Berkshire: Compelling value after strong results (NYSE: BRK.A)

Scott Olson

Thesis article

Berkshire Hathaway (NYSE:BRK.A)(NYSE: BRK.B) released its latest quarterly results on Saturday. The company’s underlying performance has been strong, despite headwinds from elements such as Hurricane Ian. While Berkshire Hathaway may appear overvalued based on reported net earnings, I believe that stocks are actually good value below $300, as I will explain in this article.

Berkshire Hathaway performed relatively well despite headwinds

Berkshire Hathaway reported a net loss of $2.7 billion for the third quarter, but that does not reflect the company’s underlying business performance and its cash generation. Instead, the net loss was driven by market value losses in its equity portfolio. These should not be considered as important as the profits of its operating companies, in the same way that it also makes sense to withdraw market gains into Berkshire’s stock portfolio.

When we look at Berkshire Hathaway’s operating earnings, where changes in the fair value of its equity portfolio are not included, performance has been quite strong over the past quarter. Operating profit totaled $7.8 billion during the period, or just over $30 billion annualized. This is a 20% increase over the prior year period, which almost perfectly matches the 19% year-to-date growth rate, Q1 operating profit in Q3 in 2022 having totaled $24.1 billion, compared to $20.2 billion a year earlier.

Looking at the performance of the various business units, some did better and some did worse during the quarter. Insurance underwriting revenue was negative $1.0 billion, compared to $0.8 billion a year ago. Hurricane Ian, which hit in late September and caused more than $50 billion in damage, played a role in the lower profitability of the insurance business. However, this was offset by stronger investment gains in the insurance portfolio, which increased by $250 million year over year. Rising interest rates help Berkshire Hathaway generate higher interest income from the money it invests in fixed-income investments such as treasury bills and corporate bonds, which explains why the insurance float generated higher profits in the third quarter of this year, compared to a year earlier. As interest rates continue to rise, I expect Berkshire’s insurance investment earnings to rise further in the fourth quarter and likely beyond, especially as low-yielding bonds are repaid over time, allowing Berkshire to reinvest these proceeds in higher yielding investments.

Berkshire’s railroad company, Burlington Northern Santa Fe, performed surprisingly poorly. The unit still generated operating profit of $1.44 billion during the period, or nearly $6 billion annualized, but profits were down 6% year over year. other. Many other railroads have increased their profits over the past year, such as Union Pacific (UNP), which was able to increase its operating profit by 13% in the last quarter. Against this peer, BNSF thus underperformed by almost 20% in terms of earnings growth, which was worse than expected. It was also a reversal in the first and second quarters, when BNSF saw operating profits rise year over year.

Fortunately, that could be offset by stronger earnings in Berkshire’s utilities and energy, where operating profits rose $90 million year-over-year to $1.6 billion. dollars for the quarter. Overall, Berkshire’s operating business performed relatively well, although performance was a bit uneven. As the trend since the beginning of the year remains positive, I think there is a good chance that the fourth quarter results will also increase considerably compared to the period of the previous year, the energy crisis and with rising interest rates being tailwinds (for Berkshire’s utilities/energy unit and its insurance investment income, respectively).

Balance sheet and stock portfolio

Berkshire Hathaway’s operations are of considerable value, but so too is the company’s stock portfolio, which is worth hundreds of billions of dollars, making it a significant part of the company’s total value. .

At the end of the third quarter, Berkshire’s stock portfolio totaled $306 billion on a market basis, that is, at then-prevailing prices. Since the end of September, stock prices have moved, so let’s take a look at the most important positions:

Chart
Data by YCharts

American Express (AXP), Apple (AAPL), Bank of America (BAC), Chevron (CVX) and Coca-Cola (KO) have all risen since the end of the third quarter, with Chevron and Bank of America posting double- gains of figures, while the AAPL increased only slightly. The good performance of Chevron and BAC can be explained by a positive macroeconomic environment for these two companies, due to OPEC production cuts which have pushed up oil prices and rising interest rates, which help to increase banks’ net interest margins. Both companies also reported strong third quarter results, to which the market reacted positively.

Given that these five companies represent about three-quarters of Berkshire’s total stock portfolio, their performance is by far the most important to the total value of the company’s stock portfolio. Based on the individual fair value amounts at the end of the third quarter for these five positions and the gains made since then, I estimate that the value of equity in these five positions has increased by $16 billion. To be on the safe side, let’s reduce that to $14 billion and assume that the other positions had no gains, which brings us to a present value of equity of $320 billion.

Berkshire Hathaway also has a large cash position, although it’s debatable how this should factor into Berkshire’s fair value as a business. Some think it should be taken at face value, which would be very significant, as the cash position stood at $109 billion at the end of the third quarter. Others feel that the cash position should not be added to the value of the business, as it is part of the insurance float. It’s a more conservative approach, maybe even an overly conservative approach, but let’s use this approach anyway in order to have a built-in safety margin. So let’s assume that the present value of the cash position is zero and that the stock portfolio is currently worth $320 billion. Berkshire Hathaway’s market capitalization is $631 billion, based on a share count of 2.2 billion Class B shares, each valued at $287 at the time of writing. The market thus assigns a value of $311 billion to Berkshire’s operating activities ($202 billion if the company’s cash position is added to its face value).

I think $311 billion is a pretty low price for Berkshire’s operating business. These have generated operating profits of $24.1 billion so far this year and are on track to earn $32 billion in 2022. Operating businesses are therefore currently valued at an implied multiple. 9.7 times operating profit, which seems pretty low to me. Not only is this a low valuation in absolute terms, but it also does not reflect the strong market position of many of these companies and the fact that they are experiencing unstoppable growth. BNSF, for example, has a wide moat because the railroads are an oligopoly and none of these companies are actively encroaching on the territories of their peers. Publicly listed rail companies are mostly valued at a multiple of 15 to 20 times earnings, implying that BNSF would be valued at well over 10 times earnings if it were a company. autonomous. Similarly, many utilities are trading at much higher earnings multiples (15 times earnings and more) than the implied valuation of Berkshire’s operating business, and so on.

One of Buffett’s favorite metrics for valuing Berkshire Hathaway is the price-booking multiple. On this basis, Berkshire Hathaway is trading almost perfectly in line with the long-term median:

Chart
Data by YCharts

When we factor in that Berkshire’s equity portfolio has risen in value since late September, the current price-to-book multiple is slightly below 1.37, suggesting a minor discount to how Berkshire was valued in the past.

It’s also worth noting that Buffett seems to believe Berkshire can be a good investment even when trading at or above the median book value multiple. Over the past 1.5 years, at a time when Berkshire repeatedly traded above 1.37x book value, Berkshire spent several billion dollars on stock buybacks, suggesting insiders who know the company very well consider Berkshire a solid value at 1.35x to 1.4x. book value. For outside investors, Berkshire is probably a solid value at this valuation as well. Combined with the sum of the parts analysis performed above, this makes me believe that Berkshire Hathaway is a compelling investment at current prices. The fact that stocks are down 21% from highs reached earlier this year also suggests that now could be a good time to enter or expand a position.

Carry

Berkshire Hathaway posted compelling quarterly results as its operating businesses grew profits at an attractive pace, despite some headwinds. The stock portfolio has grown since Sept. 30, so the third-quarter book value figure underestimates BRK’s current value. A sum-of-the-parts valuation also suggests that Berkshire is cheap here, although we place no value on Berkshire’s large cash position. Overall, I think Berkshire continues to be a high quality compound that is currently trading at an attractive valuation.

About Jimmie T.

Check Also

OPINION: Despite anger, accusing grocers of ‘greed’ is pointless

Breadcrumb Links Columnists The notion of “greed” has emerged as one of the most discussed …