Lou Simpson (Trades, Portfolio), manager of SQ Advisors, seeks long-term capital appreciation with an investing approach that departs from Wall Street-generated approaches. Simpson and his team do deep research on companies, including visits with top management and chats with the company’s competitors. During fourth-quarter 2016, Simpson trimmed his position in Berkshire Hathaway Inc. (BRK.B, Financial)(BRK.A, Financial) and gained a stake in Apple Inc. (AAPL, Financial).
Berkshire Hathaway
Simpson trimmed 19.16% off his stake in Warren Buffett (Trades, Portfolio)’s conglomerate, Berkshire Hathaway. The guru sold 442,609 Class B shares at an average price of $153.96 per share, reducing his portfolio 2.55%.
Although Berkshire Hathaway’s financial strength and profitability both rank 7 out of 10, the conglomerate has a weak Piotroski F-score of 3 and 89 cents in cash per $1 in debt. Berkshire Hathaway’s cash-debt ratio and interest coverage underperforms over 80% of global diversified insurance companies, suggesting Buffett’s conglomerate has some financial distress.
The conglomerate reported weaker earnings performance during third-quarter 2016 compared to the prior-year quarter. Net earnings declined about $2.3 billion from third-quarter 2015 to third-quarter 2016. For the first nine months of 2016, net earnings declined approximately $0.9 billion from the first nine months of 2015. The decline in net earnings were primarily driven by lower earnings performance from the Insurance – underwriting and railroad segments.
Insurance – underwriting net earnings declined primarily due to lower GEICO and Berkshire Hathaway Reinsurance Group (BHRG) earnings during third-quarter 2016. While GEICO wrote higher premiums, the auto insurance company also had higher losses and loss-adjustment expenses, which accounted for 82.4% of premiums earned. Higher losses due to storms and the severity of the claims contributed to the higher losses and expenses. BHRG suffered a $114 million loss in retroactive insurance, contributing to an overall pre-tax loss of $19 million, about $219 million lower compared to pre-tax gains in third-quarter 2015.
The Burlington Northern Santa Fe (BNSF) Railroad also reported weaker earnings for third-quarter 2016, including a 7.7% decrease in consolidated revenues and an 11.2% decrease in pre-tax earnings compared to the prior-year quarter. Lower freight revenues from consumer products, industrial products and coal contributed to the decline in consolidated revenues. Coal freight revenues declined 18.5% from third-quarter 2015 as demand for coal declined due to increased availability in substitute products like natural gas.
The weaker third-quarter earnings contributed to decreasing year-over-year per-share revenue growth since third-quarter 2013. Berkshire Hathaway’s three-year revenue growth of 9.30% outperforms just 58% of global diversified insurance companies.
The company’s price and price-sales ratio is currently near a 10-year high, suggesting the company is moderately overvalued. As the company has decreasing growth potential, Bill Gates (Trades, Portfolio) sold 5,644,800 Berkshire Hathaway Class B shares at $161.41 per share on Jan. 12, 2017.
Apple
Simpson invested in 1,153,828 shares of Apple, increasing his portfolio 5.63%. The Cupertino-based electronics company’s stock price averaged $113.4 per share during fourth-quarter 2016 and currently trades near $135 per share.
While a previous article suggested Apple has a declining financial outlook, deeper management discussion and balance sheet analysis suggests otherwise. The company reported a 5% increase in iPhone net sales, which represent nearly 70% of its total net sales. Service sales and Mac sales increased 18% and 7% respectively. Strong growth in each of the geographic operating segments, excluding the Greater China region, drove increases in iPhone net sales. Higher App Store and AppleCare sales drove increases in Service sales, while the introduction of the new MacBook Pro drove increases in Mac sales. While the company’s gross margins slightly contracted during the three months ending Dec. 31, 2016, Apple expects gross margins to rebound to about 39% for the three months ending Mar. 31, 2017.
Apple’s profitability ranks 8 out of 10, suggesting the consumer electronics company has solid growth potential for early 2017. Even though the company’s operating margins declined over the past five years, Apple still had higher operating margins in 2016 compared to 2006 profit margins. Additionally, the company’s operating margin outperforms 97% of competitors, suggesting it has higher growth and earnings potential than other consumer electronics companies.
Apple’s return on invested capital outperforms its WACC, suggesting the company creates value as it grows. While the company has a modest cash-debt ratio and Piotroski F-score, Apple has strong Altman Z and Beneish M scores, which suggest a solid balance sheet. Compared to values as of Sept. 24, 2016, Apple reported lower long-term assets, working capital and total term debt as of Dec. 31, 2016. Management expects the company’s cash, which increased about $9 billion during fourth-quarter 2016, will sufficiently cover its working capital needs, capital repurchases, outstanding commitments and other liquidity requirements associated with existing operations.
You can view Lou Simpson (Trades, Portfolio)’s other trades here.
Disclosure: The author has no postions in the companies mentioned.
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