As second-quarter earnings season gets underway, there are quite a few questions that are about to be answered in the investing world. One company whose latest results I'm particularly interested in seeing is Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), but not to find out how much its earnings were or how the COVID-19 pandemic impacted its business. Here's why.
Berkshire's operating businesses are largely recession-resistant, and most of the larger subsidiaries (like insurance companies and utilities) provide services that were necessary throughout the economic shutdowns of the second quarter. In short, that's not where I'm expecting any surprises.
However, there is one number in Berkshire's earnings report that I'll be paying very close attention to. Here's what it is and why it matters so much.
The number to not care about
First of all, the number investors shouldn't pay much attention to is the headline earnings per share (EPS) number because it counts unrealized gains in Berkshire's investment portfolio. During the second quarter, the S&P 500 rose by 25%, and some of Berkshire's holdings did even better -- notably Apple, which soared by more than 51%. This performance will be reflected in Berkshire's earnings number but doesn't represent an actual gain.
There are some important figures in Berkshire's numbers, such as its operating income and the combined ratios from its insurance operations. But investors shouldn't pay much attention to Berkshire's per-share earnings.
The most important number in Berkshire's earnings report
By far, the number I'm most interested in seeing when Berkshire reports its earnings in early August is the amount of cash and short-term investments on its balance sheet. We won't find out what stocks Berkshire bought or sold until mid-August, but the cash number will let us know if it was an active quarter.
Berkshire has had a cash problem for several years, but not the kind that many other companies have. Berkshire has too much cash, and its operating businesses generate billions more every quarter. Warren Buffett and Berkshire's management team haven't been able to find many attractive opportunities -- either in the stock market or in acquiring entire businesses -- to deploy its capital. As a result, cash keeps accumulating and sat at a record $137 billion at the end of the first quarter.
To put this into perspective, consider that without borrowing any money, Berkshire could theoretically buy Texas Instruments, Shopify, Lowes, or Boeing and still have cash left over.
We also know that Berkshire sold its stakes in all four major U.S. airlines after the quarter ended, which added a few billion dollars to the pot.
Recently, we learned that Berkshire acquired the natural gas assets of Dominion (NYSE:D). However, it's important to mention that not only was the size of this deal relatively small by Berkshire's standards (just $4 billion of the purchase is cash, the rest is debt), but it took place in July after the second quarter ended, so it won't be reflected in the upcoming earnings report.
Did Warren Buffett finally start putting money to work?
To be perfectly clear, when Berkshire reports earnings, I want to see that the cash hoard has decreased. And preferably by a significant amount.
Many investors (myself included) weren't thrilled to see the lack of action in Berkshire's stock portfolio in the first quarter, but I understand CEO Warren Buffett's logic. The pandemic had only just begun in March, and the plunge in the market was caused by extreme uncertainty, which Buffett tries to avoid at all costs. There was no end to the exponential growth in COVID-19 cases, and until a few days prior to the end of the quarter, there was no agreement on any type of financial relief for affected Americans.
However, the second quarter was a different animal entirely. The CARES Act was signed into law just before the second quarter began and gave some much needed clarity on the economic-relief efforts that were to be undertaken. Plus, COVID-19 case numbers leveled off in early April and were on the decline until mid-June, and the economy started to reopen in many areas in May.
The bottom line is that, while it's understandable why Buffett didn't pull the trigger on many stock purchases in the first quarter and hasn't yet made an "elephant-sized" acquisition (Dominion's natural gas business is not one), I wouldn't be surprised if Berkshire put significant cash to work in the stock market in the second quarter as the economy began to stabilize.