Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) (NEOE:BRK:CA) reported earnings for Q2 on August 3rd and delivered a solid operating performance: In the June quarter, revenue increased 1% YoY, while, operating income jumped 16% YoY. Most interesting, however, I think, is Warren Buffett’s ongoing effort to swap equity holdings for cash and cash like securities (e.g., Treasuries). In the first quarter of 2024, Berkshire Hathaway’s cash pile reached a new record of $271 billion, as Buffett likely sold a net of $77 billion worth of shares over the past 3 months ending June. According to my knowledge, there has never been a quarter where Berkshire sold equities more aggressively, in terms of dollar-value, than in the past quarter. In addition, Buffett also aggressively slowed the pace of share buybacks, to $345 million for the past quarter. Overall, I expect markets on Monday to respond friendly towards BRK shares, as the conglomerate’s record operating performance raises little argument for concern, in my view.
Post-Q2, I value BRK.B stock with a residual earnings model based on consensus EPS projections through 2026, in combination with an 8.5% cost of equity and a 2% terminal growth rate, suggesting that BRK.B shares could be about 5-6% overvalued on a $404 target price. I assign a “Hold” recommendation.
For context, since the start of the year, Berkshire Hathaway shares have notably outperformed the broader market: YTD, BRK stock is up about 20%, compared to a gain of approximately 12% for the S&P 500.
Seeking Alpha
BRK Beats Earnings Estimates
Berkshire reported strong Q2 2024 earnings, generating approximately $93.6 billion of revenues during the period spanning from April through the end of June, marking a 1% YoY increase. Notably, this growth was primarily driven by higher insurance premiums, increasing from $65.6 billion in Q2 2023, to $68.4 billion in Q2 2024, up 4% YoY. Meanwhile, Revenue in the Railroad segment dropped $100 million, to $5.7 billion (down 1-2% YoY), and revenue in the energy business fell $1.6 billion, to $18 billion (down 8% YoY). Revenue in the Service and Other business was about flat, at $1.5 billion. Overall, revenue came in slightly below consensus estimates at $95.7 billion, according to data compiled by Refinitiv.
BRK Q2 results
On the profitability front, Berkshire boosted group operating earnings by about 16% YoY, reaching $11.5 billion. Similar to trends seen in the topline performance, this increase was mainly fueled by the insurance sector, with operating income from underwriting up 82% YoY and insurance-investment income up 41% YoY. In contrast, operating income for the railroad and the energy business decreased slightly YoY.
BRK Q2 results
Insights On Capital Allocation Point To Risk-Off
Investing in Berkshire Hathaway stock is all about trusting Warren Buffett’s (and his team’s) ability to allocate capital. On that note, the insights for Q2 2024 are very interesting — as Buffett continues to swap billions of stock for cash, and cash-like securities.
Balance Sheet: Cash Hits Another Record
In the first quarter of 2024, Berkshire Hathaway’s cash pile reached a new record of $271 billion, well ahead of Warren Buffett’s previous projection at the shareholder meeting in Omaha that cash could exceed $200 billion by the end of the current quarter. In more detail, cash and cash equivalents increased to $36.9 billion (compared to $33.7 billion at the end of December 2023), while short-term investments in U.S. Treasury Bills surged to $234.6 billion (compared to $129.6 billion at end of December 2023).
BRK Q2 results
Equity Out, Treasuries In
In Q1, sales of equity securities were about $19.97 billion only, which suggests that Buffett sold an eye-watering ~$77 billion worth of equity in the June quarter. At the same time, Buffett’s Berkshire Hathaway has only purchased $4.3 billion worth of stock over the past 6 months, of which $2.7 billion has been repurchased in Q1. Thus, it is fair to say that Buffett is grossly accelerating equity sales, while equity purchases are slowing. While it is not clear which equities Buffett has sold in the past quarter, regulatory filing suggests that the stake in Bank of America (BAC) has likely seen a large sell-down, paired with an ongoing “dumping” of Apple (AAPL) shares. Indeed, as of the end of Q2, Berkshire Hathaway owned approximately $84.2 billion worth of Apple, down from $135.4 billion at the end of Q1. Given that Apple stock increased by 22.82% during the quarter, which suggests that Buffett may have sold roughly half of his Apple holdings during Q2. We will have a more detailed view on Berkshire’s equity portfolio by August 15th, through the quarterly SEC 13f disclosure.
Pointing to Buffett’s net sale of equities, it is important to highlight that most of the freed cash is flowing to fixed-income securities, specifically U.S. treasuries. Over the past six months, Berkshire bought $229.5 billion worth of Treasuries, more than double the $99 billion purchased over the same period one year earlier. Meanwhile, redemptions in H1 2024 jumped to $120.5 billion, compared to $59.8 billion in 1H 2023.
BRK Q2 results
Shifting perspective on the cash flow statement down towards cash flow from financing activities, it is interesting to highlight that Buffett’s relative dislike of equity securities also extends to securities of Berkshire: In Q2 2024, the pace of share buybacks slowed to $345 million, down from $1.4 billion repurchased in Q2 2023. For 1H, buybacks amount to $2.9 billion (compared to $5.9 billion in 2023).
BRK Q2 results
In my view, the expectation of a lower Fed funds rate over the next 1-2 years is a major driver behind Warren Buffett’s decision to swap equities for fixed income. Here is why: As expectations for rate cuts in 2024 have turned decisively dovish, Buffett is likely aiming to allocate capital towards “overvalued” Treasury yield.
Valuation: Set TP AT $404
As Buffett is slowing share buybacks, let’s try to calculate the fair value of the Berkshire conglomerate. In my opinion, companies with stable and relatively predictable business fundamentals, such as BRK, can be accurately and precisely valued using a residual earnings model. This model is based on the principle that a company’s valuation should be equal to its discounted future earnings after accounting for the capital charge. As per the CFA Institute:
Conceptually, residual income is net income less a charge (deduction) for common shareholders’ opportunity cost in generating net income. It is the residual or remaining income after considering the costs of all of a company’s capital.
With regard to my BRK.B stock valuation model, I make the following assumptions:
- To forecast EPS, I anchor on the consensus analyst forecast as available on the Bloomberg Terminal till 2026. In my opinion, any estimate beyond 2025 is too speculative to include in a valuation framework. But for 2-3 years, analyst consensus is usually quite precise.
- To estimate the capital charge, I anchor on BRK.B cost of equity at 8.5%, which is approximately in line with the CAPM framework.
- For the terminal growth rate after 2025, I apply 2%, which is about in line with estimated nominal global GDP growth and reflects Buffett’s skew towards value, rather than growth.
Given these assumptions, I calculate a base-case target price for BRK.B stock of about $404/share.
Analyst Consensus; Company Financials; Author’s Calculations
I acknowledge that investors may hold varying assumptions regarding these rates. Therefore, I’ve included a sensitivity table to test different scenarios and assumptions (growth rates in columns, cost of equity in rows). See below.
Analyst Consensus; Company Financials; Author’s Calculations
Investor Takeaway
Berkshire Hathaway reported its Q2 earnings and delivered an overall solid operating performance at group level: Revenue for the June quarter increased by 1% YoY, while operating income surged by 16% YoY. Notably, Warren Buffett has continued to convert equity holdings into cash and cash-like securities, such as Treasuries. In fact, in Q1 2024 Berkshire’s cash pile reached another record of $271 billion, with Buffett likely selling a net of $77 billion worth of shares over the past three months ending in June. Additionally, the pace of share buybacks slowed significantly to $345 million for the past quarter.
Synthesising the insights from Buffett’s capital allocation decision in Q2, it should be very clear that the Oracle of Omaha appears to be positioning Berkshire to weather potential economic downturns or market volatility, also implying that Buffett may be waiting for more favorable conditions to deploy capital in equities. While I do not share Buffett’s risk-averse view on the market outlook, seeing a dovish rate cycle and productivity gains on the backdrop of AI deployment as tailwinds, I take note of Buffett’s long-standing investment philosophy of prioritizing financial stability and flexibility over aggressive capital gains.
Post-Q2, I value BRK.B stock using a residual earnings model based on consensus EPS projections through 2026, combined with an 8.5% cost of equity and a 2% terminal growth rate. This suggests that BRK.B shares could be about 5-6% overvalued at a target price of $404. Therefore, I assign a “Hold” recommendation.
