Monday, August 9, 2010

Berkshire Hathaway's 2Q Results

Berkshire Hathaway released the most recent quarterly results this past Friday. In the release, Buffett expressed some optimism about the US economy and said operating results for its manufacturing, service and retail businesses had improved. Here's a post commenting on the 2Q results.

We have previously highlighted the dangers of focusing exclusively on the "headline numbers" regarding Berkshire Hathaway and cynics may believe that we are viewing the world (or at least Berkshire) through rose colored glasses. However, the reality is that Berkshire’s large portfolio of derivatives cause very wide fluctuations in net income each quarter because they are marked to market and the result flows through the income statement. To argue that ignoring such movements in the short run is warranted is tantamount to making the same argument regarding broad moves in the equity market, and self evident to most value investors.

Unfortunately, for many market participants, short term is a few hours or overnight, long term is holding a position over a weekend, and a quarter is an eternity. For such observers, all that matters is the loud headline stating that Berkshire’s net income dropped by 40 percent for the quarter. Unfortunately, such myopia would conceal the underlying trends evident in the business.

The article includes this chart on Berkshire Hathaway's Manufacturing, Retail, and Service business pre-tax quarterly earnings since 1Q08:
You can see from the chart that most of Buffett's operating businesses are reasonably cyclical in nature.

On Berkshire Hathaway's Derivatives
The derivatives portfolio can make interpreting Berkshire Hathaway's results confusing. I'm sure after all of Buffett's criticism of derivatives over the past decade it probably seems strange to some that this would be the case. No doubt Berkshire's derivatives (managed by Buffett personally) add an annoying amount of noise to the short-run quarterly income statement, but that doesn't mean they don't make economic sense for Berkshire Hathaway shareholders in the long-run. The question is whether the risks of those derivatives are being well-managed. I think they are but will explore that open question in a follow up.