Unlocking Value in Berkshire Hathaway's (BRK.A) Q1 Earnings: Insights & Profitable Strategies

Scheduled from May 3rd to 5th Eastern Time, the highly anticipated annual global investment extravaganza, colloquially known as the "Spring Festival Gala for the Investment World," the Berkshire Hathaway Shareholders Meeting, will unfold.

Coinciding with this event, Berkshire's first-quarter financial results are set to be disclosed. A comprehensive view indicates that operational costs for the quarter remain a significant burden, compounded by fluctuations in the share prices of held equities, suggesting that overall profits are likely to be under considerable pressure.

Berkshire Hathaway's business model revolves around generating cash flows through stable and diversified operations, particularly in the insurance sector, and utilizing these cash flows for investments. Thus, Berkshire's commercial empire can be divided into operational activities and investment activities.

In forecasting Berkshire's Q1 performance, the focus lies on two aspects: operational performance and investment returns. Let's delve into each:

Elevated Costs and Pressured Operating Profits The operational landscape of Berkshire is bifurcated into insurance businesses and non-insurance businesses, with insurance being the cornerstone while non-insurance spans across manufacturing, services, retail, among other sectors.

Berkshire Hathaway's operating portfolio, centered in the United States and highly diversified, generally mirrors positive correlations with the growth of the U.S. GDP. Additionally, owing to Berkshire's countercyclical attributes in select sectors and its market leadership, the company's revenue picture may fare even better than GDP during periods of economic downturn.

(For example, the insurance sector, particularly reinsurance, can become more intricate due to heightened compensation for disaster events; this could lead to pressure from increased claims payouts, but simultaneously, it might also benefit from elevated insurance premium rates.)

Overall, since 2015, total revenues have entered a period of steady growth, with three primary sources: Sales and Services, Insurance, and Railways & Energy. Each business segment has maintained a consistent proportion over the years, with Sales and Services stabilizing at around 55%, Insurance at about 23%, and Railways, Utilities, and Energy sectors contributing roughly 20%.

The latest data indicates that in the first quarter of 2024, the U.S. Gross Domestic Product (GDP) grew at an annualized rate of 1.6%, a decrease compared to the growth rate in the fourth quarter of the previous year. However, this growth exhibits a degree of resilience. Consequently, Berkshire Hathaway's revenues are likely to continue on a positive growth trajectory.

this quarter is expected to maintain stability or witness growth. Insurance performance in the preceding two years was dragged down by high natural disaster losses. In 2023, with lessened catastrophe losses and improvements in GEICO's underwriting—aided by reasonable premium hikes and reduced claims—the business rebounded. For Q1 2024, if disasters remain infrequent and the premium adjustment strategy continues to prove effective, the insurance business is anticipated to see steady growth. In the context of the first quarter, the insurance business is poised to remain stable or grow if there are no large-scale disasters and the premium adjustment strategies continue to be efficacious. The decline in insurance performance over the past two years was chiefly attributed to natural disaster losses. With lower catastrophe losses in 2023 and enhancements in GEICO's underwriting performance due to increased premiums and decreased claim frequency, the insurance business regained its upward momentum.

their performance is closely tied to the recovery of economic activities, the pace of consumer demand resurgence, and the state of supply chains. In the first quarter, both the Markit Manufacturing and Services PMIs remained above the threshold level (typically 50), indicating expansion in both manufacturing and service sectors. Personal consumer spending also exhibited a trend of steady growth, suggesting that orders and revenues for the company's related businesses are likely to receive positive uplift.

Over the past three years, Berkshire's primary costs have centered on energy sales costs and operational expenses, which together account for a substantial 64% to 73%, highlighting their dominant position and high volatility.

Energy Cost of Sales: These costs are directly impacted by international commodity prices for crude oil, natural gas, and the like. During the first quarter, global oil prices trended upwards. By the end of March, Brent crude futures had climbed to a peak of $87 per barrel, marking nearly a $10 increase from the end of 2023. For Q1 2024, the average price for Brent crude futures stood at $81.76 per barrel, dipping slightly by $1.09 per barrel compared to the previous quarter and down by $0.34 per barrel year-over-year. This upward trend in energy prices exerts pressure on Berkshire's costs.

As for Energy Operating Expenses, they too face pressure from rising energy prices. Moreover, the likelihood of natural disasters and unforeseen events further exacerbates this pressure, potentially leading to a significant increase in energy operation expenditures.

Meanwhile, the strain from labor costs remains significant, notably due to persistently robust wage growth. Using BNSF as an illustration, one of the principal reasons behind its unexpectedly steep profit decline last year was the surge in wage expenses.

Entering the first quarter, while the pace of wage growth has moderated compared to the previous quarter, it remains at a high level. This continued pressure from labor costs is likely to weigh on the operating margins of the affected business segments in the near term.

Accordingly, considering both the revenue and cost perspectives, operating profits for the first quarter are anticipated to face considerable pressure.

Berkshire Hathaway's balance sheet clearly illustrates an asset allocation strategy characterized by holding minimal cash, with the majority invested in U.S. Treasury Bills (short-term U.S. government bond investments, specifically those maturing between three months and one year) and Investments in equity securities, embodying a typical barbell strategy.

1. Treasury Yields – Short-term yields show year-over-year growth with minor quarterly fluctuations

Berkshire has also augmented its holdings in short-term treasuries this year, with the 2023 annual report indicating a 25% year-over-year increase to $129.619 billion in short-term U.S. Treasury holdings. Consequently, the yields on U.S. short-term bonds are intimately linked to Berkshire's earnings. Based on data for the 3-month and 6-month U.S. Treasury yields, the return on short-term U.S. Treasuries in Q1 2024 hovered around 5.3%, exhibiting minimal change compared to the previous quarter but a substantial increase of approximately 10% year-over-year.

Therefore, the combination of yield fluctuations and Berkshire's augmented purchases of treasury bills suggests that Q1 short-term treasury returns could see a notable year-over-year increase, albeit with a possible sequential decline.

In summary, Berkshire's investment returns for this quarter are likely to paint a less than optimistic picture.

The valuation of a stock investment hinges upon a triad: EPS (Earnings Per Share), Valuation Metrics (P/E ratios, P/B ratios, etc.), and Shareholder Yield (dividends, share repurchases, etc.).

Berkshire Hathaway, historically frugal with traditional dividends - the last issued in 1967 - has of late significantly amplified its share buyback endeavors. Repurchases tallied at $24.7 billion in 2020, escalated to $27.1 billion in 2021, settled at $9.2 billion in 2022, and repeated the $9.2 billion figure in 2023, with 2021 marking a pinnacle in this recent spree.

Reports indicate that Buffett has executed buybacks totaling 3,808 Class A shares this year, equating to a sum of around $2.2 to $2.4 billion.

Assuming the 2023 repurchase scale, these actions potentially contributed around a 1% return to shareholders, thereby underscoring how Berkshire's stock price is fundamentally tied to earnings performance and market valuations. Heading into the first quarter, underwhelming investment returns and tepid profit growth forecasts could spur short-term share price depreciation.

In anticipation of such quarterly dynamics and anchored by Berkshire's sturdy financial footing, a tactical response to any momentary share price decline could involve leveraging derivatives to hedge against volatility.

For those committed to a long-term holding strategy in Berkshire or similar stocks, implementing a covered call strategy by selling call options above the prevailing market price can serve dual purposes: generating premium income, which directly supplements portfolio returns, and potentially lowering the effective cost basis of the held shares through collected premiums.

1. **Premium Harvesting**: Selling calls at a strike price above the current market value secures an immediate premium, augmenting overall investment returns.

2. **Cost Efficiency**: Should the stock fail to breach the option's strike price prior to expiration, the option expires worthless, enabling retention of the underlying shares alongside accumulated dividends or intrinsic value, while the initial premium acts as a cost reducer.

3. **Managed Upside Potential**: A key consideration is that this strategy inherently caps potential capital gains. Should the stock's price soar beyond the option's strike before expiration, the shares may be called away, limiting participation in further appreciation.