Berkshire’s Q4 Earnings: Why I Nearly Doubled My Stake (NYSE:BRK.B)

Berkshire Hathaway (NYSE:BRK.B) (BRK.A) released its fourth quarter earnings this past Saturday, February 24. The release easily beat estimates on revenue as well as on earnings per share (“EPS”). Although not every shareholder was happy with Berkshire’s Q4 results, I found them to be adequate. Sitting on an Apple (AAPL) position that I suspected had become overvalued, I sold my shares in that company to buy more Berkshire, increasing my stake by 71%.

The irony isn’t lost on me that Apple is itself a major Berkshire holding. I bought back a fraction of the Apple shares I sold indirectly through Berkshire. However, the point about Berkshire’s massive Apple exposure can be overstated. People like to point out that Apple is 50% of Berkshire’s equity portfolio, this is true if you limit the definition of “equity” to public equities. Berkshire’s $174 billion Apple position makes up 16.2% of total assets and 30.6% of shareholder’s equity. By either measure, it is much less than 50% of Berkshire’s investment portfolio.

The point is: Berkshire Hathaway and Apple are not financially identical. An investment in Berkshire stock is not merely a glorified bet on Apple, it is a bet on a diversified portfolio in which Apple is the largest holding. It’s also a much cheaper “bet” than Apple is, so I felt that upping my Berkshire position was a more sensible decision than continuing to hold Apple would have been.

That’s not to say that I bought more Berkshire just because of valuation. The stock scores a C- on valuation in Seeking Alpha’s quant ratings, which does not indicate “extreme” cheapness. However, Berkshire’s recent fourth quarter earnings were very good, featuring high double-digit growth in operating earnings. Some segments did not do so well, such as BNSF, which earned less than it did in 2019! The overall package seemed to deliver, though, so I bought some more shares.

My previous two articles on BRK.B rated the stock ‘buy‘ and ‘strong buy,’ in that order. In the first one, I rated the stock a buy on the grounds that the successful Japan bet proved that Berkshire’s strong capital allocation skills remained intact; in the second one, I rated it ‘strong buy’ on the grounds that it was cheap and poised to take new highs. Later, the stock rallied and achieved the “new highs” that I had predicted. I’m still fairly bullish on Berkshire Hathaway today, but we need to take account of the highs that have been achieved. The stock has become more expensive; accordingly, I am demoting my rating back down to ‘buy.’

Why Berkshire Can Still Be a Good Investment

Because Berkshire Hathaway’s sheer scale limits its potential returns, it makes sense to start this analysis with a discussion of how Berkshire can, theoretically, still be a good investment. In other words, we need to establish that extremely large companies can be worth owning. This is not a trivial point: a company managing assets equal to the world’s money supply, cannot grow faster than the money supply growth rate.

Milder versions of this rather extreme dynamic apply to today’s “giant” companies: they certainly can outperform, but their ability to do so is held back by their size. If you invest 100% of your net worth in a $1 billion company that goes to $10 billion, you 10X your net worth. If Berkshire invests $1 billion into a company and then sells it for $10 billion, it barely moves the needle. Size, therefore, is indeed the anchor of performance.

So, can Berkshire outperform today, at its massive $891 billion market cap?

Theoretically, there is nothing preventing it from happening. As I wrote in a recent Tweet, Berkshire has slightly outperformed the S&P 500 over the last five years. It’s entirely possible for it to continue to do so. A company occupying 6% of the universe it operates in can do somewhat better than that universe simply by investing more cautiously than others are. Berkshire’s outperformance of the S&P 500 tends to increase in periods when very expensive stocks are crashing. It’s true that Berkshire faces a pricey universe of stocks today: it’s too big for $1 billion deep value plays to make much of a difference in its results. It can, however, elect to invest in treasuries rather than stocks. Today, with the NASDAQ-100 pushing 35 times earnings, it would probably be wise to do so. Indeed, Buffett is doing so, having a record $167 billion in the cash pile as of the fourth quarter.

Fourth Quarter and Full Year Results

Having established that it is possible for Berkshire Hathaway stock to perform well, I can now start building a case that it is likely to perform well. Such a case can be built on the company’s recent fourth quarter and full year earnings release/annual report.

The headline numbers for the quarter were:

• $37.5 billion in GAAP net income, up 107%.

• $29.1 billion in investment gains, up 153%.

• $8.4 billion in operating income, up 28%.

The same figures for the full year were:

• $96.7 billion in GAAP net income, up from a loss.

• $58 billion in investment gains, up from a loss.

• $37.35 billion in operating income, up 21%.

Overall, the growth was quite satisfactory. For the quarter, the operating earnings by segment were as follows:

• $848 million in insurance underwriting, up 430%.

• $2.76 billion in insurance investment income, up 38%.

• $1.355 billion from the railroad, down 7.7%.

• $632 million from utilities and energy, down 14.4%.

• $3.69 billion from other businesses, down 0.48%.

• A $804 million loss from other (including things like Forex changes), improved from $1.45 billion.

The details of the segment results included some unappealing metrics. For example, BNSF’s operating results deteriorated far more than other railroads in the same period. The whole railroad sector is seeing carloads and revenue decline, but the effects of this trend are being felt more at Berkshire than at other companies. The strong insurance results, however, had a more dominant effect.

Some have criticized Geico and other Berkshire insurance subsidiaries for playing it too safe, and not having much growth in premiums compared to other insurers. Geico’s premiums are certainly growing less rapidly than, say, Progressive’s (PRG), but it also has a better combined ratio than that company does. Berkshire’s insurance segment pays out fewer claims than most other large U.S. insurers do, on a pound for pound basis. If a major calamity were to befall large swaths of the United States, Berkshire’s insurers would be better positioned to survive it than most of the others would be. The fact the company’s insurance profits are rising despite all of this risk management is a testimony to what a bang-up job Ajit Jain is doing running Berkshire’s insurance companies.

Valuation

Having looked at Berkshire’s earnings, we can now proceed to valuing the shares. I will mostly use multiples from Seeking Alpha Quant in doing this; however I will calculate the P/E ratio by hand using operating earnings.

Berkshire’s operating earnings in the trailing 12-month period were $37.35 billion. The company had the equivalent of 2.173 billion class ‘B’ shares at the end of that period. So Berkshire had $17.188 in earnings per class ‘B’ share. Going with that as earnings, we have the following multiples:

• P/E: 23.8.

• Price/sales: 2.45.

• Price/book: 1.7.

• Price/cash flow: 18.

Berkshire’s multiples relative to the S&P 500 are hard to characterize. The P/E ratio is currently a little higher than that of the index (which is at 23.2), but the price/book and price/cashflow ratios are far lower. On the whole, I’d describe Berkshire as being cheaper than its benchmark, but I wouldn’t say that those who think differently are out to lunch. I understand where they’re coming from.

Turning to discounted cash flows: if you assume 0% growth and use no risk premium, then Berkshire’s TTM free cash flow does not argue for buying the stock. In fact, it results in a fair value estimate significantly lower than the current stock price. However, Berkshire has been growing its cash flows and operating earnings quite a bit lately. If it can keep up these results, then its stock should experience significant appreciation.

The Bottom Line

The bottom line on Berkshire Hathaway is that its 2023 earnings were satisfactory. There was weakness in some segments, but there was strength in more of them. Berkshire isn’t the cheapest stock on the planet right now, but it is relatively modestly valued while growing. On the whole, I consider it worth the investment today.