investor owns a bigger stake in the company, since the capital base has shrunk due to the buyback. However, for the quarter, the buyback activity continued to slow down as Berkshire shares roared to a record high during the quarter. For the quarter, the total buyback spending was just about $1.1 billion while for the 9 months of 2023, the buyback figure stood at a moderate level of $7 billion.

Apple triggers bulk of the investment losses in Q3

Berkshire Hathaway did post a significant investment loss of $24.1 billion in the third quarter, which largely came from a decline in the stock price of Apple. Incidentally, Apple is the biggest stock holding of Berkshire Hathaway and the stock is down nearly 11.7% in the September quarter. However, one must not forget that Apple has been the biggest growth driver for Berkshire Hathaway in the last 5 years and if you look at the track record of Apple, the stock has always managed to bounce back from lower levels. 

Not surprisingly, Warren Buffett has asked the shareholders of Berkshire Hathaway to look beyond the quarterly fluctuations in Berkshire’s equity portfolio. As Buffett puts it in his succinct yet incisive style, “The amount of investment gains or losses in any given quarter is usually meaningless. In fact, the net earnings (losses) per share can be extremely misleading to investors who have little or no knowledge of accounting rules.”