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BRK 2013 Second Quarter Report


John Hjorth
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In other notes for other investment section:

 

cost basis for finance and financial product has increased from 3,148 to 3,254. Why would it increase? It is amortization of some cost? Also Since BAC was trading at 13 at the end of June 2013 compared to 11.36 on Dec 2012 end but unrealized gains increase only from 1,804 to 1,981. Does this figure looks understated?

 

Yeah book value of is ~123K but still looks under reported considering conservative accounting by management and assets on book not reflecting true market value.

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At P/B 1,436 there is still more upside. It´s 20% over buyback level.

 

The nature of a very good business model is that it works very well.  :)

 

Appears Mr. Market is trying to find the appropriate premium to BV that BRK now deserves. This, after many years of removing the "Buffett premium".

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Berkshire continued to add stocks in the quarter, spending $4.64 billion for purchases, while selling $781 million. Most of the additions were in a category the company calls “commercial, industrial and other.”

 

So they have been a net buyer this quarter by about 4billions, it appears non-negligible to me...Combs and Weschler adding to their holdings, or Buffet making a new sizeable bet?

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I think this report is rather remarkable.

 

How many companies this size have been able to grow earnings this fast ( and they seem to be accelerating)?

 

I've jotted down quarterly operating earnings for 13 years now. I include insurance underwriting gains/losses, and exclude investment gains/losses. You can't get this from the annual letter, because Warren excludes underwriting results. Here they are, annually, starting in 2000:

 

$1.8B

$1.5B

$3.9B

$5.4B

$5.1B

$4.98B

$9.3B

$9.6B

$9.6B

$7.7B

$11.1B

$10.8B

$12.6B

$15B? (2013)

 

A lumpy but terrific 17.6% CAGR - through 2012 - in a fairly miserable 13 years for the U.S. economy.

 

( One thing I like about tracking these numbers every quarter is the perspective it gives you. For instance, BRK 'only' grew operating earnings by 5% Y/Y. But Q2 in 2012 was huge-it was 32%, 21%, and 100% above the three previous Q2's).

 

So here we are, halfway through 2013, and BRK has posted $3.8 B and now $3.9B...if mother nature copperates, we will probably crack $15B for the first time. The Heinz $$ starts flowing now, too ( $700MM / yr, I think).

 

Every three years or so, BRK seems to 'vault up' another few billion. Looks like the new level is around $15B. That will be a floor in a few years, if 50 years of history mean anything.

 

If you take the undistributed earnings from the equities, that runs around $4.1B this year.* Add it all up and you're around $19B in look-through earnings ( I don't know why Buffett dropped that metric).

 

So how much is BRK worth?

 

Well, I would say this beautiful contraption, given its management, safety and track record of growth, is surely worth 15 X earnings.

 

So if you believe in the look-through model, that's $285B, pretty much exactly where we are.

 

Fairly valued, but 2 years ago if you'd have told me BRK would be at $177,000 I'd have said it would be overpriced. I don't believe that. If I had to choose between buying and selling, I'd be a buyer. I think they can still grow earnings at 12% for some time now, and maintain that multiple.

 

I'd be happy to make 12% going forward with the bulwark of my portfolio ( at this stage of my life).

 

P.S I notice interest income is up for the first time in many quarters. Because of dividends...good to see.

 

 

*After subtracting a 10.5% tax (I'm told by smarter people than me) BRK would pay if they were distributed to BRK.

 

 

 

 

 

 

 

 

 

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Libs,

 

Are your operating earnings including your 15 B estimate for 2013 pre-tax or after-tax. If pre-tax, why would you combine those with 4.1 B in after-tax earnings from public investees to arrive at 19 B in "look-through" earnings?

 

By the way, I also think "look through" earnings power is the best way to value Berkshire along with the growth in that earnings power (versus the two column method which Tilson keeps using), and I get to about 19 B or so (so also approximately a 15x multiple based on today's share price)... but in your method, are you sure you are using after-tax operating earnings or are you mixing in pre-tax with after tax?

 

 

 

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OK thanks. So we are looking at around 15x earnings which is a pretty full valuation, but Berkshire does have growth to it. My simplified view of potential annual growth at a high-level is the following:

 

1. Currently, I would assume investments of 10B or so per year on average at 10x AT earnings multiple which will add about 1B in look through earnings per year (and I assume the yield on cash held currently is approximately 0%). So relative to that 19B of earnings currently, that's about 5% growth per year from acquisitions. Not a bad start.

2. add annual growth in the earnings of the fully owned businesses

3. plus annual growth in the look-through earnings of partially owned public investees

 

It is really hard to see a lot of intrinsic growth in earnings for the S&P 500 when corporate profits are already at all time highs. This will also impact Berkshire over time. However, #1 above is independent of this issue which is a big advantage for Berkshire relative to other companies. In a down year (or years) for the markets/economy, the 10B annual might become 20B and so instead of adding 5% you would add 10% earnings growth from #1 just when growth from #2 and #3 is flat (or negative).

 

In contrast, #2 and #3 are exposed to this all time high in general corporate profits in the US. With insurance, pipelines and Burlington making up the bulk of #2, however, Berkshire may be somewhat less exposed to this issue than the average company in the S&P 500. So non-acquisition intrinsic growth may be somewhat more immune to a decline in overall US corporate profits relative to the average US company. (Note Burlington is a transport company which is cyclical, but it is taking share from trucking and also raising prices annually both of which are fairly independent from the general economy; pipelines and insurance are reasonable independent as well.)

 

But for Berkshire to get 12% growth, #2 and #3 would have to deliver 7% of the 12% in growth (as the other 5% is taken care of by #1) which is around 1.4 Billion AT per year going forward. I don't think that that 7% is sustainable/possible given I do expect some reversion to the mean over the long-term for these high corporate profits in general (I am assuming Grantham at GMO is right on this).

 

I think this dynamic is an important contributor to these "jumps" in earnings you note every 3-4 years with an annual average growth of 12%. Every few years when the market/economy declines, and the 7% can not be achieved, Berkshire invests more at good prices fuelling future growth.

 

I don't think Warren can get 12% growth going forward (unless this new venture into insurance with ex-AIG execs becomes very sizeable, or we see significant inflation) given my pessimistic outlook on corporate profit growth. Nevertheless, the above built-in shifting of the source of growth of Berkshire's earnings from #2&3 when the economy is good, to mainly #1 when markets are down, leads me to believe Berkshire will get growth (and very possibly high single digit growth) going forward. I am fairly convinced, however, that Berkshire will outperform the average S&P 500 company over the coming decade.

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That's another great post Libs. A great idea to note those numbers. If I remember correctly, Charlie said they weren't reporting look-through earnings anymore because those investee earnings were making up an increasingly insignificant portion of total earnings. But if your numbers are accurate they do seem noteworthy.

 

But for Berkshire to get 12% growth, #2 and #3 would have to deliver 7% of the 12% in growth (as the other 5% is taken care of by #1) which is around 1.4 Billion AT per year going forward. I don't think that that 7% is sustainable/possible given I do expect some reversion to the mean over the long-term for these high corporate profits in general (I am assuming Grantham at GMO is right on this).

 

I imagine a 30 B acquisition would take care of it. And should they land one, would a decrease in general corporate profit levels slow Berkshire's profit growth? I'm open to reasons why.

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Jbird,

 

I was trying to breakdown the annualized growth rate into the three main drivers. A 30B acquisition would be great but that falls into category#1 where I am assuming 10B annually for acquisitions (this could be slightly low but not overly). I certainly think a 30-40 B acquisition is possible one-time but that won't happen annually.

 

With decent inflation Berkshire could maybe get to 10% growth. I just don't see 12% annualized over the next decade (unless they expand insurance very significantly or we have pretty decent inflation).

 

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I guess my best guess is 8-12% growth annually (which is quite good given current yields):

 

8% growth would mean 5% for acquisitions of 10B per year (ie my #1 category baseline). This leaves 3% growth to find somewhere. They should be able to get that even if general corporate profits fall by 3% a year for the next 10 years (as their businesses may be more immune to this relative to the average this may mean 2% less growth for them instead of 3% less). However, GDP growth may also be 1% lower than the last decade. So if they have been getting 7% intrinsic growth for #2 and #3 over the past decade, giving that a 2+1% haircut means 4% growth. On this amount we might have deflationary forces to a degree. 

 

To get to 12% they would probably need decent inflation, significant expansion of their new insurance unit, and maybe higher than 10B a year in acquisitions (say 12-15 B or so annually). All of this is certainly possible.

 

Its quite a business for such a large company that's for sure and at 15x earnings I would agree that if I was forced to be a buyer or seller, I would certainly be a buyer. That growth fully reinvested over a decade turns out to a fairly big number which is achieved reasonably tax efficiently.

 

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OM

 

You make good points. But.....I'm still sticking with 12% for two reasons:

 

1) Berkshire is pretty well moated-up. I'm not terribly worried about margin declines for our businesses.

 

2) While reported earnings have grown by 17%, undistributed earnings have grown at ~16% CAGR since 2002. ( FWIW at YE 2002 equities were valued at $28B; now, at $100B....prettty impressive considering the lousy stock market, and Buffett's focus on buying companies outright during that time.) So, if the two pillars of look-through earnings have grown at 16-17% CAGR during a tough decade, I think 12% is reasonable going forward.

 

I guess what I'm saying is, the big picture stuff - primarily the culture and capital allocation discipline - are so good at BRK, it's probably been a mistake to get too granular on these projections....If you went through this exercise for the last 50 years, I'll bet you would have emerged with very rational projections that would have, indeed,  fallen far short.

 

Bottom line...I'm hoping for 15%, expecting 12%, and etching in 8% with a branding iron  :)

 

 

 

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OM

 

I guess what I'm saying is, the big picture stuff - primarily the culture and capital allocation discipline - are so good at BRK, it's probably been a mistake to get too granular on these projections....If you went through this exercise for the last 50 years, I'll bet you would have emerged with very rational projections that would have, indeed,  fallen far short.

 

Bottom line...I'm hoping for 15%, expecting 12%, and etching in 8% with a branding iron  :)

 

What other businesses are out there where you can etch with a branding iron? Whether it is 8% or something else?

 

culture and capital allocation discipline: In Munger's words, BRK's moat lies in the fact that business owners come to BRK(versus all others) to get acquired. Then they get to say no or yes. ;) This will be the cultural treasure to be preserved long after W/C. On this note, the 2013 letter says they need to make occasional large acquisitions; thanks to increasing bolt-on's. That makes one wonder if owners of the bolt-on's also "come to the BRK subsidiary" with a price? If at least some of them do, that would ease much of the transition worry which to some extent has kept the stock price subdued.

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Any guesses on what stocks they've added? Wells Fargo is a no-brainer. But is all the $4b in the commercial and industrial category really Todd and Ted? What are the most likely candidates from the portfolio. DTV? IBM? Tesco? Or perhaps my favorite, Posco. None of those stocks (bar DTV) have had a good 2013 so they all make sense to me.

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Any guesses on what stocks they've added? Wells Fargo is a no-brainer. But is all the $4b in the commercial and industrial category really Todd and Ted? What are the most likely candidates from the portfolio. DTV? IBM? Tesco? Or perhaps my favorite, Posco. None of those stocks (bar DTV) have had a good 2013 so they all make sense to me.

Purchases of equity securities end of June 2013 : $6.052M [Gross][excluding Heinz]

Purchases of equity securities end of March 2013: $1.401M [Gross] =>

Purchases of equity securities second quarter 2013: $4.641M [Gross][excluding Heinz]

 

Cost basis of equity securities commercial, industrial and others end of June 2013: $28.272M [excluding Heinz]

Cost basis of equity securities commercial, industrial and others end of March 2013: $24.341 =>

Increase in cost basis of equity securities commercial, industrial and others second quarter 2013: $3.931M [excluding Heinz]

 

The Q2 13F-HR will be out in a few days, and it will for sure be interesting reading, and might or might not reveal the answer to what the three capital allocators have been up to!

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