Warren Buffett explains why Berkshire Hathaway is such a successful business and how the cash flows.
At the beginning of the 2023 Annual Meeting, Buffett explained the Berkshire Hathaway business model in his opening monologue. He encouraged shareholders to especially pay attention to operating earnings rather than reported GAAP earnings.
Buffett pulled up a bunch of financial slides, including the Q1 2023 after-tax operating earnings across all of their business arms such as insurance, BNSF, BHE, and both controlled and non-controlled businesses.
He explained how reported earnings will go down because people started buying less this year compared to 2022. The pandemic hoarding mindset is over and Berkshire’s retail businesses are entering into a different business phase. There’s less need for as much inventory as they had accumulated when there was more consumer demand. While the economy during the pandemic wasn’t as bad as during World War II, it was still significant and Berkshire benefited.
While earnings may be slightly declining, investments are ticking up. Buffett also explained how its investment income is more this year, primarily due to the increase in interest rates for fixed income sources, such as from US Treasury Bonds. Instead of only earning 4 basis points, Berkshire is earning close to 6% on its $125 billion cash pile, which means at least $5 billion coming in per year now instead of $50 million before.
This means Berkshire is likely to have a better year for insurance underwriting because they’re able to obtain higher yields at nearly risk-free rates. Insurance isn’t as affected by the “business cycle” that’s happening in retail now.
He shared his expectations but nothing is promised in life nor in business, as Buffett reiterates. We should expect Berkshire’s operating earnings to go up over time, however, because of the advantage of retaining earnings.
Buffett explained the power of insurance float, which is money they can invest from the premiums they collect from insurance customers. While float doesn’t belong to Berkshire and is listed as a liability on the balance sheet, Berkshire can earn returns on the $165 billion of float until they pay out claims.
While Buffett compares float to having a bank without employees nor interest nor owing anyone anything, I think float is more like a free loan.
Buffett said stockholders’ equity is expensive in a long term sense because you generally pay back long term debt at a fixed rate, but the value of a company’s equity is theoretically limitless to the upside if the business continues to perform well.
But long term debt comes due eventually, and it may not be available at rock bottom cheap rates anymore as during the pandemic years.
Unlike the limits of debt, ongoing float continues to finance the asset side of the balance sheet, as well. This advantage of float is essentially leverage that has often been free for Berkshire, and it explains why Berkshire is one of the best businesses in the world.
Float is their moat!
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