A Worthy Conglomerate
In this edition of the Smart Investor newsletter, we examine a sprawling conglomerate. But first, let us delve into the latest Portfolio news and updates
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Portfolio Updates
❖ Super Micro Computer (SMCI) reported mixed results for the fiscal fourth quarter as its earnings missed estimates. The company also announced a 10-for-1 stock split, which will start trading on a split-adjusted basis on October 1. More worryingly, the company’s gross margin dropped in Q4 to 11.2% from 17% in the same period a year back even as demand for its AI chips continues to remain strong. SMCI’s Q3 outlook missed at the midpoint of the analysts’ range of earnings of $7.48 per share.
❖ Google (GOOGL) suffered a setback on Monday as a U.S. judge ruled that the tech giant violated antitrust law and has created an illegal monopoly to become the world’s default search engine. A separate proceeding will decide on penalties (monetary or otherwise), changes to Google’s monopolistic practices, and the potential breakup of the company. This ruling could potentially change the landscape of online advertising that Google has dominated for years. Online advertising comprised 77% of Google’s revenues in FY23. Google plans to file an appeal against this ruling.
❖ Dell (DELL) announced a reorganization of its sales team and will cut jobs as a part of this process. The company did not give the exact number of jobs that would be affected. This reorganization will also include a newly formed sales team focused on artificial intelligence products and services.
❖ Regeneron (REGN) reported robust results in the second quarter that exceeded analysts’ expectations. The biotech company’s blockbuster drug for macular degeneration, Eylea, saw its revenues in the U.S. grow by 2% year-over-year to $1.53 billion. Eylea comprised more than 40% of REGN’s revenues in the second quarter. Following the results, analysts at RBC Capital and Barclays raised the price target and reiterated a Buy on the stock. The analysts cited Eylea sales, solid Q2 results, and the first regulatory approval for Dupixent for chronic obstructive pulmonary disease (COPD) by the European Commission.
❖ TSMC (TSM) was rated as a “top pick” by Morgan Stanley analysts as its shares listed on the Taiwanese index, Taiex, declined by 9.8% on Monday amid a global sell off in stock markets. The analysts appreciated TSMC’s quality and resilience during a prolonged semiconductor downturn. Furthermore, they noted that the stock is currently trading at 16 times its projected earnings estimate for 2025 and presents an “attractive” valuation. The chipmaker delivered robust results in the second quarter fueled by surging demand for its AI chips.
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Portfolio Earnings and Dividend Calendar
❖ There are still some Portfolio companies scheduled to report over the next week. These companies include Texas Pacific Land (TPL) and Emerson Electric (EMR) on August 7 and Parker Hannifin (PH) and Martin Marietta Materials (MLM) on August 8.
❖ The ex-dividend date for Howmet Aerospace (HWM) and KKR & Co. (KKR) is August 9th and August 12th, respectively.
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New Buy: Berkshire Hathaway (BRK.B)
Berkshire Hathaway is a holding company headquartered in Omaha, Nebraska. The company was founded in 1839 as a textile manufacturer that later transformed into a conglomerate under the management of Chairman and CEO Warren Buffet and the late Charlie Munger.
Berkshire is one of the top ten components of the S&P 500 index and ranks among the largest American-owned private employers in the United States. The Bill and Melinda Gates Foundation is a significant shareholder, owning 4% of Berkshire’s Class B shares.
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Class A and Class B Shares
The company’s class A shares have the highest per-share price of any public company in the world, reaching $600,000 in February 2024, due to the board’s longstanding opposition to splitting them. Since Warren Buffett took over, Berkshire has paid a dividend only once, choosing to retain corporate earnings on its balance sheet in a manner that mutual funds cannot.
However, the company did create a Class B stock, initially valued at 1/30th of the Class A stock price and 1/200th of their voting rights. After a split in January 2010, the Class B shares were adjusted to 1/1,500th the price and 1/10,000th the voting rights of the Class A shares. Holders of Class A stock can convert their shares to Class B, but not vice versa. Buffett introduced the Class B shares reluctantly, primarily to prevent the creation of unit trusts that would have marketed themselves as Berkshire look-alikes.
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Berkshire Hathaway – Sprawling Conglomerate
Berkshire Hathaway is a holding company that owns subsidiaries engaged in diverse business activities. The most significant of these are its insurance operations, both primary and reinsurance, its freight rail transportation business, and its utility and energy generation and distribution businesses. Berkshire also operates numerous other businesses involved in manufacturing, services, retailing, and more.
Berkshire’s operating businesses are managed in a highly decentralized manner, with few centralized business functions. The senior management team, led by Warren Buffett, is responsible for significant capital allocation decisions, investment activities, and selecting the Chief Executives for each operating business. The company’s insurance and reinsurance activities are conducted through numerous domestic and foreign-based subsidiaries, providing a range of property, casualty, life, and health insurance worldwide. The key underwriting groups include GEICO, Berkshire Hathaway Primary Group (BH Primary), and Berkshire Hathaway Reinsurance Group (BHRG).
BH Primary consists of independently managed insurers offering various insurance coverages primarily to U.S. policyholders. BHRG provides a wide range of coverages on property, casualty, life, and health risks to insurers and reinsurers globally. Berkshire’s insurance subsidiaries have two distinct activities – underwriting insurance and investing. These insurance subsidiaries maintain significant levels of invested assets, managed by Buffett and other investment managers. The investment portfolios include a large concentration of publicly traded equity securities, as well as fixed maturity securities and short-term investments. Some of Berkshire’s prominent investments include Kraft-Heinz, American Express, Bank of America, Coca-Cola, and AAPL.
The company also owns Burlington Northern Santa Fe (BNSF), based in Fort Worth, Texas, which operates one of North America’s largest railroad systems through BNSF Railway. Additionally, Berkshire holds a 92% ownership interest in Berkshire Hathaway Energy Company (BHE), headquartered in Des Moines, Iowa. BHE is a global energy company with subsidiaries involved in generating, transmitting, storing, distributing, and supplying energy. Its domestic regulated energy interests include four U.S. utility companies serving approximately 5.3 million retail customers and five U.S. interstate natural gas pipeline companies operating around 21,000 miles of pipeline.
In 2017, Berkshire acquired a 38.6% interest in Pilot Travel Centers (PTC), headquartered in Knoxville, Tennessee. After increasing its stake in PTC gradually, PTC became an indirect wholly-owned subsidiary of Berkshire earlier this year. PTC’s business activities primarily involve distribution of fuel and energy products and services, operating over 650 travel centers and around 75 fuel-only retail locations across the U.S. and Canada.
Berkshire’s manufacturing subsidiaries are categorized into industrial products, building products, and consumer products. The industrial products businesses manufacture components for aerospace and power generation, specialty chemicals, metal cutting tools, and various industrial products. The building products group product portfolio for homes includes flooring, insulation, roofing, engineered products, paint, coatings, bricks, and masonry products. The consumer products group manufactures and distributes recreational vehicles, batteries, apparel, footwear, and other items.
The company’s service businesses include grocery and food service distribution, professional aviation training programs, shared aircraft ownership, and electronic components distribution. Other service businesses include quick-service restaurant franchising and servicing, media (television and information distribution), and logistics. Berkshire’s retailing businesses span automotive, home furnishings, and various other consumer products and services.
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Berkshire’s Strong Financials and Cash Stockpile
Berkshire Hathaway exceeded analysts’ expectations with robust second-quarter revenues. However, the company’s quarterly net income fell 15% year-over-year, dropping to $30.34 billion. This decline was influenced by rising stock prices in the second quarter, which increased the value of Berkshire’s stock investments. Warren Buffett has consistently advised shareholders to ignore Berkshire’s quarterly investment gains and losses, as these fluctuations often result in disproportionate net profits or net losses.
Over the past five years, Berkshire’s revenues have grown at a compound annual growth rate (CAGR) of 8.1%, while earnings have surged at 21.7%. The company generates most of its revenues from its insurance and reinsurance business, leasing services, and sales and service revenues. These segments contributed 73% of the company’s revenues in the second quarter.
Berkshire’s insurance business continued to perform strongly in the first half of the year, with post-tax earnings from insurance underwriting increasing by 81.5%. Additionally, investment income in the insurance business rose by $951 million in the second quarter. Besides the insurance business, the company’s other core businesses are also doing well with robust profits.
Recently, Berkshire made headlines by nearly halving its stake in Apple, reducing its holdings to 400 million shares worth $84.2 billion in the second quarter, down from $135.4 billion at the end of the first quarter. The company sold around 390 million Apple shares in the second quarter, in addition to 115 million shares sold in the March quarter.
Furthermore, since mid-July, Berkshire has sold more than $3.8 billion worth of shares in Bank of America, its second-largest stock holding. This marks the seventh consecutive quarter in which Berkshire sold more stocks than it bought. The company’s cash balance grew significantly, reaching $277 billion at the end of the second quarter, up from a record $189 billion in the first quarter. This increase was largely due to the net sale of $75.5 billion worth of stocks in the second quarter.
Many analysts interpret these actions as a sign that Warren Buffett, the Oracle of Omaha, is cautious about the U.S. economy or believes that stocks are overvalued.
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Berkshire’s Returns in Focus
Berkshire’s debt-to-equity ratio stands at 21.2%, which is considered higher overall in the insurance industry. However, the company has managed to reduce this ratio over the past five years. More importantly, its interest coverage ratio of 18.8x indicates that its earnings comfortably cover its interest payments.
The company’s net profit margin, return on assets (ROA), and return on invested capital (ROIC) are all in the top 20% of the industry, while its return on equity (ROE) of 13.58% surpasses 60% of companies in the insurance sector.
Overall, Wall Street analysts are cautiously optimistic about the stock, and the overall technical moving average consensus about the stock rates it a Buy.
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Dividends and Stock Buyback Policies
Berkshire Hathaway does not distribute dividends. The company has a flexible stock repurchase program that allows it to buy back shares whenever Warren Buffett, the Chairman and CEO, believes the price is below the company’s intrinsic value. This program lets Berkshire repurchase shares either in the open market or through private deals, with no set limit on the number of shares. However, repurchases are not made if they would lower the value of Berkshire’s consolidated cash and U.S. Treasury Bill holdings below $30 billion.
In the first six months of 2024, Berkshire brought back stock worth $2.9 billion. In the second quarter alone, the company bought back $345 million worth of shares, a significant decrease from the $2.57 billion repurchased in the first quarter. Notably, no stock buybacks occurred in the first three weeks of July.
Many analysts interpret this decline in stock buybacks as a sign that Buffett sees few attractive opportunities in publicly traded stocks, including Berkshire’s shares.
Investing Takeaway
Berkshire Hathaway’s stock stands out for its solid fundamentals, despite the company’s reluctance to pay dividends and its approach to stock buybacks. Thanks to its operational diversification and conservative investment strategy, Berkshire remains one of the least risky companies globally. Its substantial cash reserves and defensive investments enable it to withstand increased risks that could challenge weaker insurers. Consequently, Berkshire presents itself as a strong value investment today.
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New Sell : Airbnb (ABNB)
Founded in August 2008, Airbnb has become a major player in the travel and hospitality industry. As an online marketplace for short and long-term homestays and experiences, it boasts listings in over 220 countries and regions. By FY23, the company had attracted more than 150 million guests and featured over 6 million active listings.
Despite its growth, Airbnb’s stock has declined over the past year, negatively impacting portfolio performance. Investor concerns have centred around demand for U.S. rentals amid a slowing economy and backlash against short-term rentals in popular European destinations.
These concerns proved valid when Airbnb’s Q2 earnings missed expectations, and the company provided a soft revenue outlook. It warned of slowing U.S. demand and shorter global booking windows, and it anticipated moderation in year-over-year growth for its “Nights and Experiences” category.
Following the disappointing Q2 report, the stock tumbled as investors sold off amid broader market nervousness. Wall Street analysts have largely adopted a Hold rating, but recent technical indicators suggest the stock is a Sell.
While Airbnb’s long-term outlook might improve, we believe it’s prudent to sell the stock for now and revisit this travel and hospitality giant in the future.
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Portfolio Stocks Under Review
❖ We are placing Vertex (VRTX) under review as the biopharma company swung to a loss in the second quarter while analysts were expecting the company to report earnings of $4.17 per share. The company’s Q2 results have been underwhelming. While the company did raise its FY24 revenue forecast citing its cystic fibrosis (CF) treatment and the soon-to-launch gene therapy Casgevy, we prefer to adopt a wait-and-watch mode for the stock.
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Smart Investor’s Winners Club
*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Despite the turbulence in the stock market, overall, and particularly in the technology sector in the past week, the list of Winners has expanded to 15 stocks.
The Winners list counts 15 stocks: SMCI, GE, AVGO, ANET, TSM, AMAT, ORCL, EME, APH, GD, VRTX, CHKP, TPL, PH, HWM
ITT is now the closest contender for re-entry, with a 29.8% gain since its purchase date. Will it close this minute gap, or will someone else outrun it to the finish line?
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Smart Investor Portfolio
| Portfolio YTD Return |
Portfolio Volatility (Beta) | Portfolio Dividend Yield |
| 12.79% | 1.15 | 0.68% |
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