It's been an "interesting" year on Wall Street. I say interesting with quotes because we've witnessed some truly unprecedented economic data and headlines. In no particular order, we've:
- Watched the U.S. inflation rate soar to levels not seen since the early days of the Reagan administration.
- Seen Russia's invasion of Ukraine cripple an already fragile energy supply chain.
- Borne witness to back-to-back quarters of U.S. gross domestic product declines that hasn't officially been labeled as a recession.
- Witnessed the Federal Reserve begin a monetary tightening cycle with the stock market in a notable decline.
As if this wasn't enough, Wall Street was graced with an eye-popping headline following the release of Berkshire Hathaway's (BRK.A -0.10%) (BRK.B -0.36%) earnings report on Aug. 6, 2022. In the three months ended June 30, 2022, Berkshire Hathaway lost -- and I hope you're sitting down for this -- $43.76 billion dollars.
How on Earth did Berkshire CEO Warren Buffett, one of the greatest investors of our generation, manage to lose almost $44 billion in three months' time? Let me spoil it for you: All is not what it seems in Berkshire's quarterly earnings report.
Berkshire Hathaway's historic quarterly loss isn't what it seems
Back in 2016, the Financial Accounting Standards Board passed new measures aimed at making corporate income statements, and generally accepted accounting principles (GAAP) reporting, more transparent for investors. One of these measures, ASU 2016-01 ("Recognition and Measurement of Financial Assets and Financial Liabilities"), eliminated the need to classify various categories of equity investments and, instead, required that equity investments be measured at fair value. This meant that changes in equity investments from one quarter to the next would be recognized as net income, or a net loss. Berkshire Hathaway officially adopted this accounting change in its reporting beginning in 2018.
In simpler terms, the closing price of Warren Buffett's investments on March 31, 2022 represented their fair value at the end of the first quarter. Comparably, the closing price of securities on June 30, 2022 represented their fair value at the end of the second quarter. In addition to counting the realized gains and losses recognized by selling stocks, ASU 2016-01 requires Buffett's company to recognize the unrealized gains and losses as a result of share price movements in its investment portfolio from one quarter to the next.
During the second quarter, the three major U.S. stock indexes were pummeled. The timeless Dow Jones Industrial Average, broad-based S&P 500, and tech-centric Nasdaq Composite respectively plunged by 11.3%, 16.5%, and 22.4% in a three-month stretch. Not surprisingly, Berkshire Hathaway's investment portfolio took it on the chin as well. This resulted in a staggering "loss" of $66.9 billion from investments and derivative contracts in just three months, and the aforementioned net loss of almost $44 billion for the second quarter.
Warren Buffett's company is as strong as ever
Did Warren Buffett lose close to $44 billion in three months? On paper, and based on financial requirements, yes. But when looking at what counts, this was another successful quarter for the Oracle of Omaha and his company.
To begin with, Warren Buffett and his investing lieutenants, Todd Combs and Ted Weschler, aren't traders. While they might chase the rare arbitrage play or high-yielding stock in an inflationary environment, most of Berkshire Hathaway's more than four dozen holdings are longer-term investments. In fact, the Oracle of Omaha has continuously held 15 stocks for at least a decade. Stocks are always going to ebb and flow, which makes unrealized gains and losses something of a moot point in Berkshire Hathaway's quarterly operating results.
A far better measure of Warren Buffett's success as an investor can be found in his annual letter to shareholders. In that letter, investors can see that Berkshire Hathaway's Class A shares (BRK.A) have averaged a 20.1% annual return since the Oracle of Omaha became CEO in 1965. Imagine averaging a 20.1% annual return for 57 years!
To add, "unrealized losses" is simply another phrase that means opportunity for Warren Buffett. A declining stock market provides the Oracle of Omaha and his investing team with the opportunity to deploy their mammoth cash pile into stocks, acquisitions, or even share buybacks. The plunging stock market during the second quarter allowed Buffett to buy $57.3 billion worth of equity securities, as well as $1 billion worth of the company's Class A and B common stock. Buffett and his right-hand man Charlie Munger have overseen $62.1 billion in aggregate stock buybacks since July 2018.
Another thing for investors to note is that Berkshire Hathaway's over five dozen owned entities performed extremely well during the challenging second quarter (Q2). Total insurance earnings hit $3 billion, which was up from $1.9 billion in Q2 2021, while railroad BNSF saw its quarterly profit rise to $2.15 billion from $1.98 billion in the prior-year quarter. All told, Berkshire Hathaway's operating businesses increased their net income to $10 billion in Q2 2022 from $8.6 billion in the prior-year period.
Sure, Warren Buffett oversaw a nearly $44 billion "loss" in the second quarter. However, his company is as strong as it's ever been.