Berkshire Hathaway’s (BRK/A, BRK/B) fourth-quarter earnings release also includes the annual letter from Warren Buffett as part of the annual report. The yearly letter continued the theme from last year as a type of owner’s handbook for Berkshire shareholders. Buffett noted that he and Charlie Munger do two main things at Berkshire. First, invest in operating businesses, usually by owning 100%. This review will focus on the performance of these operating businesses controlled by Berkshire Hathaway BRK.B . Second, buy non-controlling stakes in publicly traded stocks. An analysis of Berkshire’s publicly traded holdings is here. Buffett also noted that shareholders should focus on Berkshire’s operating earnings rather than the volatile GAAP results. He also took particular aim at those blindly deriding corporate stock repurchases. He unequivocally stated, “Gains from value-accretive repurchases, it should be emphasized, benefit all owners – in every respect.”

Berkshire Hathaway reported a gain of almost $18.2 billion in the fourth quarter versus a profit of over $39.6 billion in the same quarter of 2021. This gain broke the string of bottom-line losses thanks to the fourth-quarter rebound in the stock market since results are heavily impacted by gains or losses from the investment portfolio, with unrealized losses from their portfolio included in earnings. Operating earnings, which remove the distortion from market changes and better reflect the firm’s earnings power, fell by 8% for the quarter versus 2021. The 2022 calendar year operating earnings rose 12% over the same period in 2021. Providing an illustration of the value from share repurchases, per-share operating income for 2022 increased by 15% versus 2021.

Because the Covid-19 pandemic negatively impacted most businesses, including Berkshire, beginning in early 2020, comparing current results to pre-pandemic 2019 results is helpful. Operating earnings for the calendar year 2022 are 28% above 2019. Operating earnings increased across all primary business segments except insurance underwriting, which was well below 2019 levels. Thanks to share repurchases, operating earnings per share for 2022 were a whopping 43% above 2019.

A further look into the different operating segments for the fourth quarter of 2022 shows generally weaker results across the segments versus 2021. Interest income and Berkshire Hathaway Energy were the stronger segments in the fourth quarter. Notably, the operating income for all segments, except the Other category, was better relative to the pre-pandemic levels of 2019.

The operating segments for all of 2022 show better results than 2021, except for insurance underwriting and the railroad. Operating income for all segments, except insurance underwriting, was better for 2022 relative to the pre-pandemic levels of 2019.

Insurance: 2022 investment income was 35% higher than in 2021, primarily due to higher interest income from short-term investments. Investment income was previously depressed by ultra-low interest rates implemented in response to Covid, but the Federal Reserve raised rates aggressively in 2022 to fight inflation. Investment income should continue to see improvement as the Federal Reserve seems likely to remain in hiking mode through at least most of this year. Underwriting results were poor for 2022, but the real culprit was GEICO, with significant underwriting losses. Berkshire Hathaway Primary Group and Berkshire Hathaway Reinsurance Group had underwriting gains for 2022. GEICO continues to suffer from more frequent auto claims and rising claims severity due in part to the higher valuation of used vehicles. According to the Mannheim index, used vehicle prices have fallen from their peak, but prices are still 42% above the level at the end of 2019. GEICO expects to generate an underwriting profit in 2023 since it received approval to raise premium rates due to the increased claim costs.

The two most essential concepts in insurance investing are “float” and underwriting profit. In simple terms, float is created for insurance companies because insurance premiums are paid before any claims are made by the insured. Insurance companies can invest the float, sometimes for years, before insurance losses are reimbursed. Berkshire has a history, unlike many insurance companies, of earning an underwriting profit, meaning that their float costs them nothing and makes them money in addition to allowing them to earn a profit off of investing the float. An underwriting profit means the insurance premium exceeds all insurance claims and expenses. Despite Berkshire’s underwriting loss for 2022, it posted underwriting profits for calendar years 2021, 2020, and 2019. Berkshire’s float was higher at approximately $164 billion versus the $147 billion level on December 31, 2021, and above the $138 billion on December 31, 2020. In general, the value of float increases as yields rise. Float per share has increased to $112,066 from $98,960, also aided by share repurchases. Berkshire completed its purchase of Allegheny in October 2022, which increased float in the fourth quarter.

Railroad: Berkshire owns one of the largest railroads in North America, the Burlington Northern Santa Fe (BNSF) railroad, operating in the U.S. and Canada. Net operating earnings fell 1% versus 2021 but were 8% over pre-covid 2019. 2022 revenue was higher due to higher pricing and a fuel surcharge driven by higher fuel prices, but volume declines and higher operating costs hurt the bottom line.

Utilities and Energy: Berkshire owns 92% of Berkshire Hathaway Energy Company (BHE) which generally provides steady and growing earnings, as one would expect from what primarily consists of regulated utilities and pipeline companies. The utilities were boosted by higher customer usage and customer growth, partially offset by increased costs. The pipelines benefited from “higher regulated storage and service revenues.” Overall, BHE posted 12% higher operating earnings in 2022 relative to 2021 and 37% above 2019. Interestingly, this group also operates Berkshire Hathaway HomeServices (BHHS), the largest residential real estate brokerage firm in the country. The slowdown in housing activity is evident in the results, with 2022 net earnings 74% below 2021. The 2022 BHHS earnings suffered from lower mortgage and refinance activity thanks to higher interest rates and a decline in closed brokerage transactions.

Manufacturing, Service and Retailing: This segment consists of many diverse businesses, so this analysis will focus on a few significant themes when looking at this segment. Berkshire’s aerospace exposure remains substantial despite selling its publicly traded airline holdings earlier in 2020. Berkshire previously took a $10 billion impairment charge on the Precision Castparts PCP (PCC) business due to its exposure to the COVID-disrupted aerospace industry. PCC’s pre-tax earnings rose slightly in 2022 relative to 2021, primarily due to improved demand for aerospace products. The rebound in domestic air travel and the restart of Boeing 787 production in the third quarter has boosted the outlook for this business, which continues to be hampered by increased costs and supply chain issues. Management continues to note that future growth is predicated on increasing production since the company has suffered from worker shortages and supply chain disruptions. Berkshire’s FlightSafety and NetJets continued to see a rebound, with training hours up 11% and customer flight hours rising 9% in 2022 versus 2021.

Housing-related businesses like Clayton Homes, Shaw, Johns Manville, Acme Building Products, Benjamin Moore, and MiTek posted sharply higher earnings relative to 2021, a 40.7% increase in quarterly pre-tax profits versus 2021. Berkshire noted that higher prices and volumes offset cost pressures. Despite the good news for the year, management indicated that “comparative revenues and earnings in the near term will likely decline from current levels” due to the impact of higher interest rates on new home construction.

The most significant portion of the retailing segment is Berkshire Hathaway Automotive (BHA), owning over 80 auto dealerships. BHA had 18.4% higher earnings in 2022, driven by higher vehicle gross profit margins. These vehicle margins peaked in the first half of 2022 and declined in the second half. Berkshire noted that 2022 apparel and footwear earnings plunged 68% relative to 2021 due to lower sales and higher inventories. Management said it was “taking measures to right-size our operations for the long-term and reduce inventory to more appropriate levels.” In addition, 2022 earnings were lower for Pampered Chef, See’s Candies, and their furniture retailers, including Nebraska Furniture Mart. This weakness in some of the retailing exposed businesses is not a surprise, given similar results of declining demand and higher inventory levels from others in the industry. Berkshire added a global toy company, Jazwares, with the acquisition of Allegheny in October 2022.

Berkshire’s McLane unit had 17.8% higher profits in 2022 versus 2021. McLane is a wholesale distributor to retailers and restaurants. The increase in earnings was primarily due to “slightly higher gross margin rates.” Still, supply chain constraints, labor shortages, truck driver shortages, and higher inventory costs hurt the business last year. Berkshire had been pessimistic about McLane in 2022 but removed any forecast for 2023.

Other: The segment had a significant profit for 2022 primarily due to foreign currency gains and an increase in equity method earnings at Kraft Heinz (KHC), Pilot, and the inclusion of Occidental Petroleum OXY in the fourth quarter of 2022. This segment includes companies’ profits that must be accounted for under the equity method due to the size of ownership and influence on management. The after-tax equity method earnings have Berkshire’s proportionate share of profits attributable to its investments in Kraft Heinz (KHC), Pilot, Berkadia, Electric Transmission of Texas, and Iroquois Gas Transmission Systems. The equity method earnings include Occidental Petroleum (OXY) beginning in the fourth quarter of 2022. Berkshire now owns 21.4% of the outstanding shares of Occidental. More about the possible reasons for the Occidental investment is here.

Pilot is the largest operator of travel centers in North America, under the names Pilot and Flying J. In January 2023, Berkshire acquired an additional 41.4% ownership of Pilot for roughly $8.2 billion. As a result of the Berkshire’s ownership increasing to 80% of the entity, it will be shown as part of the consolidated financials for the operating companies in the future.

The foreign currency exchange rate gains were generated from bonds issued by Berkshire Hathaway and denominated in British Pounds, euros, and Japanese Yen. These foreign currency liabilities are not a concern as Berkshire has significant assets and earnings denominated in these foreign currencies. Investment losses from non-U.S. dollar investments generally offset these gains.

Berkshire bought back a little over $2.6 billion of its stock in the fourth quarter. Until an announcement in mid-2018, Berkshire had only made repurchases when the stock traded at less than 1.2 times the price-to-book (P/B) ratio. While that constraint is now relaxed, it is still a good indicator of the general range when aggressive repurchases will likely be seen. Berkshire’s P/B ratio was between 1.3 and almost 1.5 times during the quarter, so one might have thought the purchase amount would have been lower. Berkshire only intends to repurchase shares when the “repurchase price is below Berkshire’s intrinsic value, conservatively determined.” The P/B ratio remains a reasonable proxy for gauging Berkshire’s intrinsic value. Still, Warren Buffett and Charlie Munger’s judgment about its intrinsic value versus other available uses of capital can differ from that simple price-to-book measure.

In addition, Berkshire made other purchases but was a net seller of publicly traded stocks in the fourth quarter. Berkshire bought $1.7 billion of stocks while selling $16.3 billion for a net decreased investment of $14.6 billion in publicly traded equities. The details can be found in the 13F, which is reviewed here.

Summary: Quarterly results are generally not meaningful for Berkshire since it is managed with a focus on increasing long-term value and not meeting quarterly hurdles. This ability to take advantage of time arbitrage has served the company and shareholders well over the years. The goal in looking at the results is to see if the segments are generally operating as expected and consider the capital allocation decisions made by Warren Buffett and Charlie Munger.

Operating earnings for the fourth quarter of 2022 fell by 8% over 2021 but are 52% above pre-pandemic 2019 levels. The 2022 calendar year operating earnings growth was impressive at 12% and 28% above 2021 and 2019, respectively. In recent years, a significant capital allocation decision was made to increase share repurchases. This activity signals that Buffett and Munger believe Berkshire Hathaway’s price is below their intrinsic value estimate. If they are correct (and there is no reason to doubt them), the purchases are a value-creator for the remaining shareholders. Operating earnings per share for the 2022 calendar year were 15% above 2022 and 43% above 2019, with the additional benefit from share repurchases. The increase in repurchases in the fourth quarter was interesting, given the higher valuation of Berkshire. Still, it might have something to do with the inability of the duo to find some other opportunities with a more attractive risk versus reward for investing capital. In addition, a 1% U.S. excise tax on share buybacks became effective at the end of 2022, so the additional purchases might have been timed to avoid taxation.

The underwriting loss for the insurance businesses in 2022 is disappointing. GEICO, one of Berkshire’s crown jewels, continues to be challenged by the impact of the pandemic. Still, it is encouraging that the premium increases are in the pipeline, and management believes GEICO will revert to its typical underwriting profits in 2023. Other better news for 2022 was that the investment income from the insurance business continued to rebound sharply as the Federal Reserve aggressively raised short-term interest rates. Cost pressures from rising inflation caused non-insurance profit margins in 2022 to decline below 2021 levels, but margins remained higher than in pre-pandemic 2019.

Berkshire’s stock price handily outpaced the S&P 500 in the fourth quarter, soaring by 15.3% versus a total return of 7.6% from the S&P 500. For 2022, Berkshire’s price is +4.0%, while the S&P 500 had a total return of -18.1%. Cash levels were above last quarter. Berkshire retains a fortress balance sheet with cash and equivalents of over $128 billion, providing flexibility to take advantage of opportunities, including repurchasing its stock. Berkshire has stated that there would be no stock repurchases if it would cause cash levels to fall below $30 billion.

Berkshire’s third quarter 10Q filing noted that they “do not expect a material impact on our consolidated financial statements” from the passage of the Inflation Reduction Act of 2022. The inflation reduction act becomes effective for tax years beginning in 2023 and includes a 15% corporate minimum tax, tax credits for clean energy, and a 1% tax on stock repurchases. Berkshire’s effective income tax rate was 27.9% in 2022.

Despite the advanced age of its two top leaders, shareholders should take comfort in knowing that the firm continues to be managed to survive and emerge stronger from any economic or market downturn. Berkshire’s businesses are performing well, aside from woes at GEICO and some slowing due to macroeconomic headwinds. According to FactSet, S&P 500 earnings per share grew 3.9% in 2022 which is significantly less than Berkshire’s 15% growth in operating earnings per share. Management warned that some businesses, particularly the retailing and housing related business, have seen some softness. Berkshire retains its Fort Knox balance sheet and a diversified mix of businesses, which allows the unique ability to take advantage of significant opportunities when disruptions or crises provide them.