Warren Buffett (Trades, Portfolio)'s principles are beacons of wisdom in the ever-evolving investment world. His emphasis on operating profits takes center stage, guiding investors to navigate the complex interplay of finance, innovation and industry dynamics.
When Berkshire Hathaway Inc (BRK.A, Financial) (BKR.B) released its second-quarter report, it beat expectations due to outstanding insurance results.
In this discussion, I will review the company's quarterly performance, achievements, insights and industry resonances that define its movements.
Operating profits, insurance success and industry dynamics
Buffett highlights the importance of operating profits; thus, investors should pay attention to operating earnings, which exclude changes in the value of Berkshire's approximately $353 billion equity holdings that must be included with its accounting standards.
In the second quarter, the operational businesses saw growth of about 7% year over year, with insurance performing exceptionally well. Specifically, operating businesses at Berkshire earned $92.5 billion in revenue and made $10 billion in profit.
Additionally, overall earnings of $35.9 billion comprised investment gains of $25.9 billion, while the same quarter a year ago showed losses of $53 billion due to the stock market decline.
Due to greater interest income on Berkshire's massive holding of cash and equivalents, primarily U.S. Treasury bills, the company's investment income in insurance increased to $2.4 billion from $1.9 billion in the prior-year quarter.
Source: Berkshire Hathaway's earnings release
Higher insurance underwriting profits, which increased to $1.2 billion from roughly $700 million in the same period last year, contributed to Berkshire's results. The Geico auto insurance division was a significant contributor, which turned a similar-sized deficit in the second quarter into an underwriting profit of approximately $500 million.
Despite a 14% decline in active policies compared to last year, Geico's premium per policy increased by 16.3%. Further, Geico and other auto insurers are rapidly hiking their rates to offset much-increased claims costs and reflect rising costs to repair damaged cars.
Moreover, the manufacturing, service, retail aviation and automotive industries are strong performers, offsetting other sectors' declines. Due to decreased freight volumes and increased non-fuel operating expenses, Berkshire's Burlington Northern Santa Fe railway division posted a 24% decline in operating income to $1.26 billion after taxes.
Lastly, Berkshire Hathaway Energy saw earnings of $785 million after taxes.
Float, cash reserves and capital management
The current float is $166 billion, and following the purchase of Alleghany last year, Berkshire's insurance float growth has halted. The amount of cash and T-bills held by Berkshire is $141.9 billion, $14.2 billion more than it was at the end of the first quarter. With T-Bills yielding about 5.5%, the conglomerate may wait before making new investments.
In the second quarter, Berkshire's asset base exceeded $1 trillion, a significant accomplishment for a business that had assets worth less than $30 million in 1964. Remarkably, as of the end of the second quarter, Berkshire's shareholder equity had increased from $22 million in 1964 to $540 billion.
It is also important to pay close attention to its cash position. Berkshire's cash hoard has consistently stayed well over $100 billion in recent years, giving Buffett and his team a lot of capital to pursue investment possibilities. The company had $147.4 billion in cash and short-term investments at the end of the second quarter, a significant increase from the $130.6 billion in cash that was on hand at the end of the first quarter.
Unsurprisingly, $97.3 billion of this was stored in short-term Treasury securities. Despite Buffett having been open about his desire to make a significant acquisition and his expanding cash reserves, increased interest rates have enabled Berkshire to deploy its unused capital to generate billions in annual interest income.
In its Form 10-Q for the second quarter, Berkshire Hathaway noted it repurchased $1.4 billion worth of its shares, a significant decrease from the $4.4 billion in the first quarter. Only an additional $100 million of its shares were bought through July 26 as part of its ongoing share repurchase program. It is expected that Berkshire may have adopted a wait-and-see strategy given the continued turmoil in the banking industry during those months.
Valuation is not attractive
The company has a price-book ratio of 1.59, which is close to its 10-year high of 1.60. This indicates the stock may be overvalued and poses a risk of a potential correction in the future. Moreover, the company's revenue per share has declined over the past three years, while the share price is close to its 10-year high. This suggests a potential disconnect between the company's financial performance and stock price.
Further, the price-sales ratio of 2.86 is close to its 10-year high of 3.02. This indicates the stock may be overvalued based on its sales.
Takeaway
Buffett's steadfast emphasis on operating profits shines as a North Star, prompting us to uncover subtleties beyond accounting norms. This quarter echoes with a resounding surge of approximately 7% year-over-year growth in operational sectors, painting a vivid picture of prosperity and resilience.
However, Berkshire Hathaway's valuation remains stretched, so investors might want to consider entering at a lower, more attractive price.
