As shareholders began to file into the arena for Berkshire Hathaway’s 2023 annual meeting, the company’s first quarter results were released. Shareholders in a mad rush to secure seats might have been in a celebratory mood after glancing at their phones to see that Berkshire reported net earnings of $35.5 billion for the quarter, up sharply from $5.6 billion a year earlier. That’s quite an impressive increase for one year!
Berkshire had a good quarter, but the jump in net income overstates the company’s progress. Since 2018, Berkshire’s results have been severely distorted by an accounting change that requires unrealized gains and losses in the company’s equity securities portfolio to be included in net income. Berkshire’s operating income for the first quarter, excluding investment gains, came in at $8.1 billion, up from $7.2 billion a year earlier.
I was able to conduct a quick review of the 10-Q prior to the webcast and wrote some initial impressions in a Twitter thread. A more detailed review had to wait until after the question and answer session when Warren Buffett and Charlie Munger answered questions for over five hours. On Monday, I published an article with my impressions of the questions related to succession planning, voting control, auto insurance, Occidental Petroleum, Berkshire Hathaway Energy, China, and Apple.
Financial media reports of Berkshire’s quarterly results are typically rushed and misleading. It takes time to delve into the details needed to understand the situation. I can sympathize with reporters who must file news stories immediately. Not facing such constraints, my habit has been to spend more time reviewing the results and to write about a subset of Berkshire’s operations each quarter. While it isn’t practical to delve into every corner of this massive conglomerate in this format, we can at least take a look at high level trends in operating earnings and a few other key areas.
Investors should be skeptical when executives attempt to turn their attention away from figures based on Generally Accepted Accounting Principles (GAAP). Investors benefit from uniform and well-understood standards in accounting. All too often, executives point to non-GAAP figures to cast results in a more favorable light or to de-emphasize the role of stock-based compensation. However, there are times when GAAP accounting makes little sense on its merits and adjustments must be made.
I’ve written in the past about how accounting changes introduced in 2018 have distorted Berkshire Hathaway’s results, so I will not belabor the point here. While the performance of Berkshire’s large portfolio of equity securities absolutely does have an impact on long term intrinsic value, quarterly fluctuations are usually meaningless. Obviously, if there is some dramatic underlying business reason for a change in the value of a large holding, that must be considered along with Berkshire’s quarterly operating results, but run-of-the-mill fluctuations are rightly ignored over short periods of time.
The following exhibit shows Berkshire Hathaway’s operating earnings on an after-tax basis alongside the company’s reported net earnings since 2018:
Note that the scale of the y-axis on the two charts differ. Operating earnings ranged from a low of $4.4 billion in Q4 2019 to a high of $9.3 billion in Q2 2022 while net earnings have ranged from a loss of $49.8 billion in Q1 2020 to a profit of $39.6 billion in Q4 2021. The heavy black horizontal line representing the x-axis on the net earnings chart represents breakeven results.
While we can see that both measures fluctuate significantly on a quarterly basis, the fluctuations in net earnings are just wild and provide no analytical value whatsoever. The extremes of net income simply coincide with large swings in stock prices. The magnitude of these swings overwhelms any analysis of Berkshire’s operating results.
The following exhibit shows a reconciliation of after-tax operating earnings with reported net income over the past twelve quarters which is useful to observe variability of results within each of Berkshire’s major reporting areas.1
Berkshire’ insurance underwriting exhibits significant volatility on a quarterly basis which is an inherent part of the business model. Other groups, most notably Berkshire Hathaway Energy and the BNSF railroad, have seasonal patterns. For this reason, operating earnings fluctuate significantly from quarter to quarter. Many shareholders are satisfied with monitoring operating earnings on an annual basis.
One of the slides Warren Buffett displayed at the annual meeting showed operating earnings over the past four years. From this slide, we can see that operating earnings have increased over time. As Mr. Buffett pointed out, since Berkshire has retained earnings and reinvested in its businesses, one should expect operating earnings to rise over time and be higher five, ten, or fifteen years from now.
It is useful to track Berkshire’s after-tax operating earnings every quarter on a trailing twelve month basis, as shown in the chart below:
Each point in the graph shows the trailing twelve months, or four quarters, of after-tax operating earnings. For example, the data point for March 31, 2023 is the aggregation of operating earnings for Q2, Q3, and Q4 of 2022 and Q1 2023.
On a trailing twelve month basis, we can see the recovery in operating earnings after the trough of the downturn during the early months of the pandemic. Trailing twelve month operating earnings hit a record high for the first quarter of 2023.
During the Q&A session at the annual meeting, Warren Buffett said that he expects the majority of Berkshire’s businesses will report lower earnings in 2023 compared to last year. However, higher interest rates are sure to benefit Berkshire’s large holdings of short-term treasury bills. As a result, barring major catastrophes, Mr. Buffett expects that operating earnings will increase in 2023.
The rest of this article reviews the following areas in more detail:
- GEICO Returns to Profitability
- Investment Income
- Manufacturing, Service, and Retailing
- Pilot Travel Centers
- Repurchase Activity
GEICO Returns to Profitability
Berkshire divides insurance activities into underwriting and investing because management views these activities as distinct from each other. With few exceptions, managers are directed to underwrite with a goal of profitability which provides Berkshire with cost-free float that can be invested to generate investment income. As of March 31, 2023, insurance float was approximately $165 billion.
Berkshire posted a net underwriting profit of $911 million in the first quarter of 2023 compared to $167 million in the prior year, as we can see in the following table:
The highlight of the quarter was GEICO’s return to underwriting profitability after six straight quarters of underwriting losses. Management increased average premiums per auto policy by 15.2%. However, over the past year, GEICO’s policies-in-force has declined by 2.4 million, or 13%. This dramatic decline in policies-in-force was due to a combination of higher premiums and a significant reduction in advertising spending.
As I discussed last week in Progressive vs. GEICO: The Battle Continues, the entire auto insurance industry has been hammered by inflation over the past two years. GEICO has reduced advertising spending and accepted lower market share while Progressive has aggressively increased advertising spending and picked up customers.
As Ajit Jain noted during Berkshire Hathaway’s 2023 annual meeting, there is a tension between rates and market share. GEICO made a strategic choice to prioritize underwriting profitability over market share in recent quarters. It is worth taking some time to look at GEICO’s recent results in more detail.
The following exhibit shows GEICO’s results over the past twelve quarters:
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Long Berkshire Hathaway.
- In Q1 2023, Berkshire implemented an accounting rule change related to long-duration insurance contracts. This resulted in retrospective revisions to Berkshire’s income statements for 2021 and 2021 detailed in Item 5 of the 10-Q on page 49. I have not retrospectively changed any of my spreadsheets. As a result, the figures in all exhibits are presented as originally reported. I do not believe that the change materially changes any of my conclusions regarding Berkshire’s insurance operations.