Berkshire Hathaway (BRK/A, BRK/B) reported earnings of $26.3 billion in the third quarter versus a loss of $12.8 billion in the same quarter of 2023. Operating earnings, which remove the distortion from market changes and better reflect the firm’s earnings power, fell by 6% for the quarter versus 2023. Providing an illustration of the value from share repurchases, per-share operating income for the year-to-date increased by 15% compared to 2023, while operating earnings grew by 14%. Warren Buffett leads Berkshire as CEO and Chairman with Greg Abel, Vice Chairman of Non-insurance, and Ajit Jain, Vice Chairman of Insurance.
Berkshire’s most significant business by year-to-date operating earnings is insurance, followed by the manufacturing, service, and retailing segment.
A more detailed look into the various operating segments for the third quarter shows slightly worse results than in 2023. The insurance business is the primary driver of the relative woes for the quarter. Operating income, excluding insurance, fell by 3% compared to the same quarter a year ago.
Insurance: In the three quarters of 2024, investment income was 41% higher than in 2023, primarily due to higher yields and short-term investment balances. Buffett predicted at the annual meeting in May that higher yields and cash levels should lead to higher investment income in 2024. Berkshire’s luck in avoiding catastrophe losses ran out in the third quarter, with estimated losses from Hurricane Helene of $565 million. Further, management forecasts that “pre-tax incurred losses from Hurricane Milton could be between $1.3 billion and $1.5 billion.” These losses should be reflected in fourth-quarter earnings. Further, National Indemnity Company, which is a subsidiary of Berkshire Hathaway Reinsurance Group, had a “pre-tax charge in underwriting expenses of $490 million in connection with a settlement agreement reached concerning certain non-insurance affiliates that filed voluntary petitions under Chapter 11 of the bankruptcy code in the United States Bankruptcy Court for the District of New Jersey in 2023.”
GEICO continued its improvement thanks to “higher average premiums per auto policy, lower claims frequencies and improved operating efficiencies compared to 2023.” Geico suffered from rising claims severity and catastrophe losses, partially offsetting the better news. At the annual meeting, Ajit Jain, who manages Berkshire’s insurance businesses, stated that GEICO is “making progress” but “still behind” on the technology front. Jain set a timeline for being caught up in technology to the end of 2025. The most crucial positive news was that policies in force grew in the third quarter “driven by increased new business and stable retention rates.”
The two most essential concepts in insurance investing are “float” and underwriting profit. In simple terms, float is created for insurance companies because insurance premiums are paid before any claims are made by the insured. Insurance companies can invest the float, sometimes for years, before insurance losses are reimbursed. Berkshire’s float was higher at $174 billion, $5 billion higher than its level on December 31, 2023. In general, the value of float increases as yields rise since an insurance company can earn more when investing the cash. Float per share increased to a new high of $121,034. Though not a factor this quarter, share repurchases aid the growth of float per share.
Berkshire has a history, unlike many insurance companies, of earning an underwriting profit, meaning that their float costs them nothing and makes them money in addition to allowing them to earn a profit off of investing the float. Berkshire has three main insurance businesses: GEICO, Berkshire Hathaway Primary Group, and Berkshire Hathaway Reinsurance Group. Two of the three insurance segments earned an underwriting profit in the third quarter, but all three had profitable underwriting year-to-date. An underwriting profit means the insurance premium exceeds all insurance claims and expenses. For example, GEICO had a combined ratio of 81.0% in the third quarter, which means that only 81.0 cents of every dollar in insurance premiums were spent on losses and expenses. A combined ratio over 100% indicates the insurance company has an underwriting loss, as seen with the Berkshire Hathaway Primary Group in the third quarter.
Railroad: Berkshire owns one of the largest railroads in North America, the Burlington Northern Santa Fe (BNSF) railroad, operating in the U.S. and Canada. Railroad freight volume and revenues improved for the quarter versus 2023. Greg Abel, who oversees the railroad and other businesses outside of insurance, said at the annual meeting that BNSF needs a cost structure that allows it to compete in the rail and overall transport sectors. Abel added that “excellent progress” has been made. There continue to be signs of progress in the third quarter as operating earnings and pre-tax margins improved.
Utilities and Energy: As a result of acquiring the 8% minority interest at the end of September, Berkshire is the sole owner of the Berkshire Hathaway Energy Company (BHE). The purchase involved cash, a promissory note, and Berkshire Hathaway B shares. Reflecting the more uncertain future of BHE due to political and wildfire litigation risks, the purchase was at a significant discount to the price paid to acquire Greg Abel’s shares in 2022.
BHE generally provides steady and growing earnings, as one would expect from what primarily consists of regulated utilities and pipeline companies. In addition, BHE typically produces significant tax credits due to its renewable electricity generation. For this reason, Berkshire focuses on after-tax earnings, which is “how the energy businesses are managed and evaluated.”
BHE had a solid quarter, but the soaring profits were primarily due to accruing $1.4 billion for wildfire losses in the third quarter of 2023, which flattered the year-over-year comparisons. BHE has set aside $2.15 billion since 2023 for possible losses from the wildfires involving PacifiCorp.
Manufacturing, Service and Retailing: This segment consists of many diverse businesses, so this analysis will focus on the best and worst performers and some themes when looking at this segment.
The service group saw the most significant decline in pre-tax earnings for the quarter, primarily attributable to TTI and the aviation services businesses. TTI is a distributor of electronic components, and management began noting weakness in the group in 2023 due to inventory levels and sagging demand. Berkshire expects these headwinds “to continue over the remainder of 2024.” It is not abnormal for distribution businesses to suffer from these issues after a period of supply chain issues and high demand, as seen surrounding COVID. The aviation services businesses, consisting of NetJets and FlightSafety, saw strong revenue growth, but increased costs caused a decline in earnings.
The retailing group was another major drag in earnings growth. The most significant portion of the retailing segment is Berkshire Hathaway Automotive (BHA), owning over 80 auto dealerships. BHA had 10.0% lower earnings in the third quarter, driven by lower gross profit margins on vehicle sales. Pre-tax earnings for the remainder of the retailing group collapsed by 61.9%.
On the positive side, the consumer products group saw the fastest increase in quarterly pre-tax profits. According to management, the “increases were primarily attributable to higher earnings from our apparel and footwear businesses and Duracell and a 3.9% increase in year-to-date earnings from Forest River.”
Berkshire’s aerospace exposure remains substantial despite selling its publicly traded airline holdings in 2020. Berkshire’s Precision Castparts (PCC) business has been a bright spot within the industrial products segment due to its exposure to the aerospace industry. Berkshire noted that “long-term industry forecasts continue to show growth and considerable demand for air travel and aerospace products.” PCC’s pre-tax earnings rose by 25.1% relative to 2023, primarily due to “sales increases and generally improved manufacturing and operating efficiencies.”
Pilot Travel Centers(PTC): Pilot is the largest operator of travel centers in North America, under the names Pilot and Flying J. On January 16, 2024, Berkshire acquired the final 20% and now owns 100% of the entity. It is shown as a segment within the financials of the operating companies. Still, the January 2023 results are included in the non-controlled business results, so the year-to-date comparison is apples-to-oranges. Pre-tax earnings fell by 25.4% in the third quarter, driven by lower average fuel prices and increased expenses.
Non-Controlled Businesses: This segment includes companies’ profits that must be accounted for under the equity method due to the size of ownership and influence on management. The after-tax equity method earnings have Berkshire’s proportionate share of profits attributable to its investments in Kraft Heinz (KHC), Occidental Petroleum (OXY), and Berkadia. In addition, the January 2023 results from Pilot are included in the 2023 non-controlled business results. According to Bloomberg, Berkshire is Occidental Petroleum’s largest shareholder, with an almost 28% stake. More about the reasons for the Occidental investment is here.
Other: The segment had a loss in the quarter produced primarily by foreign currency exchange rate gains generated from bonds issued by Berkshire Hathaway and denominated in British Pounds, euros, and Japanese Yen. These foreign currency swings are not a concern as Berkshire has significant assets and earnings denominated in these foreign currencies. Investment losses from non-U.S. dollar investments generally offset some of these gains and vice versa, depending on currency exchange rates. Acquisition accounting expenses are also reflected in this segment. These expenses are created by amortizing intangible assets connected to companies purchased by Berkshire. Finally, other earnings include “ Berkshire parent company investment income, corporate expenses, intercompany interest income on loans to operating subsidiaries when the related interest expense is included in earnings of the operating subsidiaries and unallocated income taxes.”
Investment Portfolio: Berkshire was a net seller of $34.6 billion in publicly traded stocks in the third quarter. Berkshire bought $1.5 billion of stocks while selling $36.1 billion. As Buffett said at the annual meeting, “We only swing at pitches we like.”
Surprisingly, the majority of the sales were from Berkshire Hathaway’s sales sizable stake in Apple (AAPL). These continuing sales follow on the heels of liquidating almost fifty percent of its holdings in the second quarter. Before Berkshire sold some Apple stock in the first quarter, it comprised over fifty percent of its publicly traded portfolio. The scale of the Apple sales comes as a bit of a shock because Buffett said at the annual meeting that Berkshire’s holdings of American Express (AXP) and Coca-Cola (KO) were “wonderful” businesses but said Apple is an even better one. Since these sales were known from other filings, selling about $9.3 billion in Bank of America (BAC) stock was not unexpected.
After the sales, Berkshire’s insurance company investment portfolio is down to 48% publicly traded stocks from 63% in the first quarter, while cash rose from 28% to 49%. The 13F filing with the SEC, released on November 14, will provide more details of the publicly traded stock portfolio changes.
What To Watch: As a positive, GEICO has retained profitability and begun to grow policies in force in the third quarter. Returning GEICO to a growth company was crucial. The BNSF railroad profit margin had slipped relative to 2023 and the five other major railroads, but there looks to have been some improvement in profitability and efficiency in the third quarter.
While BHE didn’t suffer from wildfire liabilities in the quarter, the threat hasn’t gone away and possibly imperils the attractiveness of future capital spending in the business. This wildfire problem is intertwined with a legal, regulatory, and political process, so any definitive conclusions could take years. Further, significant additional capital investments in liability-impacted utility areas should signal positive progress since Buffett stated, “We will not knowingly throw good money after bad.”
The underwriting losses from Hurricane Helene were felt in the quarter, and Hurricane Milton will haunt fourth-quarter insurance earnings. Berkshire has a history of being a disciplined underwriter, so the short-term pain should lead to the ability to earn higher premiums to insure these risks in the future.
Summary:
Berkshire’s stock price outperformed the S&P 500 in the third quarter, rising by 13.1% versus a total return of 5.9% from the S&P 500. Year-to-date through November 1, Berkshire’s price was +26.8%, while the S&P 500 had a total return of +21.5%.
Quarterly results are generally not meaningful for Berkshire since it is managed with a focus on increasing long-term value and not meeting quarterly hurdles. This ability to take advantage of time arbitrage has served the company and shareholders well over the years. The goal in looking at the results is to see if the segments are generally operating as expected and consider the capital allocation decisions made by Warren Buffett.
Buffett provided a blueprint for the goals of Berkshire’s management. The first goal would be to “increase operating earnings.” Secondly, success in the “decrease shares outstanding” goal would boost operating earnings per share faster. Lastly, “hope for an occasional big opportunity,” allowing for a sizable cash investment at an attractive expected return. This analysis will use Buffett’s blueprint as a lens through which to evaluate how Berkshire is performing.
Increase operating earnings: Operating earnings were 6% lower than last year’s same quarter, but the first three-quarters were 14% higher, which is a solid start to the year. Buffett says that operating earnings are the “most descriptive” way to view Berkshire since it removes the short-term volatility of market fluctuations in the net earnings. Buffett added at the annual meeting that “we would expect our earnings should go up modestly from year to year.”
Decrease shares outstanding: Particularly since 2018, a significant capital allocation decision has been made to increase share repurchases. When Berkshire Hathaway actively repurchases shares, it signals Buffett believes its share price is below his intrinsic value estimate. If he is correct, the purchases are a value-creator for the remaining shareholders. Berkshire has stated that there would be no stock repurchases if it would cause cash levels to fall below $30 billion, so the firm’s safety will not be compromised. Year-to-date operating earnings were 14% above 2023, with per-share growth of 15%, aided by modest share repurchases. Berkshire repurchased no stock in the third quarter.
Until an announcement in mid-2018, Berkshire had only made repurchases when the stock traded at less than 1.2 times the price-to-book (P/B) ratio. While that constraint is now relaxed, it is still a good indicator of the general range when aggressive repurchases will likely be seen. Berkshire’s price-to-book ratio was somewhat elevated during the quarter, so share repurchases were suspended. Berkshire only intends to repurchase shares when the “repurchase price is below Berkshire’s intrinsic value, conservatively determined.” The price-to-book ratio remains a reasonable proxy for gauging Berkshire’s intrinsic value. Still, Warren Buffett’s judgment about its intrinsic value versus other available uses of capital can differ from that simple price-to-book measure. Buffett’s use of shares to purchase the remainder of Berkshire Hathaway Energy is also likely a signal of how he sees the current valuation of Berkshire shares. He would be unlikely to be repurchasing shares and simultaneously using them as currency for a transaction since that would lead to a logical contradiction.
A longer-term view of the positive impact of Berkshire’s share repurchases is illuminating. Since the start of more aggressive share repurchases in 2018, Berkshire’s operating earnings have grown at a 16.9% compound growth rate, while operating earnings per share have done 2.4 percentage points better at 19.3%.
Hope for an occasional big opportunity: Berkshire has a fortress balance sheet with cash and equivalents of over $320 billion. This cash hoard provides flexibility to take advantage of opportunities, including repurchasing its stock if the price declines to attractive levels.
Buffett said at the annual meeting that there were no significant opportunities to invest the cash at attractive expected return: “I don’t think anyone sitting at this table has any idea how to use it effectively, and therefore, we don’t use it.” His opinion doesn’t seem to have changed, and based on the percentage of Berkshire’s cash holdings relative to the company’s size, he has continued actively reducing risk.
Despite Berkshire shares being too dear relative to Buffett’s estimate of intrinsic value for share repurchases, shareholders should take comfort in knowing that the firm continues to be managed to survive and emerge stronger from any economic or market downturn by being in a financial position to take advantage of opportunities during a crisis.
While the third quarter was a step back for quarterly operating earnings due to insurance underwriting losses, Berkshire demonstrates its resiliency. GEICO and the railroad showed signs of progress, which is not insignificant given the size of those businesses. Share repurchases might be off the table for now, removing one lever for Buffett to create value. Still, shareholders can take solace in the fact that share price increases led to this situation rather than value destruction. While no opportunities to employ capital were evident in the third quarter, Berkshire has $320 billion in cash on its balance sheet to take advantage of future opportunities.
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