Portfolio manager’s Letter May 2006
I like to watch Berkshire Hathaway’s table of Operating Earnings (page 47 of the 2005 Annual Report), In order to get a picture of internal growth and to sort through some of the lumpy stuff like hurricanes and capital gains. In the table below I break out three main three main operating categories; Underwriting Gains, Investment Income, and Income from operating businesses (19 year because my collection of Annual Reports only goes back to 1989).
From the table we can see that Total pretax Operating Income has grown from $329 million in 1987 to $7.5 Billion in 2005. The growth for the 19 year period works out to annual rate of 19% which is not bad for a company the size of Berkshire Hathaway, but what is more interesting to me is that the rate for the last ten years is 24%. Better yet the growth rate for the last 5 years is also 24%.
Operating Profit for the non-insurance operating business has grown from $204 million to $4 billion and here again if you look at the bottom of the table you will see that ten year growth (28%) has outpaced the 19 year figure (18%). In this case though, the five year pace (23%) is off from the ten year figure but still stronger than the 19 year pace.
I think these figures are interesting because while operating earnings where not particularly significant in valuing Berkshire Hathaway 19 years ago, or ten years ago, they have now grown to the point that they will soon overwhelm all other valuation metrics. While it would seem obvious that Berkshire Hathaway’s huge size means it will not continue to grow as it has in the past it, appears to me that Wall Street is underestimating the Companies current growth and future potential. It is important to remember that the last five years have not provided the kind of environment in which Berkshire Hathaway is designed to work best.
Berkshire Hathaway is sitting on $40 some billion cash which has had a negative impact on the growth of investment income. With the world awash in cash for the last five years (as Asian Central Banks discovered how to stimulate the American consumer) it has been difficult for Warren Buffett to find investments that offer attractive returns.
In spite of this Berkshire Hathaway has been able to increase the operating income of it’s owned non insurance businesses at a rate of 23% per year. Nor have the last two years been great years for the insurance business, with hurricane losses of $1.25 billion in 2004 and $3.4 billion in 2005. If 2005 had been storm free Berkshire Hathaway would have had an enormous pre tax underwriting profit of $3.4 billion.
The Table above has lead be to me to review my past growth estimates. In particular I wonder about the estimate from portfolio manager’s letter june 2005 “Warren Buffett Premium“. My thinking at the time was that Berkshire Hathaway’s intrinsic value growth rate must have been 10% to 12% since 2000; otherwise Berkshire Hathaway would have been buying back stock.
On reflection, and in the face of the above I believe that Berkshire Hathaway’s intrinsic value is probably growing faster than 12% per year. I used to feel that 15% growth was not out of the question, but had backed off that view because 15% percent growth would have meant the stock has been trading below Warren Buffett’s theoretical buy-in price for quite a while. So why if Berkshire Hathaway is a better value now than it was in March 2000 has Warren Buffett not announced a buy-back.
But actually, if you think about it, there may be a lot of good reasons that Warren Buffett would not want to do a buy-back now, including but not limited to the fact that he does not want to talk the price of the stock up at this particular time; or that he will be able to buy it cheaper later; or that he feels that it is probably in the best interest of shareholders to leave the money where it is.
|Year||Underwriting Gain||Investment Income||Operating Businesses||Total Operating Income (Before Tax)|
|Investment Income||Operating Businesses||Total Operating Income|