Crucial Takeaways From Berkshire Hathaway’s Second Quarter 2022 Earnings
Berkshire Hathawa BRK.B BRK.B y’s (BRK/A, BRK/B) slipped to a loss of over $43.7 billion in the second quarter versus a profit of over $28 billion in the same quarter of 2021. Thanks to sharp declines in the stock market, that result is dominated by losses from the investment portfolio since unrealized gains from their portfolio are included in earnings. Operating earnings, which remove the distortion from market changes and better reflect the firm’s earnings power, for the quarter rose sharply by 39% versus 2021. Year-to-date operating earnings rose by 19% over the same period in 2021. Providing an illustration of the value from share repurchases, per-share operating income for the second quarter increased by 43% versus 2021.
Because the Covid-19 pandemic negatively impacted most businesses, including Berkshire, in early 2020, comparing current results to pre-pandemic 2019 results is helpful. Operating earnings for the second quarter of 2022 are 51% above 2019. And thanks to share repurchases, operating earnings per share are a whopping 68% above 2019.
A further look into the different operating segments in 2022 shows strong earnings growth across most segments versus 2021. Notably, the operating income for all segments is significantly above the pre-pandemic levels of 2019.
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Insurance: Second quarter investment income was 56% higher than 2021 and 27% better than 2019, primarily due to higher interest income from short-term investments. Investment income was depressed by ultra-low interest rates implemented in response to Covid, but the Federal Reserve has raised rates aggressively in the second quarter to fight inflation. Investment income should continue to see improvement as the Federal Reserve is likely to be in hiking mode for the remainder of the year. While underwriting results were positive overall, Geico had an underwriting loss. Geico continues to suffer from more frequent auto claims and rising claims severity due to the higher valuation of used vehicles. Geico has posted an underwriting loss year-to-date, which drove the 53% decline in Berkshire’s year-to-date underwriting profit relative to 2021. During the annual meeting earlier in the year, there was a question about the strength of Berkshire’s Geico car insurance business relative to Progressive PGR (PGR). Progressive has done better than Geico recently based on their earlier adoption of telematics. Geico recently moved in that direction, and it will be instructive to see if Geico can close the gap in the coming years.
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. Berkshire had an underwriting profit for the second quarter of 2022, year-to-date 2022, and calendar years 2021, 2020, and 2019. Berkshire’s float was flat at approximately $147 billion versus the level on December 31, 2021, and above the $138 billion on December 31, 2020. Though float is not as valuable in a low interest rate environment, its value increases as yields rise. Float per share has increased to $99,961 from $98,960, aided by share repurchases.
Railroad: Berkshire owns the Burlington Northern Santa Fe (BNSF) railroad operating in the U.S. and Canada. Net operating earnings rose 10% over the same quarter in 2021 and 24% over pre-covid 2019. Revenue was higher due to higher pricing and a fuel surcharge driven by higher fuel prices, while volume was slightly lower.
Utilities and Energy: This business generally provides steady and growing earnings, which one would expect from what primarily consists of regulated utilities and pipeline companies. In June 2022, Berkshire bought the Berkshire Hathaway Energy Company (BHE) common stock owned by Greg Abel, Berkshire’s Vice Chairman – non-insurance operations, for $870 million, and Berkshire now owns 92% of BHE. A question about a possible conflict of interest stemming from Abel’s partial direct ownership of a Berkshire subsidiary was asked at the annual meeting, so this transaction ends any concern in that area. 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. The 2022 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 (PCC) business due to its exposure to the COVID-disrupted aerospace industry. PCC’s pre-tax earnings rose in the second quarter relative to 2021, primarily due to higher demand for aerospace products. Berkshire sounded more optimistic about the outlook of PCC with a rebound in domestic flight and the need for narrow-body aircraft. Management suggested that future growth is predicated on the ability to increase production since the company has suffered from worker shortages and a restart in Boeing 787 production. Berkshire’s FlightSafety and NetJets continued to see a sharp rebound, with training hours up 29% and customer flight hours rising 25% year-to-date versus 2021. Unfortunately, the earnings of aviation services were dented by increased costs, including those for subcontracted aircraft, due to the sharp jump in customer flight hours.
Housing-related businesses like Clayton Homes, Shaw, Johns Manville, Acme Building Products, Benjamin Moore, and MiTek posted sharply higher earnings relative to 2021. Berkshire continues to note that prices were increased to offset cost pressures, and supply chain disruptions remain an issue. Perhaps the early signs of a slowing housing market are showing up in the group, with higher selling prices due to higher costs being the primary driver of revenue growth rather than unit volume and product mix. The most significant portion of the retailing segment is Berkshire Hathaway Automotive (BHA), owning over 80 auto dealerships. BHA had lower quarterly revenues despite a higher average unit sale price. Unit sales were lower, reflecting significant new vehicle supply shortages attributable to the global computer chip shortages and other supply chain disruptions. Berkshire noted that second-quarter apparel and footwear revenues plunged relative to 2021. In addition, earnings were lower for their furniture retailers, including Nebraska Furniture Mart, with prices higher due to increased costs but lower transaction volumes. This weakness in some of the retailing exposed businesses is not a surprise, given similar statements from others in the industry. Berkshire’s McLane unit had lower profits in 2022 versus 2021. McLane is a wholesale distributor to retailers and restaurants. The decline in earnings was primarily due to supply chain constraints, labor shortages, truck driver shortages, and higher inventory costs. Berkshire continues to expect the challenging environment for McClane to continue through 2022.
Other: The segment has a significant profit for the second quarter and year-to-date 2022 primarily due to foreign currency gains and an increase in equity method earnings at Kraft Heinz (KHC) and Pilot. The foreign currency exchange rate gains were generated from bonds issued by Berkshire Hathaway and denominated in British Pounds, euros, and Japanese Yen. Investment losses from non-U.S. dollar investments generally offset these gains. These foreign currency liabilities are not a concern as Berkshire has significant assets and earnings denominated in these foreign currencies. 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.
Berkshire bought back $1 billion of its stock in the second quarter. Until an announcement in mid-2018, Berkshire had only made repurchases when the stock was trading 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 1.2 times to above 1.5 times during the quarter, so it makes sense that the pace of repurchases slowed. 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. It worked well this quarter since Berkshire only acquired shares in June, and the price-to-book didn’t fall below 1.2 times until then. Still, Warren Buffett and Charlie Munger’s judgment about its intrinsic value versus other available uses of capital could differ from that simple measure in the future.
In addition, Berkshire made other purchases. Berkshire made $6.2 billion in stock purchases for its portfolio while selling $2.3 billion in stocks for a net additional investment of $3.9 billion in publicly traded equities. One purchase was additional shares of Occidental Petroleum OXY (OXY). Berkshire now owns approximately 17% of the outstanding shares of Occidental, with a market value of $9.3 billion at the end of June. More about the possible reasons for the Occidental investment is here. Berkshire expects to close on the purchase of Allegheny Corporation (Y) in the fourth quarter for approximately $11.6 billion in cash. Allegheny shareholders approved the transaction on June 9.
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 second quarter of 2022 grew by 39% over 2021. In addition, 2022 operating earnings are 51% above pre-pandemic 2019 levels. 2022 year-to-date operating earnings growth is similarly impressive at 51% and 40% 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 2022 are now 68% above 2019, benefiting from the share repurchases! The slowing repurchases in the second quarter reflect the higher valuation of Berkshire until June and the ability of the duo to find some other opportunities with an attractive risk versus reward for investing capital.
One of Berkshire’s crown jewels in insurance businesses, GEICO, continues to be challenged by the impact of the pandemic. The underwriting loss at GEICO was disappointing, but results should improve as auto claims normalize with auto pricing. The performance differential versus Progressive (PGR) will also be part of the equation to get the business back on track. The better news was the investment income from the insurance business continued to rebound sharply as the Federal Reserve aggressively raised short-term interest rates. Excluding the insurance business and consistent with the S&P 500 data, cost pressures have caused profit margins to decline relative to second quarter 2021 levels. Even though non-insurance margins are lower than 2021, margins remain higher than the pre-pandemic second quarter of 2019.
Berkshire’s stock price trailed the S&P 500 in the second quarter, declining by almost 23% versus a total return of -16% from the S&P 500. Year-to-date through the end of June, Berkshire’s price is almost -9%, while the S&P 500 has a total return of nearly -20%. Despite additional investment purchases, cash levels were above last quarter. Berkshire retains a fortress balance sheet with cash and equivalents of over $101 billion, which provides flexibility to take advantage of opportunities, including repurchasing its own stock. Berkshire has stated that there would be no stock repurchases if it would cause cash levels to fall below $30 billion.
Despite the headline loss in the second quarter, Berkshire’s businesses are performing exceptionally well, aside from woes at GEICO and some slowing due to macroeconomic headwinds. 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 retains its Fort Knox balance sheet and a diversified mix of businesses. The firm maintains the unique ability to take advantage of significant opportunities when disruptions or crises provide them.
Bonds See 2023 Recession, Stocks Aren’t So Sure
The yield curve is one of the most robust recession predictors and has signaled a recession may be coming since mid 2022. In contrast, U.S. stocks as measured by the S&P 500 are up materially from the lows of last October and only just below year-to-date highs, seemingly rejecting recession fears. Yet, fixed income markets see the Fed potentially cutting rates by the summer, perhaps reacting to a U.S. recession.
The Evidence From The Bond Markets
The recessionary evidence, at least from fixed income markets, is mounting. The 10 yield Treasury yield has been below the 2 year yield consistently since last July. That is is called an inverted yield curve and has signaled a recession fairly reliably when compared to other leading indicators.
Building on that, fixed income markets see almost a nine in ten chance that the Federal Reserve cuts rates by September of this year. That’s something the Fed has repeatedly said they won’t do on their current forecasts. Yet, a recession could cause it to happen.
The Stock Market
In contrast, the stock market shows some optimism. The S&P 500 is up 7% year-to-date as the market has shrugged off fears of contagion from recent banking issues. In particular, tech stocks have rallied.
In contrast, more defensive sectors such as healthcare, utilities and consumer goods have lagged in 2023. This suggests that the stock market is taking more of a ‘risk on’ position and is perhaps less worried about the economy.
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That said the stock market is a leading indicator of the business cycle, it may be that stocks see a recession, but are now looking past it to growth ahead and are factoring in the lower discount rates that a recession might bring as interest rates decline. Also, the U.S. stock market is relatively global, so the fate of the U.S. economy is a key factor in driving profits, but not the only one.
Monitoring unemployment data will be key. Though the yield curve is a good long-term forecaster of recessions it is less precise in signaling when a recession starts. Unemployment rates can offer more accurate recession timing. Unemployment edged up in February, suggesting a recession may be near, but we’ve also seen monthly noise unemployment. Two similar monthly unemployment spikes during 2022 both proved false alarms.
However, if we see a sustained move up in unemployment from the low levels of 2022 that may be a relatively clear sign that a recession is here. Economist Claudia Sahm estimates that a sustained 0.5% increase in unemployment rate from 12-month lows is sufficient to trigger a recession. Unemployment rose 0.2% from January to February 2023, so maybe we’re on the way there. Of course, the jobs market performed better than expected in 2022 and it could do so again. Still, fixed income markets do suggest a 2023 recession is coming. Stock markets don’t necessarily share that view.
Which States Have The Highest And Lowest Life Expectancies?
There’s a wide variance of life expectancies among the 50 states in the U.S., according to a recent report prepared by Assurance, an insurance technology platform that helps consumers with decisions related to insurance and financial well-being.
Figure 1 below shows the 10 states with the highest life expectancy, starting with Hawaii, the state with the highest life expectancy.
Figure 2 below shows the 10 states with the lowest life expectancy, starting with Mississippi, the state with the lowest life expectancy.
Assurance scoured life expectancy data prepared in January 2023 by the U.S. Centers for Disease Control and Prevention (CDC). With this data, Assurance created several easy-to-understand graphics that offer information about life expectancies.
Life expectancies are a basic measure of well-being
As measured by the CDC, life expectancies are a basic measurement of well-being in a broad population and not a prediction of how long an individual might live. The CDC measures the expected lifespan for a person born in the year of measurement. This measurement is calculated based on the assumption that the individual will live and die according to the rates of death that are prevalent in the measurement year for each age. There’s no assumed improvement or backsliding in the assumed mortality rates in future years for each age in the life expectancy calculation.
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By contrast, an estimated lifespan for an individual would consider their current age, their gender, and some basic lifestyle information. It might also attempt to project future improvements or backsliding in mortality rates based on key factors.
Significant influences on life expectancy calculations
Leading causes of death in the U.S. are heart disease, cancer, and accidents in that order. These immediate causes are significantly influenced by factors in the population such as poverty rates, educational attainment, rates of obesity and smoking, access to healthcare, prevalence of violent crime, and the support people receive from federal, state, and local governments. All these factors can vary widely among different states, which can be a key reason why life expectancies vary by state.
When you think about it, all these factors also have the potential to influence a person’s quality of life. The measured life expectancy rate rolls up all these factors into one objective measurement of well-being that’s based on population data.
In addition to the factors listed above, mortality rates increased and life expectancies decreased in the past few years due to the Covid-19 pandemic. A recent article titled “Live Free And Die” summarized recent research results that show that life expectancies in most countries around the world rebounded after the Covid-19 pandemic but that they continued to decline in the United States. Many of the reasons cited in the article for the continued decline in U.S. life expectancies are the same or similar to the factors listed above.
Why should retirees care about the life expectancies reported here if these measures don’t predict your own lifespan? Life expectancy calculations indicate the general well-being of the entire population in your area. While the living conditions in your area can influence your own lifespan and quality of life, retirees should focus on their remaining life expectancy given their age. They should also consider how the factors listed above that influence life expectancies in the population might apply to them.
You can obtain customized estimates of your remaining life expectancy at the Actuaries Longevity Illustrator. Part of your planning for retirement is understanding how long you an an individual might live, instead of relying on generalized information about larger populations you see in the media.
IRS Dirty Dozen Campaign Warns Taxpayers To Avoid Offer In Compromise ‘Mills’
Owing taxes can be stressful. Unfortunately, the actions of some companies can make it worse. As part of its “Dirty Dozen” campaign, the IRS has renewed a warning about so-called Offer in Compromise “mills” that often mislead taxpayers into believing they can settle a tax debt for pennies on the dollar—while the companies collective excessive fees.
The “Dirty Dozen” is an annual list of common scams taxpayers may encounter. Many of these schemes peak during tax filing season as people prepare their returns or hire someone to help with their taxes. The schemes put taxpayers and tax professionals at risk of losing money, personal information, data, and more.
(You can read about other schemes on the list this year—including aggressive ERC grabs here, phishing/smishing scams here and charitable ploys here.)
Tax Debt Resolution Schemes
“Too often, we see some unscrupulous promoters mislead taxpayers into thinking they can magically get rid of a tax debt,” said IRS Commissioner Danny Werfel.
“This is a legitimate IRS program, but there are specific requirements for people to qualify. People desperate for help can make a costly mistake if they clearly don’t qualify for the program. Before using an aggressive promoter, we encourage people to review readily available IRS resources to help resolve a tax debt on their own without facing hefty fees.”
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Offers In Compromise
Legitimate is a key word. Offers in Compromise are an important program to help people who can’t pay to settle their federal tax debts. But, as the IRS notes, these “mills” can aggressively promote Offers in Compromise—OIC—in misleading ways to people who don’t meet the qualifications, frequently costing taxpayers thousands of dollars.
An OIC allows you to resolve your tax obligations for less than the total amount you owe. You generally submit an OIC because you don’t believe you owe the tax, you can’t pay the tax, or exceptional circumstances exist.
Because of the nature of the OIC—and the dollars involved—the process can be time-consuming. It can also be confusing for taxpayers who may not have a complete grasp on their finances.
First, you must complete a detailed application, Form 656, Offer in Compromise. You must also submit Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, or Form 433-B, Collection Information Statement for Businesses, with supporting documentation (generally, bank and brokerage statements and proof of expenses).
You’ll also need to submit a non-refundable fee of $205 and payment made in good faith. The payment is typically 20% of the offer amount for a lump sum cash offer or the first month’s payment for those made over time. Generally, initial payments will not be returned but will be applied to your tax debt if your offer is not accepted. Payments and fees may be waived if the OIC is submitted based solely on the premise that you do not owe the tax or if your total monthly income falls at or below income levels based on the Department of Health and Human Services (DHSS) poverty guidelines.
The IRS will examine your application and decide whether to accept it based on many things, including the total amount due and the time remaining to collect under the statute of limitations. The IRS will also review your income—including future earnings and accounts receivables—and your reasonable expenses, as determined by their formula. The IRS will also consider the amount of equity you have in assets that you own—this would include real property, personal property (like automobiles), and bank accounts.
Before your offer can be considered, you must be compliant. That means you must have filed all your tax returns and paid off any liabilities not subject to the OIC. After you submit your offer, you must continue to timely file your tax returns, and pay all required tax, including estimated tax payments. If you don’t, the IRS will return your offer.
Additionally, you cannot currently be in an open bankruptcy proceeding, and you must resolve any open audit or outstanding innocent spouse claim issues before you submit an offer.
You can probably tell—it’s a lot to consider. You may want representation. A tax professional can help marshal you through the process and offer practical guidance, while communicating what fees could look like.
By contrast, according to the IRS, an OIC “mill” will usually make outlandish claims, frequently in radio and TV ads, about how they can settle a person’s tax debt for cheap. Also telling: the fees tend to be significant in exchange for very little work.
Those mills also knowingly advise indebted taxpayers to file an OIC application even though the promoters know the person will not qualify, costing taxpayers money and time. You can check your eligibility for free using the IRS’s Offer in Compromise Pre-Qualifier tool.
“Pennies On A Dollar”
What about those promises that taxpayers can routinely settle for pennies on a dollar? Not true. Generally, the IRS will not accept an offer if they believe you can pay your tax debt in full through an installment agreement or equity in assets, including your home. That’s why the IRS tends to reject a majority of OICs that are submitted. The acceptance rate is less than 1 in 3, according to the 2021 Data Book.
The IRS will generally approve an OIC when the amount offered represents the best opportunity for the IRS to collect the debt. It’s true that there’s a formula that the IRS uses to figure out how much they think they can collect from you. But there is some wiggle room to account for special circumstances, including a loss of income or a medical condition. It’s worth noting those are the exceptions, not the rule.
While submitting an OIC may keep the IRS from calling you, it doesn’t stop all collections activities—don’t believe companies that suggest that submitting an OIC will make your tax debt disappear. Penalties and interest will continue to accrue on your outstanding tax liability. Additionally, the IRS may keep your tax refund, including interest, through the date the IRS accepts your OIC.
You may also be liened. In most cases, the IRS will file a Notice of Federal Tax Lien to protect their interests, and the lien will generally stay in place until your tax obligation is satisfied.
An OIC is a serious effort to resolve tax debt and shouldn’t be taken lightly. Be skeptical—if it sounds too good to be true, it likely is. If you’re considering an OIC, hire a competent tax professional who understands the rules and is willing to level with you about your chances of being successful—including other options. Don’t fall into a trap that can make your situation worse.
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