Why Berkshire Hathaway's Massive Q4 Loss Is Almost Meaningless

Warren Buffett's conglomerate, Berkshire Hathaway (BRK.A 0.95%) (BRK.B 0.72%), has outperformed the market over the long term, but changes to certain accounting rules mean it has to look at certain parts of its valuation on a more immediate-term basis. As a result, its quarterly numbers have become a lot more volatile. And conditions were absolutely not helped by an uncharacteristic whiff by Buffett: As he now admits, he overpaid when he helped finance the Kraft Heinz merger. The food giant last week wrote down the value of some of its top brands and dialed back its dividend. For Berkshire, the stock's decline handed it a $2.7 billion loss in 2018.

In this segment from MarketFoolery, host Chris Hill and Motley Fool Chief Investment Officer Andy Cross discuss Buffett's letter to shareholders, the reasons why mark-to-market isn't the smartest way to value Berkshire, whether the Kraft Heinz deal makes Berkshire less likely to jump into another major acquisition soon, what brands Kraft Heinz might sell, and more.

Check out all our earnings call transcripts.

A full transcript follows the video.

This video was recorded on Feb. 25, 2019.

Chris Hill: Let's start with Berkshire Hathaway, and let's start with this. They posted a loss in the fourth quarter.

Andy Cross: Massive one!

Hill: Massive, although posting a loss, pretty rare for Berkshire Hathaway. We touched on this on Motley Fool Money last week with the Kraft Heinz. is debacle too strong of a word? Certainly the writedown to the tune of about $3 billion with Berkshire Hathaway. Most of that was due to Kraft Heinz.

Cross: That's true. Warren Buffett talked about this. First, he gets into the specifics around a lot of nerdy accounting language, which he loves talking about. Readers of the Berkshire Hathaway annual letter, of which I am one, know -- he always talks a little bit about this, especially now that they have to mark to market their public holdings, which causes a lot of volatility when the difference from quarter to quarter ends in a profit or loss based on how the stock market has performed. Of course, as we know, in the fourth quarter of last year, the stock market had a really rough go. He talked about the fact that that leads to a lot of volatility in their quarterly results. They don't agree with this accounting rule, by the way. He points out the fact that in the first quarter of last year, they had a minus $1.1 billion loss; second quarter, a $12 billion profit; third quarter, a $18.5 billion profit, and, Chris, as you pointed out, in the fourth quarter, a minus $25.4 billion loss.

Really, looking at the quarterly results for Berkshire Hathaway, it's almost meaningless. Their operating businesses are so consistent over time and the volatility really comes from the public equity holdings, which now, the accounting rules require them to mark at the current prices.

That being said, the writedown at Kraft Foods really hurt them as well. That hurts their profitability as well.

Hill: He was on CNBC this morning talking with our good friend Becky Quick. He was very upfront about the fact, he said, "We overpaid for Kraft Heinz." I suppose that's easy to say in hindsight. I'm wondering if you think this makes him less likely to pull the trigger on future deals. He's been very public about the fact, "We're looking to make acquisitions. We want to make them at the right price." They don't want to overpay for something. My hunch is that what happened with Kraft Heinz makes them even less likely to pull the trigger on a deal.

Cross: I don't see it that way, Chris. Kraft Heinz is a partnership deal. They went in with 3G Capital. 3G Capital's brand has really taken the hit with a lot of this because they're running the Kraft Heinz operation. They became too excited about some of the cost savings and missed a lot of the trends in the consumer products good space. That has hurt.

He talks about this in the report, as he has in the past, talking about how they have this big elephant gun, they have $112 billion in cash. He wants to deploy it. He said prices are elevated to be able to put that to work. But if he finds a business that he thinks has good long-term economic opportunities and benefits and a competitive position worth making, he will put that capital to work.

One thing I just loved is how he opens up every year and talks about the performance of Berkshire Hathaway. For the third year in a row, the Berkshire Hathaway stock beat the S&P 500, which is now the preferred metric thinking about the market price, not the book value of Berkshire Hathaway, as they have more of these operating businesses. This was the amazing stat that I saw -- over the last 54 years, Berkshire Hathaway's stock has gained 2,400,000% or an annualized rate of about 20% vs. the market's 15,000% or about 10%. Over 54 years, they have doubled the annualized performance of the market. Clearly, a talented investor.

Kraft, as he points out, they overpaid for that. He's not going to sell the stock. He wants to continue to hold it. He talks about that in his report, that they will not be selling a lot of businesses. They have a lot of cash to work from, from the balance sheet as well as from their massive insurance operations. I think when he finds the right business at the right price, he'll pull that trigger.

Hill: Not that I expect Buffett to be anything less than blunt when he's giving interviews, because he always has been, I did find it oddly reassuring that he said, "We overpaid for this." I remember at the time -- I know we talked about it on this show -- we call it a merger, but it's really Heinz buying Kraft, and the premium paid for Kraft was about 35%. It was one of those things where I think a lot of us looked at the deal and said, "OK, that seems like a high price, but it's Buffett, it's 3G Capital, we trust them."

Cross: I think they went in with their eyes a little too wide open, eyes a lot bigger than their stomach because of some of the cost savings they thought they could get out of the merger operation. They have cut out about $1.7 billion since 2015. But I think they expected that to be more aggressive. They haven't been able to do that. Some of the brands are little staid, as we talked about. Yes, they do have a dozen or so of billion-dollar brands, but those brands certainly aren't what they used to be. This is the challenge in the consumer products goods businesses. He talked a little bit about this before. The fickle consumer combines with a retailer, now, that is much more sophisticated than it used to be. Just look at what Amazon has done with the acquisition of Whole Foods. They are not price-givers anymore, they will be price-takers. That business, on the retail side, much like the airlines have gotten religion on profitability, I feel like the retailers have as well. That's also been a detriment to Kraft, and 3G missed that.

Hill: I think everyone expects there to be brands sold off from the Kraft Heinz universe. I saw one report that someone thinks that Maxwell House Coffee could fetch $3 billion. That struck me as a little high.

Cross: I was talking a little bit to some others about this -- not everyone buys Starbucks coffee. Not everyone buys Dunkin Donuts coffee. Maxwell House is a very large brand and it still takes them a lot of shelf space. If you go into certain grocery stores, it still takes up a lot of shelf space. It's a massive brand. Maybe it might be tied into some of the opportunities that the team is seeing, like you said, that 3G Capital might be divesting assets. They certainly have to, to help pay down some of the debt and get on the right footing. Whether it's Maxwell House or others, I'm pretty sure we will see over the next 18 months or so some big divestitures coming from Kraft.