Few companies exemplify a "sleep well at night" stock quite like Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). As a massive conglomerate that makes money in virtually any business you can think of managed by one of the greatest investors to ever live, there isn't much room for fireworks from quarter to quarter.
However, as big as it may be, there are a few key pieces to Berkshire that drive the bulk of its earnings power. Here are five things I'll be watching when Warren Buffett's company reports earnings on Saturday, Nov. 3.
1. Stormy weather in insurance?
Last year it was Hurricanes Harvey, Irma, and Maria, and an earthquake that took a $3 billion bite out of Berkshire's earnings. This quarter, it was Hurricane Florence, which made landfall over the Carolinas in mid-September.
Luckily, Florence isn't expected to be particularly costly for the insurance industry, as CoreLogic estimated that losses for private insurers would tally to less than $5 billion. (Hurricane Michael didn't make landfall until October, so any related losses would flow through fourth-quarter results.)
Berkshire's insurance operations are off to a good start in 2018. Through the first half of the year, all of Berkshire's insurers were in the black, with GEICO leading the pack, thanks to rate increases that helped drive an 8.7% increase in premiums per policy in the 12 months leading up to June 30.
Insurance has its ups and downs, but one thing is certain: The float generated by Berkshire's insurers is becoming more valuable as interest rates rise. Berkshire has largely resisted investing the float in longer-term bonds during this low interest rate environment, as the insurers had $69.3 billion in cash and cash equivalents compared to $18.3 billion of bond investments. Will rising rates tempt Buffett to get back into bonds?
2. Berkshire the cannibal
Buffett's sidekick, Charlie Munger, once advised investors they should "pay attention to the cannibals," referring to companies that use their excess cash to rapidly buy back stock, thus eating away at their own share count.
You can now count Berkshire as a cannibal. Berkshire changed its approach to share buybacks in July, eliminating a hard and fast rule that the company would only repurchase shares at a price equal to 1.2 times book value or less. After eliminating the valuation criteria, Buffett told CNBC that he put some of Berkshire's money to work buying back "a little" of its stock during the quarter.
We'll only know how much stock Berkshire bought back when it reports earnings, but it's unlikely to have made much of a dent in the $111 billion in cash it had at the end of the second quarter.
3. Profits from power
Whereas insurance profits vary wildly from one period to the next, the energy business is as dependable as it gets. Berkshire's energy units are generally monopolistic suppliers of power, ensuring they earn a reasonable rate for power and a respectable return on capital.
In terms of assets, Berkshire Hathaway Energy has somewhat quietly grown to become a monstrous entity on the balance sheet, with $66.7 billion of property, plant, and equipment, net of depreciation, slightly larger than the $62.5 billion of net PP&E invested in the railroad.
Investors can reliably expect the energy units to produce $500 million to $600 million in pre-tax profit quarter after quarter, as the bulk of BH Energy's haul comes from regulated markets where rates are set in such a way to all but guarantee the company earns an attractive -- but far from extraordinary -- return.
4. On the way to Santa Fe
The railroad business may have its secrets, but volume isn't one of them. Thanks to regulatory reports, we know that BNSF shipped more carloads for its customers in the third quarter, with total carloads rising 6.3% over the year-ago period. Including intermodal shipments, volume increased by about 3.6%. Importantly, BNSF's carload report ends on Sept. 29, so volume figures exclude a day that will count in Berkshire's quarterly report.
As I write every quarter, the real mystery is pricing. Prices move wildly from quarter to quarter, and certain types of stuff (agricultural products and coal) generate more revenue per carload than others (consumer goods).
Higher oil and natural gas prices remain a key driver of BNSF's revenue and profit. When energy prices are high, railroads simply benefit from increased demand for energy-related shipments. Rising energy prices also lead to higher surcharges for fuel costs, which drives revenue, and, at times, helps profitability when the increase in surcharges exceeds the increase in what a railroad pays for fuel.
When Buffett bought BNSF in 2009, he called it a "bet on the country," believing that the railroad could benefit from a steady increase in the volume of goods shipped by rail over years and decades. A healthy single-digit increase in volumes this quarter suggests his thesis is playing out just fine.
5. Berkshire's variety pack
Berkshire Hathaway's largest business is really hundreds of businesses lumped together. The manufacturing, service, and retail segment spans from highly profitable industrial manufacturers (Precision Castparts and Lubrizol) to consumer brands (Duracell, Brooks Sports, and Dairy Queen).
Roughly half this segment's pre-tax profits are earned from the industrial products group. These companies generally benefit from an increase in business investment and industrial products demand. Precision Castparts makes its money in specialty parts for aircraft and power systems, Lubrizol makes its money in chemicals, and IMC is driven by demand for metal cutting tools. In short, other companies' capital expenditures are their revenue.
Profit growth from Berkshire's well-known operating companies has largely come easy this year, thanks to a reduced corporate tax rate in the United States in 2018. In the first half of the year, the manufacturing, service, and retailing segment's pre-tax profits increased roughly 18%, but thanks to a lower tax rate, after-tax profits grew 33%.
Berkshire's next billion-dollar business
One of the most interesting things about Berkshire Hathaway is that its biggest business is likely one it doesn't own...yet. Buffett has struggled to reinvest all the cash Berkshire generates, voicing his frustration in his letters to shareholders. He's said that while there are many attractive businesses to buy, very few are available at attractive prices.
The markets just haven't gone his way. Even after October's dip, stock prices have simply fallen back to where they were to start the year, offering few real bargains for Buffett to opportunistically deploy Berkshire's billions.
If anything, this quarter will offer some clues as to future capital allocation plans, as we'll be able to see how much money Berkshire spent buying back stock, and roughly triangulate prices at which he's happy to put excess cash to work reducing his holding company's share count.