“With that focus, and with our present mix of businesses, Berkshire should do a bit better than the average American corporation, and, more important, should also operate with materially less risk of permanent loss of capital. Anything beyond “slightly better,” though, is wishful thinking.”
Letter to Shareholders, from Chairman Warren Buffet in the Berkshire Hathaway 2023 Annual Report
Berkshire Hathaway (BRK-A and BRK-B) released their FY2023 earnings on Saturday, along with a 13 page letter to shareholders from Chairman Warren Buffett, and a personal tribute to recently-deceased “partner-in-crime” Charlie Munger. This is the first annual earnings release since Mr Munger passed away, although the themes over decades espoused by the dynamic duo in the annual shareholder letter remain largely the same. For those interested in the wisdom of Mr Buffett and his decades-old philosophy for operating Berkshire Hathaway, I suggest you give the shareholder letter a read. You can access the 2023 Annual Report here, and Mr Buffett’s commentary – always interesting, honest and “to the point” – is in the first few pages.
Berkshire Hathaway is currently the 7th largest company by market capitalisation in the S&P 500, and the only one of the top 10 that is not either involved directly in tech or in the newest phenomenon, weight-loss drugs.
I believe that Berkshire’s stock is getting caught up in the hype of the current market driven by momentum, and I fear FOMO investors might just cause the stock to become increasingly untethered from its fundamental value. Mr Buffet is almost certainly aware of this. However, unlike many large shareholder-owners, I also would guess that is not happy about it. My suspicion is that the company will do little in the way of further open market stock buybacks at these lofty levels, so investors should not bet on this heady valuation sticking if the stock continues to drift away from its intrinsic value.
As a long-time admirer of Mr Buffett, I thought my followers might find a short summary of the company’s results and Mr Buffett’s commentary in the annual report interesting. Berkshire is a complex company operating in volatile business segments. For example, its core businesses is subject to unpredictable, catastrophic weather-related events (global P&C business), another operating business requires intensive capital investment (railroads), a third is arguably at odds with the ongoing ESG narrative (oil & gas), and a fourth is under scrutiny due to state regulatory changes and fires (utilities).
Themes in Shareholders Letter and 2023 Annual Report
The major themes I gleaned from the annual report are summarised below, noting that this is far from thorough and Street analysts will have a much more informed and comprehensive view. I also assume readers have a decent understanding of Berkshire Hathaway’s business.
Berkshire is mainly a financial company: At its core, Berkshire is mostly a financial company because of its substantial global insurance operations and its sizeable portfolio of public stocks and fixed income securities (latter mostly government bonds). Considering only the fully-owned operating businesses of Berkshire, the insurance underwriting and investment business generates about 40% of the company’s operating profits. The extract below in Mr Buffett’s shareholder letter will give you a sense of the company’s operating businesses and their relevancy to the company’s overall performance (p 11 of annual report).
As far as the company’s investment portfolio in public stocks and bonds, the table below will give you an idea of the company’s holdings at the end of 2023.
The company also carries some of the investments in which it owns between 20% and 50% of on the equity method, including Kraft Heinz and Occidental Petroleum. Perhaps not surprisingly given the company’s profile (even though a conglomerate), Berkshire is the largest stock by market cap in the GICS Financial Sector index, representing around 13.6% of the index (followed by JPM with circa 9.5%).
Investments in public stocks: The company plays the “long game” as far as public equity investments and takes concentrated risks in companies it believes are power-houses for the long-term. At the end of 2023, Berkshire’s top five largest public stock holdings, accounting for 79% of its public stock portfolio, included (in order of size): American Express (AXP), Apple (AAPL), Bank of America (BAC), Coca-Cola (KO) and Chevron (CVX). Although I am not sure this is current, my research shows that Berkshire owns 20.94% of AXP (but completely passive), 5.81% of AAPL, 13.24% of BAC, 9.28% of KO and 6.8% of CVX. To give you a sense of Mr Buffett’s investment horizon – truly “buy & hold” – he has had positions in AXP and KO since 2001.
Volatile bottom line: Berkshire beat bottom-line consensus analysts’ expectations for FY2023, but a significant part of the company’s earnings came from unrealised mark-to-market gains on its public securities portfolio. To give you a sense of the volatility of GAAP earnings, EPS for Berkshire (B shares) in 2021, 2022 and 2023 was $39.70/sh, ($10.33)/sh and $44.27/sh, respectively. Those are massive swings that do not at all reflect the reality of the company’s operations.
Mark-to-market of investment book in public stocks and bonds: Since GAAP started requiring SEC-listed companies to mark-to-market their holdings of public securities, Mr Buffett has been emphatic in stressing to shareholders that GAPP operating earnings are misleading because of the inclusion of substantial unrealised gains or losses on public stock and bond holdings. This mark-to-market gyrations take the focus off of the “main event” which is the company’s core operating earnings from businesses it controls. Even considering adjusted operating earnings, the company’s core businesses can be volatile, especially the P&C insurance business. The company’s substantial ownership of utilities is also creating some potential contingent liabilities due to the issue with fires on the west coast. And as Mr Buffett writes, the railroad business is extremely capital intensive and low return at the moment. It is not all roses for Berkshire going forward even when considering their core operating businesses.
Liquidity: The company values liquidity, which reflects Mr Buffett’s amazing patience in waiting for market dislocations that re-value sectors or companies below fundamental value. As history has shown, he savours the opportunity to step-in during times of market distress, which are increasingly becoming few and far between. The nearly $168 billion of cash and cash equivalents at year end on the company’s balance sheet reflects the lack of investment opportunities, as well as the company’s desire to maintain a liquidity buffer given the volatile nature of earnings at its operating companies. Cash has increased sharply over the last year as you can see below.
Berkshire’s cash position alone is between the market cap of IBM and GE, the 44th and 45th largest companies in the S&P 500. If cash is combined with the market value of its public securities holdings at December 31, 2023 (circa $545 billion in aggregate), the company would be the 12th largest company in the S&P 500, just below VISA (11th) and above JPM (12th).
Share price: As of the end of Monday’s session, Berkshire’s market cap was around $900 billion, making it the 7th largest company by market cap in the S&P 500 index (and the largest non-tech company). This is not a topic Mr Buffett alludes to or seems to care about, at least in the annual report. However, he is constantly stressing the company’s principal objective of generating shareholder value by increasing operating cash flow and remaining patient in a market characterised by over-valuations and exuberance. This is a long-term, value-oriented approach, not geared towards instant gratification, although momentum investors are bidding up the stock beyond fair value (in my opinion), along with nearly everything else. The BRK-B shares are up 13.4% YtD, vs the S&P 500 which is up 6.3% YtD. Although Mr Buffet focuses on core earnings and not the company’s share price, you can see the valuation metrics in the table below.
Evaluating the performance of Berkshire in 2023
Berkshire’s earnings beat consensus analysts’ expectations on the bottom-line, although as Mr Buffett correctly points out, the operating profit line and line items below (including EPS) are misleading because they include mark-to-market gains and losses on the company’s extensive portfolio of public stocks and bonds, as well as interest and dividend income (which is in the revenue line). The best way to grasp the trends of the business in my opinion are to focus on operating earnings from the core businesses in which Berkshire is an operator (like insurance and railroads) and to filter out the “noise” that comes from unrealised gains (losses), which are volatile year-to-year. In addition, it also makes sense to look at the results before realised gains (losses), interest and dividend income on the extensive portfolio of public stocks and bonds, even though these represent “real” cash flow. The table below is my attempt to generate a core operating profit figure for Berkshire Hathaway, noting that this differs slightly from what is included in the annual report (because I am lacking information).
The gyrations in market value of public securities when they are unrealised creates wide swings in the company’s earnings. Having said this, qualitative insights can be derived by the selection and performance of the public securities (mostly stocks) that Berkshire has invested in over long periods of time. In fact, this says a lot about the philosophy of Berkshire Hathaway. Mr Buffett is the first to admit that they do not get every call right, but history also suggests that when Berkshire invests, it is almost always for the long term, meaning decades.
Stock repurchases
Another important aspect of Berkshire Hathaway’s performance is their use of stock buybacks, which essentially provide a soft floor for the company’s stock price. Recall that the company has never paid a dividend, as they prefer the flexibility of stock buybacks. The table below will give you a flavour of the company’s share repurchases over the last three years. As you can see, the company ramped up its repurchases of its own stock in 2021, reflecting the after-effects of the pandemic sell-off, but then tamped down the repurchases as the stock became more fairly valued in 2022 and 2023. Even so, the company repurchased more than $9 billion of stock in 2023
I imagine that Mr Buffett is not at all keen to repurchase Berkshire shares in the open market at current valuation levels. This creates a dilemma for Mr Buffett, in that:
high current valuations make investments in other public stocks unattractive to Mr Buffett, who remains a value investor at heart, and
competition from strategic buyers and private equity investors make the acquisition of controlling stakes in companies at fair-value prices equally difficult.
Therefore, it appears for now that Berkshire will continue to bide its time, investing its cash hoard in US Treasuries (mostly short-dated Bills) in which Mr Buffett is clearly delighted to earn a “proper” return after years of near-nil interest rates. In the shareholder’s letter, Mr Buffett is very open in warning investors that the company’s growth will be average at best going forward given this context. To add fuel to the fire, with Berkshire’s own share price reaching a record high, the company is probably reluctant to step up its share repurchases, leaving the company with the “high class problem” of holding boatloads of cash and US Treasury securities. It increasingly raises the option of Berkshire starting a dividend program, although Mr Buffett has for decades resisted this idea, instead opting for capital being returned to shareholders via share repurchases.
Performance of Berkshire Hathaway shares
Berkshire Hathaway’s performance has been extraordinary since the company listed it’s a shares in 1980, as you can see in the table below that compares the performance of the B shares to the S&P 500 index since the end of 1989 over various periods.
For reference, Berkshire has two classes of stock – A shares (BRK-A) that are very expensive, now over $615,000/share – and B shares that are worth 1/1,500 of the A shares, or currently around $409/share. The A shares can be converted to B shares at the option of investors, which I believe is considered a tax-free exchange.
The future
The company shines in times of crisis, being the ultimate contrarian investor when investors are running the other direction. Even without Mr Munger (and one day without Mr Buffett), I don’t see the philosophy of the company changing. Investors must price the stock accordingly. At its core, Berkshire remains the ultimate value play even though the stock – like those of many other companies at the moment – has been completely caught up in the euphoria of investors piling in with little consideration of the company’s genuine fundamentals and its outlook. Some investors that focus on momentum might find Mr Buffett’s style boring. I am not one of them. He goes above and beyond nearly every Chairman of a listed company by providing a lengthy and honest assessment of the company’s prospects, with no hype built in. If you want a real experience, assuming you own shares (as little a one B share), go to the annual meeting in Omaha, which is an experience you will never forget!
Conclusion
In order to avoid any suggestion of bias, I should tell the readers of my blog that Berkshire Hathaway is my largest single stock holding. I will probably reduce the number of shares I own in the coming weeks or months, not at all because of the outlook and “style” of the company – which I admire and understand – but because it has become too concentrated of a position in my portfolio.