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Rupert Hargreaves
Rupert Hargreaves
Articles (1088)  | Author's Website |

Warren Buffett's Thoughts on Precision Castparts' Falling Earnings

The guru is not too concerned

June 11, 2019 | About:

Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) last sizable acquisition was Precision Castparts Corp., which the company paid $37 billion for toward the end of 2015.

At the time the deal was announced, it raised a few eyebrows, mainly because of the high price Buffett was offering to pay for the business. Indeed, Berkshire was paying 17.5 times projected 12-month profits according to figures compiled by Reuters.


In its last full year as an independent company, Precision Castparts earned around $1.5 billion. However, since the deal, the company's growth has failed to live up to expectations.

Falling margins

The business' profit margins, in particular, have declined since the acquisition and are now sitting around 10 percentage points lower than where they were in the years before the deal -- that's according to comments made at this year's Berkshire annual shareholders meeting.

For his part, Buffett expects this earnings contraction to come to an end at some point in the future.

When asked what he thought about the earnings contraction, he replied that while profit margins were "below what we projected a few years ago," they have improved.

He went on to say:

"My expectation is, based on the contracts we have and the fact that the initial years in anything in the aircraft industry, for example, tend to be less profitable as you go further down the learning curve and the volume curve, tend to be lower in the near-term. My expectation is that the earnings of Precision will improve fairly significantly."

The Oracle of Omaha went on to add one of the reasons why Precision's earnings have been under pressure since the acquisition of the business is the cost of the purchase.

Specifically, for the past several years, the company has been booking "about $400 million a year of purchase amortization," which Buffett views as "economic earnings" and, therefore, fall to the bottom line.

Still, even after stripping out this quirk of accounting, earnings are below where Buffett expected them to be at the time of the deal. As he went on to say:

"Even including that $400 million a year, which they would be reporting if they were independent, and we didn't report, because we bought them and there's a purchase amortization charge. Even without that, they are below what I would anticipate by a fair margin within a year or two. That's the present expectation on my part."

Buffett concluded this answer by saying that next year, "I think I'll be giving you a different answer."

The long-term focus

Buffett has never been one to try and push growth, or manipulate the earnings of his companies to try and present the best results. This seems to be a great example of that.

Berkshire bills itself as a long-term investor, which is why so many businesses come to the conglomerate seeking a merger. Its long-term view allows companies to invest for the long term without having to worry about the market's opinion of the business.

Investing in any business is critical to maintaining its long-term advantage over competitors, and it seems as if this is what Precision is doing.

Berkshire does not break out Precision's figures, so we don't know precisely what the business is up to. But like so many of Buffett's subsidiaries, this company is a long-term business with a durable and robust moat. The only way it is going to remain that way is to invest in its future, and that may mean earnings come under pressure in the short term.

This is an exciting insight into the way Buffett operates, and the way he wants his businesses to operate. Even if a company misses his growth objectives, he seems happy to let it keep spending as long as it is building the moat and guaranteeing growth for the future.

Disclosure: The author owns shares of Berkshire Hathaway.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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