Portfolio manager’s Letter February 2011
Whitney Tilson says that Berkshire Hathaway’s fourth quarter could be “the mother of all quarters”. He offers no estimate of 4th quarter (the mother of all quarters), but then neither does anyone else because estimating Berkshire Hathaway’s quarterly estimates is a fool’s game with just too many unpredictable variables. Even if you guess close on the gain or loss on the equity puts, you still have to guess on the gains on investments, because you do not know what Buffett has sold, or when he sold it, and you also have to guess on gains (or losses) from credit default swaps.
By all rights, these issues should put estimating earnings as an activity that belongs in the “too hard” pile. Clearly, this is where it has been placed by security analysts, most of whom will not follow Berkshire Hathaway, because their discipline requires estimates, and these estimates are too difficult.
On the other hand, there is value in trying. Since no one else is trying, maybe you get a trading edge even though you will occasionally look stupid. Given all of the above, what follows cannot really be classified as an estimate, but as more of a (educated?) guess (what engineers call a W.A.G.).
Berkshire Hathaway’s pretax operating earnings for the first nine months of 2010 were $12.7 billion. To estimate after tax net for 2010, add an estimate for the fourth quarter (the mother of all quarters) of 2010 $4,500 – 5,000 million (with BNF), and Losch Management Company get a total pretax operating income for the year of $17.2 – $17.7 billion.
To this we add an estimate of investment gains and derivative gains. As of the end of the third quarter, investment gains were $2.7 billion, and the derivative showed a $1.7 billion loss. During the 4th quarter (the mother of all quarters), Berkshire Hathaway sold off the last of Lou Simpson’s portfolio, so Investment gains should be about the same as the third quarter ($500 million). The total for the year would be about $2.7 billion. Estimating the derivative gains is very difficult. So far, all of the derivative loss for the year was in equity puts.
The three major factors in marking the equity puts are:
The Table below is an attempt to track some of these factors.
The 4th quarter of 2009 comes closest to showing changes similar to what we know so far about the 4th Quarter of 2010 (the mother of all quarters), with the Stock averages a little weaker in 2009, the Dollar index a little less favorable, and volatility a little more favorable. The Dollar will not track Berkshire Hathaway options perfectly, but all we are hoping for is a close guess.
In any event, based on the above, I think we can expect Berkshire Hathaway’s derivative gains to be between $1.1 billion and $1.4 billion. This assumes that the gains on the credit default swaps remain about the same as they were in the 3rd quarter. Using this figure for the 4th quarter (the mother of all quarters) will leave a loss for the year of $500-$800 million. If we add all of the above together we get:
|Operating earnings plus for 2010||$17.1 – $17.7 billion|
|Investment Gains||$2.7 billion|
|Derivatives Loss||-$0.8 – +$2.5 Billion|
|Gain from redemption of Swiss Re Preferred||$1.2 Billion|
|Total Taxable Income||$20.2 – $23.53 Billion|
|Tax @ 35%||$7.7 – $8.2 billion|
|After Tax Income||$12.5 – $15.3 billion|
|Per Share||$7,600 – $9,300|
While all of the above numbers have question marks attached, some things would appear obvious. 2010 could be a record year for Berkshire Hathaway. Previously, the best year was 2007, with $13.2 billion net. Berkshire Hathaway has a good chance of a 60% gain over last year’s earnings. Is this enough to make the “The Mother of All Quarters”? I doubt it, and how Mr. Market will react to these earnings is hard to figure, but Whitney apparently thinks they will be considered a positive surprise, and with this I am inclined to agree.
To this you can add something like $1,500 to $1,800 per share in look through earnings, if you want. This means that the current price is in the area of 11 to 12 times earnings which may, or may not be super cheap, but is certainly about as cheap as Berkshire Hathaway has ever been. In 2000 when Buffett offered to buy back stock at $45,000 per share, earnings per share were $1025, look-though earnings would have been about $600 per share so Buffett was offering to purchase at 28 times earnings plus look-though.