Saturday, February 26, 2011

Berkshire Hathaway's Profit Not As Strong As Appears On The Surface

Berkshire Hathaway (BRK.A) turned in nice results for the year ending 2010, but, on an apples to apples basis, organic results are not as strong as many in the media are reporting. Even in Warren Buffett's must read annual shareholder letter he warns the media not to focus on net income due to the ease in which it can be manipulated. Mr. Buffett notes on page 20 of his annual letter:
"Let’s focus here on a number we omitted, but which many in the media feature above all others: net income. Important though that number may be at most companies, it is almost always meaningless at Berkshire. Regardless of how our businesses might be doing, Charlie and I could – quite legally – cause net income in any given period to be almost any number we would like...We have that flexibility because realized gains or losses on investments go into the net income figure, whereas unrealized gains (and, in most cases, losses) are excluded."
In fact, these realized investment gains did inflate net income for 2010 by nearly $1.5 billion (net of est. taxes). Below is a summary of some key items in Berkshire's cash flow statement.

From The Blog of HORAN Capital Advisors

The other item investors need to factor into the company's earnings is the contribution of the Burlington Northern (BNSF) acquisition. In the company's full financial statement, it is noted on page 75 that BNSF contributed $2.2 billion to consolidated earnings in 2010, not an insignificant amount. From a cash flow growth perspective then, BRK saw cash operating flow increase 12.9% ($17,895 versus $15,846).

An important point for investors is the cash flow statement offers important insights into a firm's operations that sometimes are hidden in the income statement. It is important for investors to understand from where the company is achieving its cash flow growth. For the year, BRK saw its cash increase to $38 billion from $30 billion. New borrowings of $8 billion accounted for all of the increase.

For future growth at Berkshire, Mr. Buffett indicates in his letter, "...We will need both good performance from our current businesses and more major acquisitions. We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy."

From an investment perspective, Berkshire anticipates future growth to come from future "major" acquisitions, likely not to dissimilar to the BNSF transaction. For BRK, growth by acquisition has become a mainstay of its operation and investors historically have been rewarded with strong stock price performance. As Mr. Buffett warns, don't look at net income or earnings per share in a vacuum.


Anonymous said...

Your numbers are wrong.

On a apples to apples basis, excluding gains and BNI:

2009: $7,569
2010: $8,858

The difference is mainly due to the recovery in MSR business.

David Templeton, CFA said...

I would enjoy seeing how you arrrived at your numbers. If you want to email the analysis to me at (info at that would be great.

I am adjusting investment losses from the cash flow statement that adjusts the earnings to operating cash flows. I am excluding the derivatives activity.