Berkshire Hathaway's second-quarter earnings and my updated estimate of its intrinsic value; Update on HCI Group; Harvard tour; 5K race

By Whitney Tilson

Monday, August 9, 2021
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1) Berkshire Hathaway (BRK-B) reported second-quarter earnings on Saturday (here are links to the press release and 10-Q). As I do every quarter, I asked my longtime friend and former partner Glenn Tongue, who is the axe on the company, to share his analysis of it. Here's what he sent me:

In the second quarter, Berkshire Hathaway's earnings rebounded strongly from the COVID-impacted quarter a year earlier, led by the most economically sensitive business units: manufacturing, service, and retailing. Overall, noninsurance earnings soared 73%, while insurance earnings were down due to GEICO paying out more in claims as drivers returned to the roads. Here is the table from the 10-Q that shows the pre-tax earnings by segment:

CEO Warren Buffett and Vice Chairman Charlie Munger have built Berkshire over many decades into one of the world's largest businesses by wisely deploying the increasingly massive amounts of capital generated by the operating business (operating cash flow was a staggering $19.6 billion in the first half of the year, up from $17.5 billion year over year).

It's always instructive to analyze how Buffett and Munger allocate capital. Their first priority is to reinvest in the owned businesses, in the form of capital expenditures ($5.7 billion in the first half of year) and bolt-on acquisitions (a mere $104 million).

Their second preference is to buy high-quality businesses outright, but they haven't been able to find any so far this year, due, no doubt, to high valuations and competition from SPACs [special purpose acquisition companies] and private equity firms, which are flush with cash.

Their third option is to acquire fractional interests of high-quality businesses by buying their stocks, but, again, the price has to be reasonable. Buffett and Munger are telling us loud and clear that prices are too high, given that they've sold $8.6 billion of stocks in the first half of the year, and bought only $3.6 billion (thereby generating another $5 billion of excess cash to deploy).

Lastly, they've started buying back Berkshire stock in size, especially over the past year, as you can see in this chart:

The inter-quarter repurchases patterns give insight in their valuation thresholds. The current sweet spot for repurchasing seems to be around $290 per B-share, as repurchasing activity materially slowed above that level in May.

Thank you, Glenn!

2) Regarding Berkshire's intrinsic value, I've used a consistent and simple methodology – one that I think CEO Warren Buffett himself uses – to value Berkshire for more than two decades: Take cash and investments (valued at market) and add the value of the wholly owned operating businesses, calculated by applying a conservative multiple (I use 11 times) to the pre-tax earnings of those businesses.

This table shows how I calculate Berkshire's investments per share:

Adjusting the stock portfolio upward by the 3.4% increase in the S&P 500 Index since the quarter ended on June 30 yields investments per share of $329,000 currently.

To value the wholly owned businesses, here are the figures I use to calculate their earnings:

Note that I subtract all of the underwriting and investment profits from Berkshire's massive insurance operations but add back a rough estimate of the average insurance underwriting profits over the past decade ($1.4 billion annually).

This results in $16,759 for the trailing 12-month adjusted pre-tax earnings per share, to which I apply a multiple of 11 times to arrive at a value for the operating businesses of $184,000 per share.

Now add the $329,000 in cash and investments per share for a total intrinsic value of $513,000 per A-share (or $342 per B-share).

With the A-shares closing Friday at $430,160, that means the stock is trading 16% below my estimate of its intrinsic value.

3) In my June 11 e-mail, I wrote:

Justin Hughes of hedge fund Phase 2 Partners just sent me a bullish report he prepared on insurer HCI Group (HCI), Unlocking a Flood of Value: TypTap + HCI = $300+, which he gave me permission to share first with my readers.

I haven't done the work on HCI Group personally. But I do not doubt that Justin's analysis is correct, given his more than two-decades-long track record doing long-short investing in the financial services sector. I first met him when he spoke at my shorting conference in May 2018, where he pitched the online trading platform Plus500 (PLUS.L), which subsequently declined by 66%.

HCI shares closed that day at $91.

On Thursday, the company reported strong second-quarter earnings and disclosed that it has filed a draft registration statement to take public its subsidiary, TypTap Insurance Group, just as Justin predicted. On Friday, the stock closed up 18% at $115.64.

I e-mailed Justin for an update, and he replied:

With the company confirming the filing of an S-1 to take TypTap public, this is playing out faster than we anticipated. We believe that TypTap, which is profitable, will compare very favorably to its InsurTech peers, all of which report losses.

Even before the initial public offered is completed, as investors come to realize how highly TypTap is likely to be valued, we believe HCI shares will rise to over $200.

Thanks for sharing this great idea with my readers, Justin!

4) I flew to Boston on Saturday morning to give my nephew and cousin's son (and their families) a tour of Harvard, where my nephew might be applying in a few months.

I hadn't been back since my 30th reunion two years ago – the trip brought back memories! It also gave me the chance to tell two of my favorite jokes:

Question: How do you know if someone went to Harvard?
Answer: Don't worry, they'll tell you!

Question: How many Harvard guys does it take to change a light bulb?
Answer: One to hold the bulb while the world turns around him!

Here's a picture of us on the steps of Widener Library:

We then drove two hours to Lake Sunapee, New Hampshire, for our annual week-long gathering with extended family – the first time in two years we've been able to be together. Here's a picture of roughly half our crew – 21 of us (plus the two most beloved members of our family, Phoebe and Rosie!) – at the local ice cream place yesterday:

Eight of us ran in a local 5K race yesterday morning with about 150 other folks. It didn't attract any elite runners, but we're still proud of ourselves for taking four of the top 13 spots: my cousin Alex, a former 2:21 marathoner and U.S. record-holder in the 50K, was second, his son James was eighth, my oldest daughter Alison was 11th (winning the women's division by only two seconds!), and I was 13th.

Here's a picture of all of us at the starting line:

Best regards,

Whitney

Whitney Tilson
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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to more than $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor's degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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