Berkshire Hathaway (BRK.A) (BRK.B), the conglomerate juggernaut run by the famous Warren Buffett, has been on a wild ride this year. Earnings were all over the place because of the firm’s large investments and how volatile the market has been. What is most important to consider, however, is not what is happening on that front. In the long run, their shareholders will perform well. What is more important is the underlying operational health of the company. Despite some bumps and bruises seen so far this year, that looks healthily robust. Add to that Buffett’s decision to repurchase a significant amount in the second quarter of the company’s 2020 fiscal year, and it’s clear that Berkshire still provides a well-reasoned long-term for investors to consider.
Put back in context
Anyone looking at the second quarter of Berkshire in a vacuum would think the company will smash this year. Net profit allocated to common shareholders in the last four years amounted to $ 26.30 billion. This represents an almost doubling over the $ 14.07 billion seen the same quarter a year earlier. However, if you look at the figures of the year so far, the picture is much less appealing. In the first half of 2019, the conglomerate generated revenue of $ 35.73 billion. Year-to-date for 2020, however, the company lost $ 23.45 billion. This major hit, caused by a weak first quarter, may have some investors thinking that Berkshire may no longer be the kind of company it once was.
While this is a concern, it is not valid when you consider how the company’s financial operations work. Due to the nature of its equity investments, the company books large incomes as the shares it owns. When they fall in value, the opposite happens. And earlier this year, brands took a beating as it became clear just how serious the COVID-19 pandemic would turn out to be. A rebound in the second quarter pushed earnings higher, and in the long run one thing investors can be sure is that the market will continue to go up. If it is not about the long term, then investors should probably be more worried about their money.
What investors and market watchers need to focus more on are Berkshire’s corporate profits. Corporate profit ignores fluctuations caused by securities owned by the company and instead looks at the results of the companies Berkshire owns and consolidates in its financials. Even this measure can be a bit deceiving because of the track record of the company for getting other companies, real comparison makes year-over-year more art than science, but it is the best we have.
If we look at this, we find that the company generated $ 5.51 billion in profit for its last quarter. This is 10.2% down compared to the $ 6.14 billion the company generated the same quarter last year. Year-to-date results are now even closer, with profits falling just 2.3% from $ 11.69 billion last year to $ 11.42 billion now. It is important to note that all of these figures exclude some non-cash invalidations that the company recognized this year.
One metric I prefer rather than management income is cash flow from companies. After all, it is the amount of cash that the company generates over its entire life, which will ultimately determine its value. In the quarter, Berkshire saw its operating cash flow total $ 10.67 billion. This is actually 16.1% higher than the $ 9.19 billion the company generated a year earlier. For the first half of the year, operating cash flow of $ 17.47 billion was 4.2% above the $ 16.76 billion seen in the first half of the fiscal year of 2019. With capital of just $ 4.5 billion to seen so far this year, the company’s free cash flow totals $ 12.97 billion. It is not certain what investors should expect for the rest of the year, but it is likely that the cash flow in the second half will be at least as high as in the first half. With only $ 5.7 billion extra capex projected for the year (bringing capex to $ 10.2 billion by 2020, down from previous expectations of $ 10.8 billion), this implies significant free cash flow for Berkshire.
The future looks bright
As far as I am concerned, the future is looking for Berkshire and its shareholders. Although equity values will fluctuate, it was nice to see the value of the company’s equity portfolio return above the $ 200 billion mark (up to $ 207.45 billion to be exact). This compares with $ 180.78 billion in the first quarter, but it is still well below the $ 248.03 billion the company reported for the end of its fiscal year 2019. As of the end of the quarter, large investments stood for a even larger share of the company than they had in previous quarters.
You see, according to management, at the end of last quarter, 71% of Berkshire’s equity portfolio was split between four companies: American Express (AXP) at $ 14.4 billion, Call (AAPL) at $ 91.5 billion, Bank of America (BAC) at $ 22.6 billion, and The Coca-Cola Company (CO) at $ 17.9 billion. Although the sum of these stands at $ 146.4 billion below the $ 148.1 billion seen at the end of last year, it is a much larger concentration of the company’s portfolio, which at that time was just 60% used to be. It is also important to note that shares of all four of these companies have also increased recently. The worst performance has been American Express, with shares up 4.6% since the end of the second quarter. The best has been Apple, with shares up 22.1%. Factoring in these changes and ignoring the rest of Berkshire’s portfolio, the company should have received another $ 24.35 billion by holding the same number of shares in the big four it had. the end of the second quarter.
Not only will Berkshire continue to benefit as the market moves higher, the company is making some sensible moves to prepare for it in the long run. One of the most recent examples was Berkshire’s decision earlier this year to acquire the natural gas transmission and storage company Dominion Energy (D). In addition to accepting about $ 7 billion in debt, the company is paying $ 4 billion in cash for the assets. Another major investment Berkshire decided to make, however, was on its own. In the second quarter, the company bought $ 5.12 billion worth of inventory (bringing annual purchases up to $ 6.7 billion). The average purchase price paid for these units works out to $ 175.95 per Class B unit. With shares at $ 209.48 as of this writing, this is an effective gain of 19.1% for investors, and works out to $ 975 million in ‘free’ value for the company.
There are other positive things about Berkshire as well. Despite spending the capital it made on stock purchases, the sum of its cash and cash equivalents (including short-term obsolescence US Treasury Bills) rose to $ 146.60 billion at the end of the quarter. This has risen from $ 137.26 billion a quarter earlier and is above the $ 128 billion seen at the end of the company’s fiscal year 2019. As part of Berkshire’s improving financial condition, its insurance fleet has been on the rise. It ended the last quarter with $ 131 billion in float, up $ 1 billion from the first quarter and another $ 1 billion from the quarter before. The ability to invest ever-increasing amounts of float is the key to the company’s growth strategy.
Take away
From the data provided, it’s clear that not everything was great for Berkshire in their last four years, but most things went well. The company’s cash flow remains robust despite the economic downturn and almost every measure we looked at seems to be in a better position than it was just three months ago. It’s unfortunate that Buffett did not buy more shares on the cheap when he had the chance and / or that he did not make any major purchases other than what has already been revealed. Given the financial condition of the company, few companies are beyond its ability to absorb. This is a good thing for shareholders in the long run, even if it can be frustrating to see the company underperform the market in some periods of time.
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Announcement: I / we have no positions in named shares, and no plans to initiate positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I do not receive compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose supply is mentioned in this article.
