Berkshire Hathaway's Book Value Will Soar in the Fourth Quarter

Warren Buffett's Berkshire Hathaway (BRK.A -0.48%) (BRK.B -0.49%) will likely be one of the biggest winners of the tax reform bill recently passed into law. The company stands to benefit from a lower corporate tax rate on its earnings from operating businesses and capital gains. The most immediate impact of tax reform will show up on Berkshire's balance sheet when it reports fourth-quarter earnings, as its book value could soar 13% in a single calendar quarter.

A dramatic drop in deferred tax liabilities

Buffett often says his favorite holding period is "forever," precisely because holding onto winners allows Berkshire to delay making cash payments for taxes. Berkshire Hathaway ended the last quarter with deferred tax liabilities of roughly $86.6 billion, the vast majority of which is attributable to gains on investments that it hasn't sold. 

Berkshire's deferred tax liabilities were calculated assuming that it would eventually pay a corporate tax rate of roughly 35% on its gains when the profits on its biggest winners are realized. Because the corporate tax rate was reduced to 21% from 35% during the quarter, its deferred tax liabilities will have to be adjusted down to reflect the change in the corporate tax rate in its next earnings report.

Warren Buffett. Image source: The Motley Fool.

In November, Barclays analyst Jay Gelb estimated that a reduction in the corporate tax rate to 20% could send Berkshire's book value rising by as much as $27 billion due to its deferred tax liabilities, according to Bloomberg. Based on his analysis, book value could rise by 9% from the third quarter from lower tax liabilities.

Its largest investments win from tax reform

Berkshire's investments are concentrated in companies that have the most to gain from lower corporate income taxes. As of Sept. 30, 2017, Berkshire's publicly traded portfolio was valued at approximately $178 billion. Of that, nearly $73 billion was invested in banks, insurers, and financial companies, which are largely viewed as the biggest winners of tax reform since they generate the vast majority of their profit in the United States.

Four of its largest winners since Sept. 30 are detailed in the table below. Note that three of the four companies are banks. Without question, Buffett is one of the world's best bank investors.

Data sources: WhaleWisdom and Google Finance.

I calculate that Berkshire's publicly traded portfolio has gained $13.6 billion since the end of the third quarter, adding another $10.7 billion to its book value, after accounting for taxes at a 21% rate.

In all, capital gains on Berkshire's vast securities portfolio ($10.7 billion) and a reduction in Berkshire's deferred tax liabilities ($27 billion) could net shareholders a 12% increase in book value in the fourth quarter. Of course, this assumes that Berkshire's operating companies -- its insurance companies, BNSF railroad, utilities, and others -- add nothing to its bottom line, a highly unlikely outcome.

Assuming its operating businesses and valuation changes to its derivatives portfolio generate net earnings of $4 billion in the fourth quarter -- a result roughly equal to its average quarterly result in 2017, a period that includes rare losses in insurance underwriting -- book value could leap 13%. Shareholders will be very pleased with the company's next earnings report.