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Four Surprises from Berkshire Hathaway's Quarterly Report
The headlines were predictable -- Berkshire posts huge loss! -- but this earnings report holds more than a few surprises, too
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Got this beaut framed just in time to settle in and read through Berkshire Hathaway’s Q2 2022 earnings report over the weekend.
And, to be honest, I was surprised at how surprising it was.
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(1) The BHE (Berkshire Hathaway Energy) Bombshell
The most interesting nuggets in financial reports tend to be found in footnotes or, at best, consigned to the bottom of a page.
And that proved true again on Saturday.
The very last paragraph on page 20 revealed that Berkshire Hathaway bought out Greg Abel’s common stock position in its energy subsidiary for $870 million earlier this summer.
(This tweet, by the way, is as close to going viral as I get.)
Back in April, one of the questions at Berkshire’s annual meeting broached this very subject. An intrepid attendee asked Warren Buffett and Charlie Munger if they had any concerns over Abel’s personal stake in BHE — and whether or not it might cause a conflict of interest or misalignment of incentives in the future.
Buffett pawned the question off on Munger, who said:
It’s a historical accident. It’s not causing any big tension or breaches of fiduciary duty. We had the same problem with Walter Scott, who was the director for years and years, and owned stock in the same company. Also a historical accident.
I just don’t think it’s a big problem at all. I see no behavior from Greg ever that isn’t in the best interests of Berkshire.
If I thought that would make a difference, he just wouldn’t be the right kind of person to run Berkshire.
Neither man seemed the least bit worried about Abel’s 1.1% stake in BHE.
So, what changed?
Probably nothing. We don’t know which side initiated the sale, but it looks like a win-win for both parties. Berkshire moves one step closer to complete control of BHE and Abel receives a nice windfall — that he will hopefully use to purchase a chunk of BRK.A shares.
The only slight concern I’ve ever had about Abel as Buffett’s successor-in-waiting is that he has so little skin in the Berkshire game. He reportedly owns just $700,000 of BRK.B — a kingly sum to me, but relatively paltry for a man in his position. I’d love to see him sink some of that $870 million into Class A shares (for voting reasons).
In 2020, Berkshire Hathaway Energy was valued at about $50 billion and, now, the implied value has jumped all the way to $87 billion. What a rocket ship.
Based on the price paid for Abel’s stake, if Berkshire wants to finish the job by snapping up the Walter Scott estate’s 7.9% portion, that would likely set the company back about $7 billion. Well worth it, in my opinion.
Maybe that will be the big news hidden inside Berkshire’s next earnings report.
(2) No Shopping Spree
Warren Buffett’s most famous line is probably, “Be fearful when others are greedy and greedy when others are fearful.”
And, from the outside looking in, the past few months seemed like the perfect opportunity to put this contrarian adage into action.
Sky-high inflation, rising interest rates, inverted yield curves, a slowing economy — all that (and more) created a most ominous economic backdrop.
People are (understandably) scared. Isn’t it time to get greedy?
Buffett spent just $6.2 billion on new stock purchases during the second quarter, a total that comes in tens of billions of dollars less than I was expecting. So much for another net outlay of $40+ billion like in Q1.
And, adding to the anticlimax, we already knew that he spent $1.3 billion bulking up Berkshire’s stake in Occidental Petroleum.
Some nice detective work from 21st Century Value Investing fills in a few more blanks:
A far cry from the emphatic response to a bear market that many predicted from Buffett and Berkshire.
Not gonna lie, this curbs my enthusiasm for next week’s 13F quite a bit. And just about kills off any dreams that Buffett has been loading up on Paramount Global stock over the past few months.
(3) Operating Earnings vs. Bottom Line Blues
Warren Buffett takes great pains to focus Berkshire Hathaway investors on the conglomerate’s impressive collection of operating businesses, as opposed to its massive (yet volatile) investment portfolio that attracts so many media headlines.
But current accounting rules — of the mark-to-market variety — make that distinction all but impossible.
In a quarter when Berkshire’s subsidiaries beat expectations across the board (with the exception of poor GEICO), all anyone will see is that Buffett and co. posted an overall $43.8 billion “loss” because of the market downturn.
Operating earnings of $9.3 billion (up 38.8% over 2021) got swept away in the undertow of paper losses caused by the S&P 500 officially entering a bear market.
Mark-to-market accounting, which records unrealized changes in portfolio value as actual gains and losses on financial statements, renders the bottom line numbers for companies like Berkshire relatively meaningless.
Unless Buffett is selling at these low prices — and he’s not — these quarter-to-quarter fluctuations in Berkshire’s portfolio have almost no bearing on the company’s long-term value.
Let’s take a look at Apple, for instance. Berkshire owns over 900 million shares of the iPhone maker and rightly considers this holding to be one of its crown jewels.
But Apple’s untouchable status means nothing to mark-to-market accounting. Any time the price of AAPL drops, Berkshire’s earnings take a huge hit on paper.
Apple alone accounted for $32 billion in Berkshire “losses” during the second quarter. Making this all the sillier, Berkshire has now gained $25 billion of that back thanks to the market rally in July and August. In another week or two, it might all be a wash.
Making month-to-month price swings so important to a company’s bottom-line results does great damage to the long-term investing mindset that we should all be trying to cultivate.
Berkshire Hathaway agrees:
The amount of investment gains/losses in any given quarter is usually meaningless and delivers figures for net earnings per share that can be extremely misleading to investors who have little or no knowledge of accounting rules.
There has to be a better way.
(4) Red Light on Repurchases 🚦
After buying back shares at a blistering pace in 2020 and 2021, Warren Buffett took his foot off that gas pedal, too, in recent months.
Berkshire Hathaway repurchased just $1 billion of its own shares during the second quarter — the lowest amount since 2019.
Seems like curious timing for a slowdown, as both Berkshire’s Class A and Class B shares dropped over 23% by late June, reaching price levels well below where Buffett had previously executed buybacks.
Perhaps Berkshire’s repurchase frenzy is coming to an end.
For many years, Buffett deflected questions about share buybacks on the grounds that, if Berkshire’s price were to ever decline far enough to make that option attractive, other companies would likely be in even worse shape and the money would be better spent scooping up those shares.
The speculative boom over the past few years — coupled with Berkshire’s languishing price — likely forced a rethink. But it was never guaranteed to last forever.
All in all, a surprisingly quiet quarter from Berkshire.
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Disclosure: This is not financial advice. I am not a financial advisor. Do your own research before making any investment decisions.