Steady As She Goes: Berkshire Hathaway's Q3 2022 Earnings Report
The headlines were predictably misleading — Berkshire loses $2.69 billion! — but this mixed bag of an earnings report contained a few surprises, too
Happy Monday and welcome to our new subscribers!
Over the weekend, Berkshire Hathaway released its Q3 2022 results and, as always, I have some thoughts.
The headlines were predictably misleading — Berkshire loses $2.69 billion! — but this mixed bag of an earnings report contained a few surprises, too.
Let’s dive in…
Mark-to-Market Madness
First off, the scourge of mark-to-market accounting created another troubling disconnect between Berkshire Hathaway’s actual operating performance and its bottom line results in the third quarter.
As I wrote back in August:
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 [Warren] 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.
In Q3 2022, Berkshire’s operating earnings soared by 20% — but nonetheless got swept away in the undertow of paper losses caused by the S&P 500’s continued struggles.
The end result — a $2.69 billion net loss that doesn’t remotely reflect the underlying reality of Berkshire’s intrinsic value.
(To be fair, that extraordinary growth in operating earnings was artificially inflated by big gains in foreign currency exchange rates. Insurance underwriting and, to a lesser extent, the BNSF railroad disappointed, too.)
Overall, though, it was a strong quarter for Berkshire’s owned businesses. You’d just never know it from the headlines at The New York Times or Wall Street Journal.
I don’t care about the misleading headlines (“Berkshire Loses Money!”) for Warren Buffett or Charlie Munger’s sake. Their reputations are strong enough to withstand the occasional wayward (and unfair) arrow.
But I fear that this muddled reporting might confuse individual investors who don’t obsessively hang on every last piece of public information about Berkshire.
It would be a grave injustice if this accounting quirk caused anyone to get the wrong idea about the company’s actual performance — which continues to grow at a good clip — and decide to sell off what should be a cornerstone of their portfolio.
All because of temporary, unrealized, paper losses.
Mark-to-market has got to go.
A (Surprisingly) Quiet Quarter
If you had asked me a few days ago, I would have guessed that Warren Buffett had spent a lot more than $1.05 billion buying back Berkshire stock in the third quarter.
I would have pointed to the first half of July and the latter parts of September, when share prices fell to levels at which Buffett had previously been an eager repurchaser.
And I would have been dead wrong.
For the second quarter in a row, Buffett allocated just $1 billion to share buybacks. Far below the frenetic pace of 2020 and 2021.
In related news, a careful study of Berkshire’s 10-Q reveals that Buffett apparently spent around $500 million on buybacks between the end of the third quarter and October 26.
During that time, Berkshire’s Class B shares — the only kind I can afford — dropped into the $260s for several days, which perhaps indicates the price at which Buffett feels compelled to repurchase.
But what makes this modest amount of buybacks all the more confusing is that Buffett didn’t spend much money on anything else, either.
Berkshire made $3.7 billion in net stock purchases during Q3 2022 — $9 billion in, $5.3 billion out — but that total includes all of the Occidental Petroleum stock bought in July and August that had previously been disclosed via Form 4s.
Knowing that, I would temper any expectations that next week’s 13F release will be especially mind-blowing. (This may or may not be my attempt at a reverse jinx.)
Even though I’m surprised by the relative lack of activity last quarter, I’ll never complain about Warren Buffett having a $109 billion cash pile with which to attack the market. That dry powder might come in especially handy if economic conditions continue to worsen in the coming months.
And, with interest rates on the rise, Berkshire now earns hundreds of millions of dollars each quarter just for parking this cash in short-term treasuries.
Buffett is being paid increasingly large sums of interest to stay patient and pick out just the right pitch to swing at — and that almost always means good things for Berkshire shareholders.
Accounting for Oxy
Speaking of Occidental Petroleum, we received confirmation on Saturday that Berkshire will account for its 20.9% stake in the oil giant via the equity method.
In layman’s terms, that means a proportional share of Oxy’s profits — in this case, the aforementioned 20.9% — would be reflected in Berkshire’s own earnings. This year, with the Texas oiler expected to rake in up to $10 billion in profit, that would become a $2 billion boost for Berkshire.
Oxy joins Kraft Heinz, Berkadia, Pilot Flying J, and a few select others as Berkshire investments sizable enough to qualify for the equity method.
But, due to the timing of Oxy’s quarterly earnings releases, there is a twist.
We anticipate Occidental’s financial information will not be available in time for concurrent reporting in our consolidated financial statements. Therefore, we will report the equity method effects for Occidental on a one-quarter lag. Our earnings in the fourth quarter of 2022 will include our equity method share of Occidental’s third quarter earnings.
And, finally, that equity method share of Oxy’s earnings will not include the preferred shares and common stock warrants that Berkshire received when it helped finance the takeover of Anadarko in 2019.
Float On
Berkshire reached a big milestone in the third quarter: $150 billion of insurance float.
The asynchronous nature of insurance — a company receives premiums from customers, but doesn’t pay out anything until claims come due — creates what is known as “float”. This collect-now, pay-later model leaves insurers holding large sums of money that can be invested to create a new avenue of profitability.
Even better, if the insurer’s underwriting breaks even, this float is basically free. The company pays nothing for access to lots of investable money.
In Q3, Berkshire’s beleaguered underwriters weren’t nearly good enough to achieve free float — but nonetheless kept costs down to an average of 0.24%.
Just imagine showing up at a bank and asking to borrow $150 billion at a sub-1% interest rate. You’d probably get laughed right out of the building. But that’s exactly what Berkshire’s insurance operations have managed to achieve.
If there’s a secret to Warren Buffett’s success, that’s it right there. He expertly builds up float and then uses it to drive greater and greater returns for Berkshire.
And, incredibly, that historic float total is about to get even bigger.
The purchase of Alleghany Corp. closed on October 19 and Berkshire noted in the quarterly report that, “Estimated float of Alleghany’s businesses approximated $13.5 billion based on its historical balance sheet at September 30, 2022.”
The more float, the merrier.
I also highly recommend two Twitter threads from the weekend, which both expertly break down and analyze Berkshire’s Q3 2022 results.
If you’ve enjoyed reading this issue of Kingswell, please hit the ❤️ below and share it with your friends (and enemies) so they don’t miss out. It only costs you a few clicks of the mouse, but means the world to me. Thank you!
Disclosure: This is not financial advice. I am not a financial advisor. Do your own research before making any investment decisions.
Nice article. Berkshire seems to want to keep their cash position at about $100 billion and adjusts buybacks for that level. It's higher at 3Q due to the (now past) Alleghany purchase in October.