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Mind the Step, Warns the Oracle

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2023-05-07

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Warren Buffett’s Berkshire Hathaway has started 2023 in a solid fashion, but he has questioned how long that will last with a rare earnings downgrade.

The company had a good first quarter - operating earnings (without unrealised share market gains) up 12.6% to $US8.07 billion from $US7.16 billion a year ago and a statutory profit of $US35.5 billion including unrealised gains, from $US5.58 billion, a year ago (when there were unrealised market losses)

The surge in statutory profits with those market gains was due solely to the jump in the value of Berkshire’s Apple shares in the quarter - from $US119 billion at the end of December, 2022 to $US151 billion at the end of March.

But that’s about as good as it will get for this year, according to Buffett who told Berkshire’s annual meeting in Omaha, Nebraska at the weekend that shareholders had better get used to the prospect of lower earnings for the year ahead.

The 92-year-old investor expects earnings at the majority of Berkshire’s operations to fall this year as a long-predicted downturn slows economic activity across the US economy.

“The majority of our businesses will report lower earnings this year than last year,” Buffett told upwards of 40,000 people at the annual meeting.

He said that during the last six months or so, the “incredible period” for the US economy has been coming to an end.

Berkshire’s more than 90 businesses spanning most of the US economy - from railroads to power generation, distribution and sale, car sales, homes, real estate, clothing and footwear, retailing distribution and marketing, roadside services, manufacturing, aviation and its huge insurance businesses.

That’s why Berkshire is often seen as a proxy for the health of the US economy.

Buffett’s long-time business partner Charlie Munger, 99, who joined him on stage at the meeting said the more difficult economic environment will also make it harder for value investors, who typically buy stocks that look cheap compared to the intrinsic value of the businesses.

“Get used to making less,” Munger said.

Still, Buffett remained confident that his most troubled business is insurance underwriting operations — especially car insurance giant Geico will improve this year.

Berkshire already reported higher earnings at those businesses including auto-insurer Geico, which swung to profitability following six quarters of losses in the three months to March.

But it’s no wonder Buffett again lauded Berkshire's investment in Apple as the best in the company’s $US318 billion portfolio.

Thanks to a 27%-plus gain in the price of Apple shares and helped by higher returns from investments and insurance, Berkshire’s statutory profit soared.

Apple’s gain helped offset share price weaknesses elsewhere in the company’s huge portfolio.

That huge rise to $US35.5 billion in the statutory profit saw Buffett and Berkshire again caution investors to not pay attention to quarterly fluctuations in unrealised gains on investments.

“The amount of investment gains (losses) in any given quarter is usually meaningless and delivers figures for net earnings per share that can be extremely misleading to investors who have little or no knowledge of accounting rules,” Berkshire said in a statement.

The 12.6% rise - to $US8.07 billion, from $US7.16 billion - in operating earnings came from the improvement in Berkshire’s huge insurance underwriting which saw a rise to $US911 million, from $US167 million a year earlier.

Insurance investment income also jumped 68% to $US1.969 billion from $US1.170 billion, thanks to higher interest rates.

But Berkshire's railroad business, BNSF, along with its energy company saw a weakening in year-over-year earnings. Operations classified under “other controlled businesses” and “non-controlled businesses” had slight increases from the year-earlier period.

As expected Buffett's company bought another 41.4% of truck stop services group Pilot Flying J. Under the original purchase agreement, Berkshire had to spend $US8.2 billion, increasing its stake to 80% this year.

Pilot contributed $US9.5 billion of revenue and $US83 million of net earnings to Berkshire in the two months ending March 31.

Berkshire sold $US13.3 billion of shares, and only bought $US2.9 billion worth, meaning it sold $US10.4 billion of equities on a net basis. It spent $4.4 billion on buybacks in the March quarter.

The company lifted its cash pile to $US130 billion (a rise of $US2 billion) at the end of March - that’s the highest it has been since 2021.

He is obviously building a cash pile for the expected downturn, which may present ‘shopping’ opportunities.

Warren Buffett told Berkshire’s annual meeting on Saturday that Apple is a better business than any other in Berkshire Hathaway's portfolio.

"Apple is different than the other businesses we own. It just happens to be a better business,” Buffett told the annual meeting in Omaha, Nebraska.

Berkshire revealed a $US1 billion stake in Apple in May 2016, and by March this year, had boosted that stake to $US151 billion (via a combination of share purchases and higher share prices), accounting for 46% of its $328 billion equity portfolio. Last week’s four cents a share lift in Apple’s dividend gave Berkshire an extra $US214 million in investment income.

Buffett also told the meeting that his company doesn’t plan on taking full control of Occidental Petroleum which was the focus of Berkshire’s investment direction last year. the company controls around 24% directly and more via unlisted securities.

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A standout from the meeting was Buffett’s commentary on the current US regional banking problems.

He was voluble about the current fears for the stability of America's regional banks.

He took aim at bank executives who took undue risks, saying that there should be “punishment” for bad behaviour.

Some bank executives may have sold company stock because they knew trouble was brewing, he added.

For example, regional bank First Republic was seized by regulators and sold to JPMorgan after a deposit run, sold its customers huge home mortgages at low rates, which was a “crazy proposition,” he said.

“If you run a bank and screw it up, and you’re still a rich guy… and the world goes on, that’s not a good lesson to teach people,” he said.

Berkshire has been unloading bank shares in the past three years or so, selling down its once large holdings in bank stocks with shares in Wells Fargo and JPMorgan going, along with holdings in smaller banks such as US Bancorp.

But Buffett has held onto shares in Bank of America where his company is the largest single shareholder, as he explained to the meeting.

“We do remain with one bank holding. I like Bank of America; I liked the management and I proposed the deal for them. So I stuck with it,” said Buffett.

Berkshire also assailed banks, executives, regulators and the media for stoking fear in the sector.

“The situation in banking is very similar to what it’s always been in banking, which is that fear is contagious,” Buffett said. “Historically, sometimes the fear was justified, sometimes it wasn’t.”

Recent events have only “reconfirmed my belief that the American public doesn’t understand their banking system,” Buffett said.

He reiterated several times that he had no idea how the current situation will unfold.

“That’s the world we live in,” Buffett said. “It means that a lighted match can turn into a conflagration, or be blown out.”

He told thousands of shareholders that Berkshire’s $US130 billion cash pile would be used to help banks if needed.

“We want to be there if the banking system temporarily gets stalled in some way,” he said. “It shouldn’t, I don’t think it will, but it could.”

The core problem, as Buffett sees it, is that the public doesn’t understand that their bank deposits are safe, even those that are uninsured.

He said regulators and Congress would never allow depositors to lose a single dollar in a US bank, even if they haven’t made that guarantee explicit.

The fear of regular Americans that they could lose their savings, combined with the ease of mobile banking, could lead to more bank runs.

Meanwhile, Buffett said that he keeps his personal funds at a local institution, and isn’t worried despite exceeding the threshold for FDIC coverage of $US250,000 per deposit.

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