Berkshire Hathaway (BRK.A 0.26%) (BRK.B 0.06%) has a dedicated following of shareholders, largely because of the investing savvy of its leader, Warren Buffett. The insurance giant is a stalwart among value investors for its disciplined approach toward underwriting policies and investing collected premiums wisely. That business model has been extremely lucrative for Buffett and his shareholders for decades.
The latest release of Berkshire Hathaway earnings was noteworthy for what it said about one of the most challenging times in its history. Despite lingering doubts, some of the things that Berkshire said are extremely optimistic for its long-term future, even in the shadow of the COVID-19 pandemic. Below, we'll look at four of the most important lessons from the latest Berkshire report.
1. Cash is king in a pandemic -- and Buffett likes Treasury bills
Buffett has taken criticism for not deploying more of his cash hoard, especially during the decade-long bull market in stocks. Yet the amount of cash Berkshire has on hand keeps growing. When you combine the insurance business with the other segments under its corporate umbrella, Berkshire reported almost $146.6 billion in cash, cash equivalents, and short-term fixed-income investments as of June 30.
Moreover, Buffett is increasingly looking at the safest available investment vehicles for Berkshire's cash. As of the end of the second quarter, Buffett had more than $110 billion invested in short-term Treasury bills, up from less than $64 billion at year-end 2019. That's reduced the amount of cash equivalents Berkshire holds, which might have included not only shorter-term Treasuries, but also some corporate debt securities. Holding more Treasury bills ensures liquidity and the full faith and credit of the U.S. government at a time when many businesses are struggling against COVID-19. That's something that even high-quality corporate commercial paper can't promise.
2. Even Buffett's holdings are struggling
Many companies have had to take enormous charges during the pandemic to reflect changing business conditions. Berkshire is no exception, as it took a $9.8 billion goodwill and intangible asset impairment charge against its 2016 acquisition of Precision Castparts. The aerospace parts and systems supplier has been among a large group of companies that have suffered from plunging demand for aircraft in the wake of travel bans and reduced flight traffic.
Berkshire's investment in Kraft Heinz (KHC 0.63%) has also seen a dramatic drop, with the insurance giant carrying its roughly 27% stake in the food company on its balance sheet at a value $2.7 billion higher than its current market price. Berkshire concluded that it wouldn't have to take an impairment loss related to Kraft Heinz, but it left open the door to future impairment charges if the company doesn't recover quickly.
3. COVID-19 will keep affecting insurance operations
One key uncertainty about Berkshire's future involves its liability for claims related to COVID-19. Berkshire repeated that its insurance underwriting results will suffer from losses and costs of the pandemic, both from claim payouts and from increased operating costs. Moreover, the insurer has offered some premium credits back to customers, especially on the auto side, and future rulings about insurance liability for pandemic-related claims could adversely affect the way Berkshire is accounting for potential losses.
Berkshire reported a nice boost to underwriting earnings in the second quarter, doubling both from year-ago levels and from the first quarter of 2020. Investors hope that will continue, and in the long run, a stronger pricing environment for insurance and reinsurance companies could actually boost underwriting profits for Berkshire.
4. Operating income has been sluggish
Many investors won't look past a strong headline number, but Berkshire's net income now reflects mark-to-market gains that aren't meaningful from an operational standpoint. Berkshire's operating profit dropped 10% year over year, with the insurance company pointing specifically at weakness in its railroad segment as well as its "other businesses" catch-all category.
The Burlington Northern Santa Fe railroad saw pre-tax earnings fall 16% year over year, as shipping volumes fell substantially. Modest tax-related gains in utilities and energy were able to offset those bottom-line losses only partially. Big hits came from Berkshire's manufacturing, service, and retailing businesses, which include Precision Castparts and other hard-hit industrial players.
Look for what's next
COVID-19 has been a real headwind against Berkshire's performance. If hoped-for resolutions like a vaccine come quickly, then those negative impacts could reverse quickly. What's more likely, though, is that Berkshire will have to deal with the pandemic's effects for a while longer. That won't necessarily hold the stock price back, but it could delay improvement in Berkshire's financial results longer than Warren Buffett would prefer.