Brilliantly Run, But Overvalued
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Berkshire Hathaway (NYSE: BRK-A) recently reported second quarter earnings. This company, best known as Warren Buffett's investment vehicle, is one of the country's leading conglomerates, with wholly owned insurance units, railroads, chemicals, and numerous other lines. Of course, it also has vast equity stakes in many of this country's largest and best known companies. All per share numbers I use will pertain to the company's class “B” securities, which are valued at 1/1500th each share of the “A” series.
In the short statement in the second quarter press release, management notes that it breaks out derivative and investment sales gains or losses as separate line items in the condensed income statement, because “the amount of these in any given quarter or year is often meaningless.” It just so happens those two line items drove second quarter earnings to a negative comparison versus the second quarter of 2011.
Insurance, financial, and transport all did extremely well in the second quarter. But investment sales and derivatives, which combined netted the company $713 million in the second quarter of last year, netted a loss of $612 million in the recent quarter. Despite this $1.32 billion reversal, Berkshire Hathaway reported earnings of $1.882 billion, or $1.25 per share, off only about 9% from the $2.07 billion or $1.38 per share reported in last year's second quarter. If the investment and derivative loses were excluded from the calculation, earnings would have come to $1.50 per share, well above analysts' estimates for the quarter, which were for earnings of $1.18 per share.
More interesting than the quarterly numbers of Berkshire Hathaway are the investment decisions made by Mr. Buffett and his minions. The consolidated holding company generates billions of dollars in cash each year, so investment decisions with that cash hoard tend to make, or break, the company's profit.
We will not know until later this month about specific stock purchases and sales in the second quarter. What we do know is that in the second quarter, Berkshire Hathaway purchased $1.85 billion in one or more stocks, and sold $3.0 billion. The company's cash hoard now exceeds $40 billion, and Berkshire Hathaway is due for a meaningful acquisition. Buffett often has stated his desire is to make one outright acquisition per year, but none has been made since September, 2011 when the company acquired chemical maker Lubrizol for about $8.7 billion. Buffett will never make an acquisition just to make one, but will tirelessly look for the type of company he likes in order to use that cash hoard more effectively than having it sit in today's low interest environment.
If the first quarter is any guide, Berkshire Hathaway continued to lighten its huge investment in large capitalization, consumer non-durables. Most of the company's large holdings in that arena have run into substantial troubles. Berkshire Hathaway has been selling Kraft (NASDAQ: KRFT) for years, since in 2010 when Buffett called Kraft's decisions to sell its pizza business and acquire Cadbury PLC as being “dumb.” Berkshire also has sold over 12 million shares of Johnson & Johnson (NYSE: JNJ) in the past two years. That company has been struggling with the shutdown of its over the counter medicine unit, along with lawsuits and product recalls. Berkshire Hathaway also sold 3 million shares of Procter & Gamble (PG) another consumer goods company that has been languishing in the past several quarters, during the first quarter.
Over the past several years, Berkshire Hathaway has shown an appetite for more economic sensitive stocks, indicated by companies that have been bought outright in recent years such as Burlington Northern Railroad and chemical giant Lubrizol. In the first quarter Berkshire Hathaway bought for the first time a stake of 10 million shares of General Motors (GM). Berkshire Hathaway also added to its stake in some key financial stocks such as Visa (V), Bank of New York Mellon (BK) and Wells Fargo (WFC).
What companies really compare with Berkshire Hathaway? None have the true breadth and scope of assets as Berkshire Hathaway has accumulated. The company is trading now at a price to earnings ratio of 18, and a price to book ratio of 1.2. I believe though the stock price has gotten a little ahead of itself on the heels of a 27% advance since last fall. It now has a 5 year PEG of 1.41. I would be a buyer of Berkshire Hathaway if and when the price to book falls to 1.05, and the PEG is below 1.2. Otherwise, I see the brilliantly well-run company as overvalued.
At one time, Berkshire Hathaway was fundamentally an insurance company, with Geico being among the country's largest property / casualty insurers, and two different large reinsurance companies. Among the other top tier property / casualty insurance carriers, my own favorite is probably Allstate (NYSE: ALL). Due to the relative lack of any expensive catastrophic occurrences in the second quarter, Allstate's results of $423 million, or $0.86 per share in the quarter not just reversed a loss of $624 million in the second quarter of last year, but also beat analysts' estimates of $0.52 per share by a generous amount. The key metric for any insurance company is its combined ratio, the ratio of claims to underwriting revenue. Allstate's was 0.98 in the quarter, and I consider anything under 1.00 to be excellent. With its “value plans” and its acquisition of internet discounter Esurance, I can foresee solid market growth for Allstate in the next few years.
Allstate's stock price has risen about 70% since last fall, and it is now trading with a 5 year PEG of 1.01, on the high side for an insurance carrier. I would be interested in buying Allstate in the $32 to $34 per share price range, but right now I see this as an overvalued insurance carrier.
StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
