Berkshire Hathaway Gives Investors an Update

On this episode of Industry Focus: Financials, host Jason Moser and longtime Fool.com contributor Matt Frankel, CFP, dive into Berkshire Hathaway's (BRK.A 0.64%) (BRK.B 0.54%) latest earnings and the key points investors need to know. Also, Matt and Jason answer a listener's question about using bonds as an alternative to savings accounts, and they give listeners two stocks to watch. 

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Aug. 9, 2021.

Jason Moser: It's Monday, Aug. 9th. I'm your host, Jason Moser. On this week's financial show, we're taking a closer look at Berkshire Hathaway's most recent quarter. We've got a listener question on investing in municipal bonds and we'll wrap it up with a couple of stocks for you to watch. Joining me as always, albeit from a different location this week, it's certified financial planner, Mr. Matt Frankel. Matt, how is everything going?

Matt Frankel: I am just doing great, Jason. We are here in sunny Orlando, Florida.

Moser: Nice.

Frankel: Not even 450 miles from home could keep me away.

Moser: That sounds like you guys are set up with a nice little situation out there. That's the recent rental property that you all invested in, is that right?

Frankel: It is. I am at the Margaritaville Resort in Orlando. They bought a bunch of cottages around the hotel and sold them to individuals and investors and we bought one of them a couple of months ago.

Moser: I have to believe that given the location and given that sunny weather 365 down in Florida, that probably is going to work out pretty well from the investing side, and it gives you a place to take the kids every so often. You got a lot of years left with those kids in that Disney stage, they're still really young.

Frankel: For sure. At The Motley Fool, as you know, we're all about combining investments with having fun and this is a great way to do both.

Moser: Yes, it is. If your kids, if their first stock is not Disney, I'm going to be disappointed. We're going to need to have a talk. Maybe I could understand if you made Disney their first stock or perhaps this what we're going to discuss today here, Berkshire Hathaway, maybe that could be their first stock if you wanted to. I know that you're a Berkshire fan, but let's jump into Berkshire Hathaway because over the weekend, we saw the company release second-quarter earnings. Berkshire, the nice thing about their earnings release is not a lot of that pomp and circumstance, it's a 10-Q. You don't get an 8-K, you don't get a transcript, you don't get an earnings call. It's just here's what it is in fine filing fashion and keep on moving forward. You got to go in there and do a little bit of the work when it comes to digging into these Berkshire Hathaway earnings. But it seems like at least on the surface, the business is recovering nicely from what was a difficult 2020.

Frankel: Yeah. You're right. Warren Buffett and his team seem pretty much just to put the release out there, and say, "See you at the annual meeting next year." They are one of the rare companies that report their earnings on Saturdays. Every year their earnings report comes out on a Saturday morning and they do that by design. It's so the investors have a chance to digest the information outside of market hours. You always hear about these stocks spiking 20% on earnings day and then ending lower or having to be halted a few times because they're so volatile on earnings day. That's not an issue with Berkshire because one, they're a big company and don't tend to have volatile moves. Two, they intentionally give people time to digest earnings, what a concept.

Moser: Indeed.

Frankel: On the headline numbers, earnings were up about 7% year over year, but Warren Buffett himself tells investors not to pay attention to the earnings-per-share number. The reason is we all know Berkshire's the bulk of its value is in the stock portfolio. Purchase stock portfolio is worth over $300 billion, so it's about half the company right now. Those earnings results reflect the unrealized gains and losses from the stock portfolio. For example, if Berkshire's Apple investment went up $10 billion over the past year, that's reflected on a per-share basis in its earnings. Even though it hasn't really made that money yet until Berkshire hits the sell button someday. It's not really an accurate reflection of how much the company is actually making. For that we need to kind of get past the headline number, and get Berkshire's operating businesses. On the operating earnings, you mentioned they recovered nicely from COVID. You could certainly see it in this number, operating earnings, meaning that its businesses owned were up 21% year over year.

Moser: Nice.

Frankel: Those are businesses like GEICO, Duracell, Berkshire's utilities businesses, all the consumer products businesses they own, Clayton Homes.

Moser: The railroads.

Frankel: The railroads did really well. The railroads, utility and energy segment, were the best-performing part. Their earnings from that segment were up 27% year over year, which is pretty impressive. During the COVID lockdowns, they didn't have the need to transport as much around the country. Utilities and energy performed well no matter what. People still pay their electric bills during the pandemic for the most of time.

Moser: Oh, yeah. Got to keep the power on. Now more than ever everybody needs more power and more connectivity than ever before.

Frankel: GEICO did just fine during the pandemic because even though people weren't driving, I think they were one of the ones that gave a discount because people weren't driving during the pandemic.

Moser: They did. We got the same thing. We've been with Progressive for 15, 20 years now or something like that. Progressive had the same thing. We got a little bit of a rebate which was nice.

Frankel: At the same time, people weren't driving, so there were fewer claims Berkshire had to pay out.

Moser: Exactly. That's a good point.

Frankel: They pass some of that onto their customers which is nice. The insurance premiums Berkshire collective were up 10% year over year, which is to be expected. That's slower growth because that was a very resilient business during the pandemic. There's that. Got to remember, this whole quarter being compared to the second quarter of 2020, which is a terrible comparison for any company. Berkshire has over 60 businesses that it owns, in addition to its stock portfolio. Pretty much all of its businesses were affected to one extent or another. Some were absolutely devastated by the pandemic.

Moser: Matt, I think one of the things that has been a big point of conversation in regard to Berkshire Hathaway is not just this quarter, but it's been many quarters now. Really, it's two things, talk of a dividend and talk of acquisitions. When is Berkshire Hathaway going to pay a dividend? When is Berkshire Hathaway going to make another meaningful acquisition? This all comes at the same time as the company is repurchasing a lot of its own stock. When I say a lot, they repurchased, I think close to $6 billion worth of its own stock in the second quarter alone. The first half of the year, that's over $12 billion in repurchases and it's basically on pace for what they did last year as well. We can go a number of different ways here, but at the end of the day, this is a business, it's finding more value in itself than it feels like it's finding anywhere else, I don't really hold a grudge against that. You can argue whether there's other better opportunities out there, but clearly, they feel like that's where the most value is these days.

Frankel: I think a lot of investors feel like I do, like I want Berkshire to do something with its cash.

Moser: Right.

Frankel: It doesn't necessarily have to acquire a business, it doesn't necessarily have to put it in the stock market. It can buy back shares if that's where it sees the value, I'm totally fine with them doing that. If that's where they see the value, you mentioned over $12 billion in the first half of the year. This is a company that until a few years ago wasn't really buying back stock at all because they had an outdated buyback program for a while.

Moser: They changed the standard, too, at some point the standard fell below, I think it was what? 1.2 or 1.1 times book value, and that was their line, where they felt that's when they can start buying back. But then they changed that and it basically just said wherever Warren and Charlie feel like there's value there they're going to go ahead and green-light it.

Frankel: Now, it says that whenever Buffett and Munger agree that it's trading for a significant discount, that's how they put it to its intrinsic value. If both Buffett and Munger agree and they leave at least $30 billion in reserves, then they could buy back shares whenever they want. Right now, Berkshire has, even after all those buybacks, $144 billion in cash. There's a little bit of wiggle room left. They could have bought back a lot more. Berkshire actually breaks down the buybacks by months in its quarterly reports.

Moser: Yeah. I did notice that.

Frankel: You could see like when they thought it was a particularly good deal and it's not always when the share prices are lowest. This time, they apparently thought June was the biggest buyback month of the quarter. Wasn't necessarily, the share price was the cheapest, it wasn't. It's just based on a combination of the share price and what's going on with their businesses. Buffett's assistant is in the office all day and tries to calculate this stuff, no one knows the secret sauce there. But they both apparently agree that the business is trading for a significant discount to the actual true value of the sum of the parts.

Moser: Yeah.

Frankel: They didn't make any major acquisitions in the second quarter. We know and I will talk about this in a second if you want, but they didn't really do a lot of stock buying in the second quarter. But they apparently thought that their own stock was the best place to put money to work. When you're considering an investable universe of 5,000 stocks or whatever it is, that's saying a lot.

Moser: That is saying a lot. I'm glad that you brought that up because that leads me into my next question really, and I'd love to get your take on this because you noted that they didn't do a whole heck of a lot of buying on the open market and adding to their investment portfolio. I think I saw the numbers, they sold some, they bought some but it wasn't anything out of control there. It certainly wasn't in line with the amount of money that they spent buying their own stock. That just didn't really feel like a surprise at this point. It does feel like, you know what you're going to get with this business, you got Warren and Charlie running the show here, it's Berkshire Hathaway, you know what you're getting. By the same token, and we talked about this all the time, investing is about the future, it's about what's going to happen. We have to start looking at Berkshire Hathaway through the lens of Greg Abel and Todd, and Ted, right? These are the three big names, who are going to have a lot to do with where this business goes in the coming decade and beyond. 

Of course, Warren and Charlie, if they've stuck within their circle of competence, so to speak, don't feel like they really have that prowess when it comes to tech, which is probably not the greatest time, because tech is really just proliferating in every way. What do you think the Berkshire Hathaway of the future looks like? It feels like this business may have to make some kind of meaningful pivot, I don't want to say remain relevant, but at least in order to grow, in order to stay at the top of the conversation for investors over the next decade and beyond, it feels like they're going to have to make some kind of a pivot there.

Frankel: There's a lot of speculation as to what the Berkshire of the future might look like. It could look very much like it does today, in which case, a lot of investors are going to think it's boring, like you just alluded to. Greg Abel, he's going to be in charge of the non-stock portfolio side of the business for a large part. Ted and Todd are going to have pretty much full control of the investments. They have been taking more of a tech-focused approach, the newer companies. They were where the Snowflake investment came from, they were where Berkshire's Amazon stake came from. 

Moser: The Brazilian payments investments.

Frankel: Right. The Brazilian investments, they were the ones who first bought Apple's stock in the portfolio and they've done really well so far. A lot of people think that eventually some parts of Berkshire's business might be spun out. That's another thing that I've heard, some of the more legacy slow-growing, capital-intensive businesses like the utilities, maybe that could be spun out eventually. I don't necessarily see that happening, but there has been speculation to that. I think the new management will be more aggressive in deploying that capital. Because today's investors don't want a stockpile of cash, they want you to put that to work. Whether that's the right or wrong way to go is not for me to say. But a lot of investors, myself included, are not fans that there's $140 billion of cash sitting on the sidelines.

Moser: It's a lot of money.

Frankel: Do something with it. Buy back $140 billion a year on stock, but do something with it. I could see the incoming investment managers who currently only manage a small percentage of the portfolio. I want to say it's like $12 billion between the two of them of a $300 billion stock portfolio.

Moser: Yeah.

Frankel: They don't have a ton of control just yet, but once they have full control, I can see it being more of a modern portfolio. You'll find a lot of the more growth for your stocks we talk about in there at some point in the future, and I can see them being more aggressive with deploying capital.

Moser: I think it just goes back for businesses, allocating capital, it's difficult to do. It's nice to have all of that money, but you gotta be able to do something with it, and that's really what you're paying your talent to do. I'm not a shareholder in Berkshire Hathaway, if I were, I would be asking that question. Why do you have so much cash on the balance sheet? Isn't there something you can do with it? Buying back stock is one thing, you could argue the dividend, of course. Perhaps they feel like valuations are stretched. There's just not an acquisition that really is speaking to them at this point. But yeah, it does feel like that is something that just feels like the drumbeat is going to only get louder until they actually do something with it.

Frankel: Yeah, there are so many options, they don't have to acquire a full business. Buffett mentioned the whole SPAC boom has really pushed business valuations up to the stratosphere, at least to where he won't want to be too interested in them. They could put more money into the stock portfolio. Like I mentioned, there's an investable universe of thousands of stocks they can potentially choose from, I mean if Buffett likes Apple and Bank of America so much, buy more of them. Buffett has said before, if we could buy all of Apple, we would, put your money where your mouth is, you got $100 million buy some more of it. That's where my head is at, if you like these stocks so much, I don't get the proportions, I guess, buy a little bit more of some of these. If you have that much cash sitting around and you still like them as investments.

Moser: Yeah, that'll be a fascinating thing to watch here in the coming years. What Berkshire Hathaway looks like over the course of the next decade, I think it's going to be a story that many investors will pay attention to because I have a feeling that there are going to be some traditions and some nostalgia that remain. It just feels to me like this is a business that's really going to have to make a leap or a pivot to become that Berkshire Hathaway of the 21st century that hadn't gotten there yet. You said the word boring, and boring oftentimes can lead to some of the best investments. But boring can also become a little bit staid and stale, and so you have to always keep that in mind, particularly in this fast-changing world. It'd be a fun one to follow. 

Matt, we got a question on Twitter the other day from Matt Bayer, @MattBayer asks, "Thoughts on municipal bond funds as a pretty safe place to store some cash for a year while making a bit of return." We get questions like this in some form or another fairly often. Folks looking for a way to squeeze some type of return out of the cash that they have across a shorter timeline. Typically we say if you have money that you know you're going to need within the next three years or less, you really should be thinking long and hard before you invest that in the market. Because you can put yourself in a situation where you become a desperate seller. Nobody wants to do that. Obviously, bonds, a little bit of a different dynamic to bonds as opposed to the stock market. I'm wondering if you had any insight here, particularly given your certified financial planner status. 

Frankel: I don't want to just answer this from the municipal bonds angle. They have their own benefits specifically that they're tax-free. You don't have to pay tax on the interest you get. But a lot of people think bonds are better investment right now than just leaving some of your money in cash. There's some logic to that to be fair. I don't know what your savings account is paying right now, but I'm 100% sure mine's paying anything.

Moser: I was going to say it may not [laughs] be paying anything at all, but it's possible I saw something like a nickel worth of interest the other month, I think.

Frankel: It's nothing.

Moser: No, it's not reportable.

Frankel: Bonds are not paying a ton right now, but they are paying a lot more than 0.01% that some savings accounts are paying. It's a natural place for investors to put it. What I will say about bonds is that that's good logic. If you're going to buy a bond and hold it to maturity. For example, if I buy a 10-year Treasury bond paying 1.5% and hold it until it expires 10 years. I'm going to get those 1.5% interest payments semi-annually for the next 10 years and at the end of the term, I'll get my money back. On a shorter-term basis, bond valuations do fluctuate. If you look at a chart of any municipal bond fund or Treasury bond fund, I'm looking at the Vanguard total bond index fund as one of my favorites. Ticker symbol is BND, that's what I'm looking at right now as I'm talking. The chart fluctuates, things aren't completely stable investments. The benefit to a savings account is if I put $100 in a savings account, in six months that's going to be worth $100 roughly.

Moser: Yeah.

Frankel: If I put $100 into a bond fund, it's not going to fluctuate tremendously, but it could be worth $98, $96, $102. It's not just the interest you're getting because the value of those bonds that the fund holds fluctuate over time and the reason they fluctuate over time. The primary reason is interest rates. I don't want to get too mathematical or technical here, but the key point to note is that bond values and interest rates have an inverse relationship. If Treasury yields spike, the value of existing bonds goes down. If Treasury yields fall, the value of existing bonds go up. Treasuries and most funds are paying historically low interest rates right now. There's a little room to the downside and a lot of room for interest rates to rise. As interest rates rise, let's say that the economy overheats, the Fed has to raise rates and the 10-year Treasury yield spikes 3%. That would push the value of your bond funds down, so it's not as risk-free of an investment as you might think, it's a lot lower risk than putting your money in the stock market. But as compared to putting in a savings account right now, that bond fund I mentioned pays just under 2% dividend yield or interest rather. You're not getting that for free, you're taking on a little bit of risk to get that. There's no such thing as risk-free returns right now. A popular economic concept is risk-free returns.

Moser: Yeah.

Frankel: At a normal time, you can get that by buying like a three-month Treasury which right now pays like nothing.

Moser: Take a risk out of bed in the morning, right, Matt?

Frankel: Right. If you're buying any type of municipal bond fund, unless it's very short-term, which probably doesn't pay much. You are taking some risk to your principal as interest rates fluctuate. That bond fund I mentioned, the share price has fluctuated over the past year between about $84 a share and about $88 a share.

Moser: Oh, wow.

Frankel: Not a ton of volatility when you think about some of the stocks we follow.

Moser: Yeah, they're still there.

Frankel: The price isn't going to double, but there is risk. I mean, that's volatility, so it's more volatile than a savings account, which is what you need to know going in.

Moser: Good to know. Well Matt, before we take off, let's give our listeners a couple of stocks to watch. What is one stock you get your eye on this week?

Frankel: One that I talk about somewhat often on this show we've had the CEO on before. It is Latch (LTCH -15.00%), LTCH recently went public through a SPAC. They report the first earnings of theirs as a public company on Thursday. Now that they have all this SPAC money burning a hole in their pocket, I'm curious to see what they're doing with it, and how it's translating into earnings. Remember with Latch, it's not revenue to pay attention to its bookings. Remember Latch books their revenue a few years before they actually receive it. Because they are putting their product on newly built apartment buildings, which could take years to plan and build. Pay attention to bookings and growth in bookings, not just revenue, when Latch reports on Thursday and if the numbers look good, I think it's a big positive for the stock.

Moser: Yeah, absolutely. I'm keeping an eye on Unity (U -1.22%). Software earnings for Unity come out on Tuesday after the market closes. This is one that I've been following for a while now. To me, if it was really interesting watching this business come public because it was known as a gaming engine, one of their main goals has been to make that leap from being just a gaming engine to becoming what ultimately is seen as a creation engine where its customers in household appliances and automotive and healthcare and aerospace. They want to be seen as a creation engine for all sources of the markets. I think they're pulling it off pretty nicely. I had initially projected that they should cross $1 billion of revenue no later than 2022. It sounds like they are going to cross that $1 billion revenue mark this year 2021, so that's nice to see and a lot of that is because you see customers signing on, staying on, and then continuing to grow their relationships. Last quarter, I believe they reported 837 customers that generated more than $100,000 of revenue each over the last year for the company. 

We'll pay attention to that big customer metric, we'll pay attention to that dollar-based net expansion rate. That was 140% last quarter versus 133% from a year ago, and it feels like to me, it's still so new to the public markets. We're still letting all of their financial shakeout from the IPO. But the metrics, the key performance indicators really you're telling the story here above, a company whose services are in high demand so we'll be looking for that to continue. But Matt, I think that's going to do it for us this week, I appreciate taking the time down from sunny Florida. I'm sure you are looking to get out there to Disney World or one of the parks right now. I appreciate taking some of the time and your day to join us here and share with our listeners.

Frankel: I'm going to the pool, who wants to walk around Disney in August? 

Moser: It's a good point. I'll take that and I appreciate that. Enjoy then and we'll look forward to connecting again next Monday. Remember folks, you can always reach out to us on Twitter @MFIndustryFocus, or you can drop us an email at [email protected]. As always, people on the program may have interest in the stocks they talked about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Thanks as always to Tim Sparks for putting the show together for us. For Matt Frankel, I'm Jason Moser. Thanks for listening and we will see you next week.