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Margaret Moran
Margaret Moran
Articles (288) 

Buffett's Berkshire Reports Earnings This Weekend: Here's What to Expect

Investors should keep an eye on share buybacks and operating earnings

August 08, 2020 | About:

Warren Buffett (Trades, Portfolio)`s Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) is expected to post its earnings results for the second quarter of 2020 this Saturday morning.

Wall Street has high expectations thanks to a relatively new accounting rule that went into effect in 2019, which requires unrealized gains or losses on stock investments to be reported as part of a company`s earnings. On the back of the S&P 500`s 18% gain throughout the second quarter, as well as potential share buybacks from the value-focused guru, analysts anticipate revenue of $61.08 billion and earnings per share of $2.12.

Don`t be fooled by the stock market

Buffett wrote the following about accounting rule change in his 2019 letter to shareholders, urging investors not to pay too much attention to the fluctuations of the stock market:

"Berkshire`s 2018 and 2019 years glaringly illustrate the argument we have with the new rule. In 2018, a down year for the stock market, our net unrealized gains decreased by $20.6 billion, and we therefore reported GAAP earnings of only $4 billion. In 2019, rising stock prices increased net unrealized gains by the aforementioned $53.7 billion, pushing GAAP earnings to the $81.4 billion reported at the beginning of this letter. Those market gyrations led to a crazy 1,900% increase in GAAP earnings!

Meanwhile, in what we might call the real world, as opposed to accounting-land, Berkshire`s equity holdings averaged about $200 billion during the two years, and the intrinsic value of the stocks we own grew steadily and substantially throughout the period.

Charlie and I urge you to focus on operating earnings, which were little changed in 2019, and to ignore both quarterly and annual gains or losses from investments, whether these are realized or unrealized."

As we can see in the chart below, which details Berkshire's quarterly revenue and net income, including the prices of the portfolio stocks as part of the earnings has resulted in dramatic ups and downs. Meeting Wall Street`s expectations for this quarter would represent a dramatic 110% increase in earnings per share compared to the first quarter.

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Thus, in order to get an accurate picture of how Berkshire performed during the quarter, investors may want to follow Buffett's advice and look past earnings per share, focusing instead on operating earnings.

Operating results

Berkshire Hathaway has assets across a highly diversified range of businesses, many of which are bound to still be experiencing reduced sales from the pandemic and economic downturn. This diversity will likely help the company mitigate the negative impacts from struggling businesses.

The conglomerate`s retail businesses are likely to continue seeing reduced income, while its BNSF railroad will also be impacted by lower transportation of goods. However, its utilities businesses provide a source of stability.

The results for Berkshire's various insurance companies are a little more difficult to anticipate. With fewer people travelling during the quarter, insurance claims from car accidents will almost certainly have fallen, though the benefits from this will be somewhat mitigated by rebates.

Deals of the quarter

Investors may have been surprised that Buffett didn't swoop into equity markets during the short-lived stock market crash and buy everything cheap in sight. However, doing so would not quite fit in with the Oracle of Omaha`s strategy. Buffett is known for making deals that have an extremely high chance of becoming profitable, but not if they come at a significant risk of permanent capital impairment.

Despite the unpredictable economic situation, we know that Buffett did find some areas worth investing in. For one, he spent $4 billion on natural gas transmission and storage assets from Dominion Energy (NYSE:D), assuming $6 billion in debt as part of the acquisition. The guru also bought more shares of Bank of America (NYSE:BAC), boosting Berkshire's stake in the bank to 11.92%. It is possible that the guru made other stock acquisitions, but we will have to await the second-quarter 13-F filing to find out.

Investors are also anticipating more share buyback activity from the conglomerate to be reported. One of the biggest frustrations of Berkshire's stockholders is that they have not seen more share buybacks, despite the conglomerate's cash reserves of more than $130 billion. Berkshire also announced the following update to its share buyback policy in July of 2018, causing investors to anticipate a wave of repurchases:

"Berkshire's common stock repurchase program permits Berkshire to repurchase its Class A and Class B shares any time that Warren Buffett (Trades, Portfolio) (Trades, Portfolio), Berkshire's Chairman of the Board and Chief Executive Officer, and Charlie Munger (Trades, Portfolio) (Trades, Portfolio), Vice Chairman of the Board, believe that the repurchase price is below Berkshire's intrinsic value, conservatively determined. The program continues to allow share repurchases in the open market or through privately negotiated transactions and does not specify a maximum number of shares to be repurchased. However, repurchases will not be made if they would reduce the total value of Berkshire's consolidated cash, cash equivalents and US Treasury Bills holdings below $20 billion. The repurchase program does not obligate Berkshire to repurchase any specific dollar amount or number of Class A or Class B shares and there is no expiration date to the program."

On the one hand, Berkshire does need extra cash on hand due to its insurance businesses, as one of its biggest advantages within the sector is the ability to take on risks that competitors cannot. On the other hand, the price of Berkshire's B shares ranged from $171 to $190 throughout the quarter, and the last time Berkshire had share prices this cheap was in 2017. The conglomerate spent $5 billion on repurchases in 2019 and $1.7 billion on repurchases during the first quarter of 2020.

From a value investing standpoint, it would make sense to allocate more to buybacks at even lower prices, especially since the buyback policy sets the minimum cash reserve balance at only $20 billion. However, it is important to note that the Covid-19 crisis may have changed Buffett's outlook significantly in terms of the minimum cash balance that Berkshire needs to maintain.

Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.

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