Berkshire: Warren Buffett Does Buybacks, Earnings Remain Strong
Summary
- Berkshire's diversification allowed the company to remain highly profitable, despite the pandemic.
- The company has ramped up share buybacks in recent quarters, which is highly accretive to EPS growth.
- Shares look like a solid value right here, despite the sizeable gains the stock has experienced over the last couple of months.
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Article Thesis
Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) is a leading conglomerate and one of the favorites among retail investors, despite not paying any dividends. The company continued to do well during Q4, despite the pandemic, as operating earnings remained very healthy while the ongoing equity market rally increased the value of the company's holdings.
Shares have risen a lot in recent months, but they seem to be a solid value still, based on current book value. The fact that Buffett continued to spend billions on buybacks during Q4 underlines that shares can't be overly expensive right now.
Doing Fine Despite The Pandemic
Many companies are impacted by the current pandemic to a large extent, especially sectors such as hospitality, brick-and-mortar retail, travel, etc. A conglomerate such as Berkshire Hathaway naturally benefits from the diversification across its businesses, as not all will be impacted by the pandemic to the same degree.
It is thus not a very large surprise to see that, overall, operating profits for the company did not fare too badly. If some businesses suffer from the impact of the pandemic, others will benefit and see higher profitability. Berkshire Hathaway's insurance operations, for example, benefit from the fact that people stay home more often, which reduces the number of accidents on the country's roads, which results in lower payouts.
Berkshire's railroad and utility businesses also did well in the recent past. As the country still needs many goods moved from A to B, even during a pandemic, and as consumer spending has remained strong, which means that many goods have to be imported and moved from the country's ports to consumers, BNSF has actually fared quite well, despite the pandemic.
Thanks to these factors, Berkshire's operating earnings during the most recent quarter were actually up by 12% year over year - growing despite the pandemic:
Source: Berkshire earnings release
For the full year, operating earnings were down slightly, by ~10%, as the pandemic had a larger impact during the spring and summer months, which led to lower profitability in Q2. Nevertheless, even a 10% earnings decline during one of the biggest crises in recent memory is still a rather strong result, showcasing that Berkshire's operations are relatively resilient.
With the economy recovering during 2021, as more people are getting vaccinated and as the virus is fought back, it can be expected that Berkshire's profits will fully recover this year, especially since more stimulus spending is on the way that will benefit consumer behavior.
Strong Balance Sheet That Would Allow For A Large Takeover
Berkshire has always had a strong balance sheet, and that has not changed during the pandemic. Right now, the company holds cash and equivalents of $138 billion, which is equal to about 25% of the company's market capitalization. With a cash load like that, Berkshire is well-positioned to make either a range of smaller acquisitions or one or several larger ones.
Even if a considerable takeout premium is factored in, Berkshire could easily buy something like Kinder Morgan (KMI), Enterprise Products (EPD), or Gilead Sciences (GILD) - all of these have strong, dependable cash flows and trade at inexpensive valuations. Berkshire has made a major midstream deal last year, and private equity and other institutional investors have also done takeovers in this space in the recent past. It thus wouldn't be a very large surprise to see Berkshire make a play in this industry, although I wouldn't bet on it.
Buffett himself stated that one of Berkshire's goals is to "acquire large and favorably-situated businesses," something the company hasn't really done in 2020 if you exclude the buying of shares in businesses such as AbbVie (ABBV) and other publicly-traded companies. It remains to be seen whether Berkshire will make any major acquisitions in 2021. As far as I understand what Buffett says, he would like to do a deal if the terms are favorable for Berkshire, but that may not be the case right now, as valuations are rather high for much of the market.
There are, however, still pockets of the market where valuations are not stretched too much, which is underlined by the fact that Berkshire has continued to buy shares of publicly traded companies during the fourth quarter.
Buffett Ramps Up Buybacks
There is also another alternative to large takeovers, which is the repurchasing of Berkshire's own shares. Buffett has repeatedly explained that he likes it when companies in which Berkshire owns a stake engage in buybacks, as it is tax-efficient and increases Berkshire's portion of the company they hold.
In recent years, Buffett has also started to buy back shares of Berkshire Hathaway, seeing this as a viable approach to create shareholder value. Those buybacks were ramped up in recent quarters to new record levels:
Data by YCharts
Quarterly stock buybacks averaged around $1 billion throughout 2018 and 2019, but Berkshire ramped up the repurchasing pace by a lot during Q3 2020, as buybacks totaled $9.0 billion during that quarter alone. During the fourth quarter of 2020, which isn't included in the YCharts graph yet, Berkshire spent another $9.0 billion on its own shares.
At that pace, the company would buy back $36 billion worth of its own shares a year, which would be enough to reduce the share count by a little more than 6% a year. That may not sound like too much, but this alone would suffice to create earnings per share growth of ~7% a year - even if there are no acquisitions, and none of the portfolio companies ever grow their earnings again. This example shows that Berkshire's buybacks could be quite value-creating over the long term, as they will boost earnings per share growth meaningfully. When we add in some underlying growth in profits for the company's portfolio businesses, then earnings per share growth in the 10% range seems like a very achievable goal as long as buybacks continue at this pace.
Berkshire also continued to buy back shares during Q1, although the exact amount is not known yet. This shows that Buffett seems to see Berkshire's shares as worthy of buying right now. Valuation thus doesn't seem to be too much of a problem, despite the sizeable share price gains that Berkshire experienced over the last couple of months, as shares have risen by more than 20% since early November.
Berkshire's Valuation
At the end of the third quarter, Berkshire's book value per share was $176 (per YCharts), since then the company generated another $15 in earnings per share during Q4 (which includes gains in its equity portfolio). Book value at the end of the fourth quarter can thus be estimated at a little above $190 per share. Relative to a current share price of $245, shares are thus valued at ~1.29 times book value right here. This isn't especially low, but not extraordinarily high, either.
When we further consider that book value will have risen further during the first two months of the current quarter, due to operating profits and further share price gains in companies Berkshire holds a stake in, then the "real-time" book value multiple is likely a little lower than 1.29, I would estimate it around 1.25. Buying shares at that valuation will likely result in solid returns in the long run, although I wouldn't call Berkshire a screaming buy right here.
We called Berkshire's shares a great value last May, and since then they are up more than 40%, easily beating the S&P 500. But even following these gains, Berkshire sounds like a solid investment, although those that want to optimize their buying may want to wait for the stock to trade at 1.2 times book value or less.
Takeaway
Berkshire's diversification across many different industries paid off during the fourth quarter, as the company was able to grow its operating profits versus the previous year's quarter, despite the pandemic's impact on the economy.
Berkshire hasn't made any large deals in 2020, but with a sizeable cash hoard the company could do so this year, in case an attractive target shows up. Even if that does not happen, Berkshire should still do well, though, as the economic recovery and the company's stock buybacks should boost earnings per share and book value per share meaningfully this year.
Shares are not an absolute bargain, but not overly expensive either. Berkshire looks like a very solid hold, or possibly a buy at current prices, depending on whether you want to buy around fair value or wait until an even better opportunity arises.
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This article was written by
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Disclosure:
I work together with Darren McCammon on his Marketplace Service Cash Flow Club.
Analyst’s Disclosure: I am/we are long ABBV, EPD, KMI, BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (49)
How do they cut their way to revenue growth?
Thanks for sharing!
Growing operating profits by 10% during a pandemic is "trash"?
there is no medical no serious issue except that the DEMS are using it to increase their power and control.
Yes, nice summary!
Why is it boneheaded?
Thanks for sharing. True, his interest in VZ is interesting!
Agreed, BRK is worth more than book value for sure
Glad you agree and liked it!
