Tags: Comments / Earnings
This fanpage is not officially affiliated with Berkshire Hathaway: Disclaimer
Calling all shareholders of Berkshire Hathaway! Ever wondered how to uncover the true earnings of this behemoth conglomerate? This article is your ultimate guide to understanding the company's financial health, navigating through the confusing world of accounting principles, and appreciating the enduring value of your investment. Don't miss out on this eye-opening journey!
Introduction
Imagine a world where the value of a diamond is judged not by its brilliant sparkle but by the dust that may temporarily cling to it. This is akin to the investment philosophy of Warren Buffett, a man whose name is synonymous with long-term value and a keen eye for the underlying health of a business. At the heart of this philosophy lies Berkshire Hathaway, a behemoth conglomerate with a tapestry of diverse holdings, ranging from insurance and railroads to energy and retail.
For shareholders and analysts alike, accurately deciphering Berkshire Hathaway's earnings is akin to an art form. The challenge? The discrepancy between Generally Accepted Accounting Principles (GAAP) earnings and the operating earnings that Buffett himself holds in high regard. Buffett believes that operating earnings are a more accurate gauge of company performance 1, as accounting rules require the inclusion of unrealized gains and losses from the investment portfolio in net income. This means that a slide in the stock market could distort the results, casting a shadow on the true performance of the underlying businesses.
The confusion is often compounded by media headlines that "regularly and mindlessly misinform investors about capital gains fluctuations." 2 It is, therefore, paramount for investors to understand the real economic performance of Berkshire Hathaway's operating businesses.
As we pull back the curtain on Berkshire Hathaway's true earnings, this article will serve as your guide to calculating operating earnings and understanding the financial health of the company. We will dissect the annual report, clarify the jargon, and provide you with the tools to see past the ephemeral fluctuations of the market. To set the stage, let's take a quick glance at a recent quarter's earnings as an example (full table for Q3 2023 ↗ in the Annex):
| Description | Amount (in millions) |
|---|---|
| Net Earnings (Losses) after GAAP | $(12,767) |
| Investment and Derivative Gains (Losses) | $(23,528) |
| Operating Earnings = Net Earnings - Investment/Derivative Gain | $10,761 |
This table visually presents the stark difference between reported net earnings and operating earnings for the third quarter of 2023, a period that, despite a net loss, revealed a robust operational performance.
Understanding Berkshire Hathaway's Earnings
To truly grasp Berkshire Hathaway's financial narrative, one must differentiate between operating earnings and net earnings. Operating earnings refer to the profits made from the company's core business operations, excluding any gains or losses from investments and derivatives. These are the earnings Warren Buffett prefers for evaluating company performance, as they reflect the ongoing profitability of Berkshire's diverse business interests 1.
The stock market's ebb and flow can significantly impact Berkshire's net earnings due to accounting rules that require the inclusion of unrealized investment gains and losses. This can lead to a distorted picture of the company's financial health, particularly when the market is volatile. For instance, a downturn in the stock market can result in a paper loss for Berkshire's investment portfolio, which, although unrealized, must be reported as a loss in net earnings 1.
Berkshire Hathaway's portfolio is so vast and varied that it can experience significant capital gains or losses, which affect net income but not the operational performance of its businesses. These GAAP figures "fluctuate wildly and capriciously," and quarter-by-quarter gyrations of capital gains can misinform investors about the company's true performance 2 .
The GAAP earnings are 100% misleading when viewed quarterly or even annually. Capital gains, to be sure, have been hugely important to Berkshire over past decades, and we expect them to be meaningfully positive in future decades. But their quarter-by-quarter gyrations, regularly and mindlessly headlined by media, totally misinform investors.
Historically, capital gains have played a crucial role in Berkshire's growth. However, their short-term analysis can be highly misleading. Buffet and his long-time business partner, Charlie Munger ↗ ↗, focus on the operational figure for calculating Berkshire Hathaway's operating earnings, which they believe gives a more accurate picture of the company's economic performance 2.
The main sectors contributing to Berkshire Hathaway's operating earnings include 3:
- Insurance – Underwriting
- Insurance – Investment Income
- BNSF (railroad)
- Berkshire Hathaway Energy (BHE)
- Pilot Travel Centers (PTC)
- Manufacturing, Service, and Retailing
- Non-controlled Businesses
- Other
The third quarter of 2023 serves as a prime example of how investment losses can overshadow operational success. To calculate Berkshire Hathaway's operating earnings from the annual report, one must subtract the investment and derivative contract gains/losses from the net earnings attributable to Berkshire Hathaway shareholders. In this case, operating earnings of $10,761 million are the result of adjusting the net earnings of -$12,767 million by the investment loss of $23,528 million 3.
For clarity, here are some key terms explained:
- GAAP (Generally Accepted Accounting Principles): GAAP refers to a set of standardized accounting principles, standards, and procedures that companies use to compile their financial statements. It provides a common framework for reporting financial information, ensuring consistency and comparability in financial reporting.
- Operating Earnings: Operating earnings represent a company's earnings derived from its core business operations. It excludes non-operating items such as investment gains or losses, interest, and taxes, providing a clearer picture of the company's performance based on its primary activities.
- Investment Gains/Losses: Investment gains or losses refer to the profits or losses incurred by a company from its investments in stocks, bonds, real estate, or other financial instruments. These gains and losses are typically reported in the company's financial statements and can significantly impact overall financial performance.
Dissecting the Annual Report
The annual report of Berkshire Hathaway is a treasure trove of information for the discerning investor. It provides not only a snapshot of the company's financial position but also a roadmap to understanding its operational health. To mine this wealth of data, one must know where to look and how to interpret the figures presented.
Using the third quarter of 2023 as our guide, let's walk through the process of extracting operating earnings from the report. The key is to identify the Net Earnings (Loss) Attributable to Berkshire Hathaway Shareholders and then adjust this figure by subtracting the Investment and Derivative Contract Gains (Losses). This calculation reveals the operating earnings that reflect the true profitability of Berkshire's businesses 3.
A flowchart or diagram could illustrate this step-by-step approach for visual learners, ensuring that even those new to financial analysis can follow along. Each operating sector's earnings are detailed in the report, providing insight into the performance of Berkshire's various subsidiaries 3.
The annual report can also be a tool for projecting future performance. While past capital gains have been significant for Berkshire, Buffett expects them to continue to be positive in the coming decades, despite their misleading nature when viewed on a quarterly or annual basis 2.
An analysis of the reported 40.6% increase in operating earnings year over year offers a glimpse into the company's growth trajectory. This significant rise 4 5, underscores the strength of Berkshire Hathaway's operations, despite the net loss reported due to investment portfolio fluctuations.
To provide a historical perspective, 2022 has already been a record year with operating earnings of $30.8 billion but a net loss of $22,8 billion (GAAP). Again, the reason was an investment loss of $53,6 billion that year ↗ 2.
By dissecting the annual report and understanding the methodology behind the calculation of operating earnings, shareholders can gain a clearer picture of Berkshire Hathaway's true earnings, setting aside the temporary dust of market fluctuations to appreciate the enduring value of their diamond.
Interpreting the Results
When we peel back the layers of Berkshire Hathaway's financial statements, we uncover the true robustness of its operating earnings, which Warren Buffett has long touted as the real measure of the company's health. In the third quarter of 2023, despite the reported net loss of $12,767 million, the underlying operations were remarkably strong, boasting operating earnings of $10,761 million—a significant leap from the same quarter in the previous year.
The relevance of operating earnings for investors is paramount, particularly within the investment philosophy championed by Buffett. The record level of cash, reported at $157.2 billion 5, is not merely a stagnant pool of resources but a strategic reserve. It reflects a disciplined investment strategy that awaits the right opportunities, even amidst a market that offers few deals aligning with Berkshire's value-oriented approach.
Economic and political factors invariably sway Berkshire Hathaway's investment portfolio and operating earnings. Yet, the company's leadership, particularly Buffett and Munger, have consistently emphasized the misleading nature of GAAP figures 2. They urge investors to look beyond the quarter-by-quarter gyrations of capital gains that can misinform and distract from the company's fundamental performance.
The media, often fixated on sensational headlines, can exacerbate this confusion, emphasizing short-term losses or gains without context. It is here that investor education becomes crucial. Historical examples, such as Berkshire's navigation through past economic downturns, teach us that the company's strength lies not in its immunity to market fluctuations but in its resilience and strategic response to them.
Conclusion
To truly grasp Berkshire Hathaway's financial health, shareholders must learn to calculate the company's operating earnings from the annual report. Subtract the investment and derivative contract gains (or losses) from the net earnings attributable to Berkshire Hathaway shareholders to find the operating earnings—a metric that paints a more accurate picture of the company's performance.
The importance of looking beyond headline figures cannot be overstated. As we anticipate the release of the 2023 annual report in February 2024, applying this methodology will be crucial for shareholders seeking to understand the true performance of Berkshire Hathaway's operating businesses.
Warren Buffett's approach to evaluating company performance—focusing on the long-term and the intrinsic value of businesses—remains as relevant for individual investors today as it has ever been. Despite market volatility, the outlook for Berkshire's capital gains is optimistic, and the company is expected to continue its history of positive contributions in the coming decades 2.
As shareholders, we are encouraged to embody the patience and long-term investment philosophy that Buffett espouses. His wisdom on the subject is perhaps best encapsulated in his own words: "The stock market is designed to transfer money from the Active to the Patient."
The resilience of Berkshire Hathaway's operating earnings stands as a testament to the company's enduring strategy. Amidst market volatility, the true earnings of Berkshire Hathaway remain not just a beacon of stability but a guidepost for discerning investors who, armed with the right knowledge and perspective, can navigate the financial seas with confidence.
Annex: Example - Complete Earnings Table Q3 2023 3
Note: all Earnings (Losses) in millions. The investment part that needs to be substracted to calculate the operating earnings is highlighted red:
| Categories | Third Quarter 2023 Earnings |
|---|---|
| Insurance – Underwriting | $2,422 |
| Insurance – Investment Income | $2,470 |
| BNSF | $1,221 |
| Berkshire Hathaway Energy (BHE) | $498 |
| Pilot Travel Centers (PTC) | $183 |
| Manufacturing, Service, and Retailing | $3,341 |
| Non-controlled Businesses | $226 |
| Investment and Derivative Contract Gains (Losses) | ($23,528) |
| Other | $400 |
| Net Earnings (Loss) Attributable to Berkshire Hathaway Shareholders | ($12,767) |
References
