Buffett's investment flagship Berkshire (BRK.US) always provides investment insight.
Berkshire is a holding company that operates as a decentralized company. Its subsidiaries cover a wide range of industries and are managed by business experts in their respective fields. The top executives of the group, including Buffett, are responsible for large-scale capital allocation, investment activities and determining the selection of chief executives of various operations departments.
At present, Berkshire's consolidated operations include: 1) insurance and reinsurance; 2) rail freight; 3) utilities and energy; 4) manufacturing, services and retail. Of course, the main thing is investment.
The income of investment can be divided into two categories: one is income, the other is income. The income category includes interest income and dividend income, which is deterministic, while the income category mainly refers to the profit and loss of the investment target and the floating profit / loss of the investment target on the account. In Berkshire's performance, income is recorded in insurance investment income, while income is recorded in investment and derivatives income.
Berkshire stressed that as the gains on investments and derivatives are mainly unrealized gains and losses on equity investments to reflect changes in market prices, whether as a result of sales or temporary changes in market prices, these gains are of little significance in understanding its reported performance or in assessing the economic performance of the business.
Berkshire 2021The third of the yearQuarterly results
As a result of last year's outbreak, most of Berkshire's manufacturing, services and retail operations were negatively affected after March 2020, especially in the second quarter of 2020.
By the second half of 2020 and 2021, the revenue and profits of these businesses will have rebounded significantly, even exceeding pre-epidemic levels. As a result, the performance of industries such as railways, utilities and energy, manufacturing services and retail all improved in the third quarter of this year.
However, losses in its underwriting business widened as a result of torrential rains and hurricanes in North America.
Berkshire's share of profits attributable to other consolidated operations increased in the third quarter of 2021, as shown in the chart below, with manufacturing, services and retail being the largest at $2.706 billion. However, losses in the insurance underwriting business increased 2.68-fold to $784 million.
Can the deterioration of the insurance business be saved?
Everyone knows that Berkshire is good at investing. Because part of its investment capital comes from floating funds, which is the responsibility payment of its insurance and reinsurance business, this involves an important issue-the cost of insurance funds. In Berkshire's earnings report, one measure is the pre-tax underwriting income of the insurance business.
In fact, because of the high efficiency of its insurance business, Berkshire can not only earn a return on investment through floating deposits, but also earn additional income because of the effective operation of its insurance business without paying the cost.
But Berkshire's insurance underwriting business posted a quarterly net pre-tax loss of $1.02 billion in the third quarter of 2021, meaning the cost of insurance funds in the third quarter.
Analyzing the performance of its insurance business, we can see that the quarterly underwriting business turned from profit to loss, mainly because the expense rate of GEICO, the most important source of income, increased to 103.01%, compared with 96.77% in the third quarter of 2020.
GEICO is mainly engaged in auto insurance. The company has a cost advantage in the highly competitive US car insurance market by returning directly to customers who need insurance directly via the Internet or over the phone, rarely through exclusive agents. The increase in expense rates in the third quarter was mainly due to an increase in claim rates and a $400 million pre-tax loss from hurricanes.
The author notes that GEICO's earned premium income maintained strong growth during the period, rising 12.46 per cent year-on-year to $9.604 billion, much higher than the 1.76 per cent increase in the first half of the year, but the aggregate fees increased by 19.71 per cent year-on-year, leading to a deterioration in profit margins. GEICO posted a pre-tax loss of $289 million in the third quarter, and without taking into account the aforementioned $400m in hurricane-related losses, GEICO actually had a surplus.
As a result, Berkshire's underwriting business weakened in the third quarter, more due to one-off events than to persistent business deterioration.
It is worth noting, however, that investment is Berkshire's strength under the leadership of the "god of stock". As mentioned earlier, Berkshire's investment income is divided into income and income, and investment income (i.e. interest income, dividend income, etc.), which is included in the chart above, is $1.161 billion, up 14.38 per cent from a year earlier.
Because the investment income is of little economic significance, the author has not summarized it into the chart, but we can see Berkshire's unrecognized investment performance in the third quarter from the numerical changes. During the period, the income was only $3.878 billion, down from $24.737 billion in the same period last year. I think this is because the market value of Berkshire's position soared overnight after Wall Street soared last year, but after accumulating a certain amount of increase this year, the momentum for further increase in market value may not be as strong as last year, so the return on investment has dropped significantly.
It's all in the past.
All this is a thing of the past, how can Berkshire prepare for the future?
What investment assets does Berkshire hold?
The distribution of cash and investment targets in Berkshire's insurance business is as follows:
As of September 30, 2021, cash and treasury bills (short-term), equity investments, fixed-term investments and other targets accounted for 21.82%, 72.5%, 4.43% and 1.25%, respectively. Relatively speaking, the proportion at the end of 2020 was 18.47%, 74.22%, 5.60% and 1.71%, respectively.
It is clear that Berkshire's cash position has increased, while the share of equity investment and income has declined.
Combined with the outlook for US monetary policy, such a shift is not difficult to understand. Powell's nomination for re-election as Fed chairman may be able to maintain the continuity of the Fed's monetary policy, while market expectations of reduced bond purchases and possible early interest rate increases will be extended, meaning that "water collection" will hit the road as scheduled.
A decline in liquidity, or a rise in market interest rates, is not conducive to bond prices. Berkshire's move to reduce the size of its bonds is in line with this expected impact on the bond market.
In the stock market, in order to cope with the impact of the epidemic on the economy, the United States provided unlimited liquidity in 2020, which also contributed to the continuous refurbishment of the stock market on Wall Street. At present, the S & P 500, NASDAQ and Dow Index, the three major stock indexes, have been hovering at historic highs for a long time. Once liquidity tightens and funds withdraw, the stock market will be negatively affected. Berkshire's reduction in the proportion of equity investment may be based on this expectation.
Berkshire built its positions in two stocks and increased its holdings in two stocks in the third quarter, but sold seven stocks and cleared three stocks, according to Berkshire's latest 13F filing.
In the third quarter, Berkshire built its warehouse for floor decoration (FND.US) for furniture decorations and Royalty Pharma (RPRX.US) for biopharmaceutical royalties.
The increased holdings include energy stock Chevron Corp (CVX.US) and free media (LSXMA.US), which is engaged in media, communications and entertainment business.
Four of the seven stocks sold are financial stocks, including credit card companies MasterCard Inc and V.US, and insurance companies MMC.US and U.S. Bancorp, which used to be Berkshire's heavy holdings and made good profits. In addition, there are pharmaceutical research and development company ABBVIE.US and health products and pharmaceutical company Bristol-Myers Squibb Co (BMY.US), as well as cable television and communications company Chartered Communications (CHTR.US).
The liquidated shares include pharmaceutical giants Merck & Co Inc (MRK.US) and Organon (OGN.US), as well as European telecom operator LBTYA.US. The author noticed that the price of the liquidated shares was lower than its average purchase cost, or hinted at Berkshire's determination to close the position.
So Berkshire seems to be bullish on energy prices and household consumer stocks, but has reservations about pharmaceutical giants. As for the reduction of financial stocks, the author speculates that it may be related to the fear of raising interest rates to suppress the demand for credit card credit.
After the above investment operations, Apple Inc (AAPL.US) is still Berkshire's largest position, accounting for 42.78%. At the same time, Berkshire still holds a large number of financial stocks, including Bank of America Corporation and American Express Co (AXP.US), as well as consumer stocks Coca-Cola Company (KO.US) and Kraft Heinz (KHC.US).
Of the reported positions in US stocks with a market capitalization of $293.4 billion, the 10 stocks with the highest value accounted for 88.51 per cent of the total, mainly technology stocks (42.78 per cent of Apple Inc), financial stocks, consumer stocks and communications stocks.
It is worth noting that Berkshire's international position is not included in the 13F document, which includes its heavyweight stock, 01211.HK, 002594.SZ. According to HKEx data, Berkshire still held 225 million H shares in BYD on November 8, 2021, worth about HK $69.03 billion, or US $8.854 billion, second only to Kraft Heinz's market capitalization and still the sixth largest position.
As of September 30, 2021, Berkshire's cash and equivalents totaled $89.098 billion, an increase of $22.016 billion from the beginning of the year, or from the accumulation of profits or the sale of the above equity investments.
This year, the US economy has rebounded, partly because business activity remains strong, and because sufficient liquidity to support consumption has also encouraged economic development, and the recent employment data are unexpectedly good, reflecting very active economic activity. In the first, second and third quarters of 2021, US GDP grew at an annual rate of 0.5 per cent, 12.2 per cent and 4.9 per cent, respectively.
But at the same time, the stock market far outperformed optimistic economic data, with the Dow Jones Industrial average, the NASDAQ and the S & P 500 rebounding sharply from their lows in the first half of 2020 by 96.58%, 138.94% and 114.50%, respectively, reflecting expectations of strong economic growth.
With the reduction of bond purchases into the process and the shift in monetary policy, loose liquidity may no longer be available, and the stock market, which has accumulated significant gains, is likely to see a correction. Berkshire's decision to cut positions and free up cash from its already lucrative shares may be in order to seize the opportunities brought about by the stock market correction, which does not coincide with the famous saying of the stock god: "others panic, I am greedy, others are crazy, I am afraid."