Berkshire Hathaway: 4 Buffett Earnings Keys
NEW YORK (
) --
Berkshire Hathaway
(BRK.B) - Get Report
is scheduled to report earnings after the close on Friday. While
would be the last person in the world to recommend reading too much into one quarter's performance, here are some typical keys to look for in terms of the ongoing performance of Berkshire Hathaway and its operating subsidiaries.
1. Book Value:
Warren Buffett has said that book value is a good yardstick to measure progress, even though it has its limitations. The Oracle of Omaha explained it this way in the 2009 annual letter: "book value at most companies understates intrinsic value, and that is certainly the case at Berkshire. In aggregate, our businesses are worth considerably more than the values at which they are carried on our books. In our all-important insurance business, moreover, the difference is huge. Even so, Charlie and I believe that our book value -- understated though it is -- supplies the most useful tracking device for changes in intrinsic value... Inadequate though they are in telling the story, we give you Berkshire's book-value figures because they today serve as a rough, albeit significantly understated, tracking measure for Berkshire's intrinsic value. In other words, the percentage change in book value in any given year is likely to be reasonably close to that year's change in intrinsic value."
Last quarter, Berkshire Hathaway book value increased 2.6%. Through the first two quarters of the year, Berkshire book value increased a little more than 8%.
Bill Bergman, former Morningstar analyst covering Berkshire Hathaway, was more impressed by the book value gains that Buffett was able to engineer during the final quarter of 2009, when the consumer-driven operating subsidiaries which Buffett owns were struggling through the recession. For 2009 as a whole, Berkshire Hathaway book value per share rose about 20%, in line with the company's long-term average. It was also a significant improvement over recent years.
Over the last 45 years, book value of Berkshire Hathaway A shares has grown at a rate of 20.3% compounded annually. Berkshire has never had any five-year period beginning with 1965-69 and ending with 2005-09 (41 periods) during which its gain in book value did not exceed the S&P 500 gain.
The economy is rebounding, but Buffett has also recently noted in the press that many of Berkshire Hathaway's consumer-oriented businesses still face headwinds, especially businesses tied to the U.S. home construction business.
2. Derivatives:
Last quarter, derivatives were the big loser for Berkshire Hathaway. Quarter-to-quarter, derivative swings are going to occur. Derivatives contracts contributed a loss of $1.4 billion to Berkshire Hathaway operating earnings in the second quarter. In the first quarter, the derivaties gain was $267 million.
In the second quarter 2009, derivatives adding $1.5 billion to Berkshire operating earnings.
As Buffett said in last year's Berkshire Hathaway annual letter, "you should expect large swings in the carrying value of these contracts, items that can affect our reported quarterly earnings in a huge way but that do not affect our cash or investment holdings... As we've explained, these wild swings neither cheer nor bother Charlie and me...We are delighted that we hold the derivatives contracts that we do. To date we have significantly profited from the float they provide. We expect also to earn further investment income over the life of our contracts."
Derivatives have always been a headline-generating item for Berkshire, but the earnings-specific derivatives headline can be misleading.
Here are the pre-tax quarterly gains and losses from derivatives valuations that were part Berkshire's reported earnings last year as an indication of the quarter to quarter movement:
First quarter 2009:
loss of $1.517 billion
Second quarter 2009:
gain of $2.3 billion
Third quarter 2009:
gain of $1.7 billion
Fourth quarter 2009:
gain of $1 billion
3. Insurance:
Insurance is the driver of Berkshire earnings, even for all of its far-flung holdings. Even as derivatives gain or losses swing from quarter to quarter, insurance premiums continue to be the ballast for Berkshire earnings. Last quarter, Berkshire Hathaway insurance underwriting and investment was roughly 50% of earnings, and that marked a big comeback for the non-insurance business, which in the 2009 second quarter had been at half the level of the earnings it generated in this year's second quarter.
Through the first six months of 2010, insurance was running at roughly 50% of earnings, yet in 2009, the insurance component of earnings was much higher. So it will be interesting to monitor any changes in the split between insurance and non-insurance operations.
The two insurance metrics in the quarterly earnings are insurance investment and insurance underwriting income.
As Buffett himself explained best in his most recent annual letter: "Insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers' compensation accidents, payments can stretch over decades. This collect-now, pay-later model leaves us holding large sums -- money we call "float" -- that will eventually go to others. Meanwhile, we get to invest this float for Berkshire's benefit. Though individual policies and claims come and go, the amount of float we hold remains remarkably stable in relation to premium volume. Consequently, as our business grows, so does our float. If premiums exceed the total of expenses and eventual losses, we register an underwriting profit that adds to the investment income produced from the float."
In the second quarter, Berkshire's underwriting income was $462 million, and its insurance investment income was close to $1.1 billion. Underwriting income had tripled through the first two quarters of the year, compared to 2009, while insurance investment income was slightly down in the first two quarters of the year.
The Berkshire Hathaway float was $63 billion at the end of the second quarter.
The recent big news related to Buffett's insurance plays came on Thursday when Swiss Reinsurance said its business was healthy enough to repay Buffett ahead of schedule on the $2.7 billion that Berkshire invested in the insurance company after credit default swap losses during the financial crisis crippled the Swiss insurer. Buffett's investment return on the loan is estimated by
Bloomberg
in the range of $1.3 billion, including a premium payment and interest payments on the convertible notes that Buffett purchased.
4. Non-insurance operating subsidiaries:
In the second quarter of the year, two notable non-insurance operating subsidiaries showed up in a big way in the earnings, helping to lead to the comeback by the non-insurance business relative to insurance earnings (as noted above).
Burlington Northern, Buffett's mega-rail purchase, contributed $603 million in operating earnings in the second quarter, of a total $1.6 billion in non-insurance subsidiary earnings. Formerly floundering business jet company NetJets swung from a pre-tax loss of $348.5 million in the first six months of 2009, to a pre-tax profit of $114.5 million in 2010.
The Burlington Northern inclusion and NetJets comeback have helped to prop up non-insurance operating earnings, and its utility business, led by MidAmerican Energy, is a portfolio stalwart. The larger issue with the non-insurance operating subsidiaries is the consumer-heavy portfolio showing a continued rebound.
The only companies broken out in the last Berkshire quarterly report in terms of individual earnings profiles are the insurance companies, MidAmerican, McLane Company -- a grocery distributor that has been the recent jewel from the non-insurance, retail-oriented operations -- and Marmon, which has holdings across a wide array of business sectors.
The profile of earnings from insurance, and from utilities and energy, is fairly consistent.
Net earnings in Berkshire's "manufacturing, service and retailing" operations has spiked so far this year, with net earnings in the second quarter reaching $671 million, versus $239 million in the second quarter 2009. Through the first six months of the year, "manufacturing, service and retailing" had rebounded to almost $1.2 billion in net earnings, versus less than $500 million in the first six months last year.
Earnings were back up across the board from companies as diverse as candy sellers, home furnishing vendors, and paint makers, but it was all coming off the lows of 2009.
As Berkshire noted in its second quarter report, "These operations rebounded in 2010 from very slow economic activity in the first six months of 2009." Pre-tax earnings of our other manufacturing businesses in the second quarter and first six months of 2010 increased $289 million (113%) and $445 million (103%), respectively, compared with earnings in the corresponding 2009 periods.
Yet at the end of the second quarter, Berkshire noted that the turnaround in its "manufacturing, service and retailing" group was far from a done deal.
"Despite an increase in revenues of our building products businesses in the first six months of 2010, these operations continue to be adversely affected by overall soft residential and commercial real estate conditions."
Additionally, Berkshire noted that it wasn't just businesses rebounding that was driving improvements. "Our manufacturing businesses benefitted in 2010 from higher customer demand and the effects of cost management efforts over the past two years, which has helped improve profit margins."
-- Written by Eric Rosenbaum from New York.
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