Greggory Warren, financial services sector strategist for Morningstar, has three pertinent questions for Berkshire Hathaway.
Berkshire Hathaway’s first-quarter revenue, which includes unrealized and realized gains/losses from Berkshire's investments and derivatives portfolios, decreased 111.1% to negative $9 billion.
Excluding the impact of investment and derivative gains/losses and other adjustments, operating revenue increased 1.0% to $61.3 billion. Operating earnings, exclusive of the impact of investment and derivative gains/losses, increased 5.7% year over year to $5.9 billion during the March quarter. When including the impact of the investment and derivative gains/losses, operating earnings fell 453.5% to negative $49.7 billion.
- How much cash and cash equivalents should we consider as being counted toward reserves?
The company closed this quarter with a record $137.3 billion in cash and cash equivalents, up from $128.0 at the end of last year. This left Berkshire with an estimated $112 billion in dry powder that could be committed to investments, acquisitions, and share repurchases.
While Berkshire’s large equity investment portfolio and bond holdings have generally been far greater than the company’s required insurance loss reserves, Buffett has noted for years that he likes to keep around $20 billion in cash on hand as a backstop for the insurance business.
Given that the size of the company’s insurance operations continues to expand, and that we are now seeing an unprecedented event that could require greater levels of liquidity to meet claims that may have been considered low probability in the past, is that an adequate level of dedicated cash reserves for Berkshire, or does that number need to be higher--say $25 billion or $30 billion?
- Is Berkshire’s preferred model for acquisitions keeping it from doing deals?
While Buffett has lamented the dearth of investment opportunities during the past decade, which allowed cash to build up on Berkshire’s balance sheet (approaching $128 billion at the end of 2019), it has been a natural byproduct of the company’s disciplined approach to investing, lack of a dividend, and limited amount of share repurchases over the years.
It looks as if investment opportunities have been waylaid in the near term due to an overabundance of caution and increased competition from not only private equity and other players but the federal government, which for the time being is offering better bailout terms to distressed companies.
In a recent interview with The Wall Street Journal, it was put to Munger that in the current environment “hordes of corporate executives must be calling Berkshire begging for capital”. Munger said nothing of the sort was happening.
Is the Berkshire model perhaps being too “pull” oriented as opposed to “push”? With so much capital already out there in the hands of private equity and other larger investors in pursuit of the types of larger deals Berkshire would like to do, and the preferred process being to wait until sellers (or their representatives) call up Berkshire or drop by the offices, are there potential deals or investments that Berkshire is missing out on right now because the company is not close enough to (or informed enough about) the markets or companies in need of financial assistance or investment?
- Could it be that Berkshire’s best investment opportunity is its own stock?
Book Value per share, or BV, which still serves as a decent proxy for measuring changes in Berkshire's intrinsic value, declined 12.2% sequentially to $228,953 (from $260,906 at the end of December).
Berkshire changed its share-repurchase programme at the end of July 2018 to allow Berkshire to repurchase shares when Buffett and Munger believed “the repurchase price was below Berkshire’s intrinsic value, conservatively determined.” This effectively removed the floor that had existed under Berkshire’s shares and created a bit less certainty about where Berkshire might be willing to buy back stock.
In the back half of 2018, Berkshire bought back just over $1.3 billion of stock for 1.40 times trailing BV and 1.39 times pending BV. During 2019, the price paid was somewhat lower, as the more than $5.0 billion of stock that Berkshire repurchased was picked up for 1.36 times trailing BV and 1.29 times pending BV.
With the shares trading off meaningfully this year, Berkshire bought back $1.7 billion of its own shares in the first quarter of this year.
The equity bull market that began more than a decade ago has finally come to an end. While we have anticipated an eventual end to what had been a historic run for the markets sometime in the next three to five years, we did not see it ending with a black swan event like the COVID-19 pandemic, which has all kinds of ramifications for businesses, economies, and the markets.
We’ve always viewed Berkshire’s decentralized business model, broad business diversification, high cash-generation capabilities, and unmatched balance sheet strength as being providers of opportunities that might elude other companies, as well as offering some downside protection during a potential downturn.
While results will be affected in the near term by a return to historically low interest rates, increased credit and equity market volatility, and a deep recession that could take some time to crawl out of, we think that the advantages in Berkshire’s diversified business model should allow the company to once again increase BV at a high-single- to low-double-digit rate once we get past the fallout from the COVID-19 pandemic.
However, Berkshire still has a good investment opportunity in its own common stock, which fits more into our thesis that the company will eventually have to evolve from a reinvestment machine to one that returns much more capital to shareholders.
Berkshire’s shares are currently trading at just under a 20% discount to our fair value estimate, 1.25 times our projected BV per share for the first quarter of 2020, and 1.22 times and 1.15 times our projected BV for the end of 2020 and 2021, respectively. These are some of the cheapest levels we’ve seen in a number of years, providing a good entry point for long-term investors.
