Berkshire Hathaway (BRK.A -0.79%) (BRK.B -1.09%) is a large, highly diversified conglomerate. So if you want to own Berkshire Hathaway stock, it's crucial that you understand exactly how the company makes money.
A breakdown of Berkshire's earnings
Though there's many ways to slice the pie, Berkshire's income can be categorized into four different primary business segments:
1. Insurance
2. Regulated capital-intensive businesses
3. Manufacturing, service, and retailing operations
4. Finance and financial products
Source: Berkshire Hathaway 2012 annual letter to shareholders.
The insurance segment is "Berkshire's core operation and the engine that has propelled our expansion over the years," Warren Buffett said in the company's 2012 annual letter to shareholders. Insurance companies primarily make money in two ways:
- Underwriting profits: the spread between the premiums paid for insured coverage and the claims that insurance companies pay out.
- Investment income: the interest and dividends earned on the "float," or the premiums paid up front that are held in cash and investments to be paid out later.
The regulated and capital-intensive segment is made up of Burlington Northern Santa Fe, or BNSF, and MidAmerican Energy (89.8% owned). With their heavy investment in long-lived, regulated assets, Buffett feels it necessary to set these two giants apart from the rest. Together, these two companies attributed a whopping $4.7 billion to the bottom line in 2012.
The majority of Berkshire's acquired subsidiaries fall under the manufacturing, service, and retailing operations segment. Talk about diversity, as Buffett recently said, "The crowd of companies in this section sell products ranging from lollipops to jet airplanes." Here's just a few: NetJets, Brooks, Fruit of the Loom, See's Candies, Justin Brands, and Helzberg Diamonds. Businesses in this segment, overall, possess excellent economics. On $22.6 billion of net tangible assets, these businesses earned a 16.3% return in 2012.
Berkshire's smallest segment, finance and financial products, includes rental companies, Clayton Homes (the country's leading producer of manufactured homes), and a 50% owned collection of financial assets in Berkadia Commercial Mortgage. Why would Clayton Homes be in a segment called finance and financial products? Because it owns and services 332,000 mortgages, totaling $13.7 billion.
Truly Barney style
The composition of Berkshire's earnings is definitely not an exact representation of the composition of the stock's value. But it's a great start for any investor beginning due diligence on Berkshire Hathaway stock.
