Warren Buffett, the chairman of Berkshire Hathaway, is a legendary figure in the investment world. From 1965 to 2023, Berkshire Hathaway's returns soared by an astonishing 43,800%, cementing Buffett's status as the "Oracle of Omaha." The company's major moves often influence the markets, making its earnings reports highly anticipated events.

Berkshire Hathaway will release its latest earnings results on November 2. Each earnings release may signal a potential investment opportunity, but before diving in, investors need to understand how to interpret their financial statements.

To analyze Berkshire Hathaway's reports, we'll focus on three key areas: performance stability, changes in holdings and cash reserves, and cash flow and buyback activities.

1. Performance Stability

Berkshire Hathaway's long-term success in the capital markets is largely due to its consistent performance over the years. To evaluate this stability, we can examine both revenue and profit.

While many know Berkshire primarily for its influence in the investment world, its revenue is actually not heavily tied to its investment activities. Instead, it mainly comes from the consolidated income of its numerous subsidiaries.

Beyond its foundational insurance business, Berkshire's subsidiaries span a wide range of industries, including retail, manufacturing, railroads, home goods, power, and energy. For example, See's Candies, one of Buffett's proud acquisitions, is a Berkshire subsidiary. Collectively, these subsidiaries contribute several hundred billion dollars in annual revenue.

From a long-term perspective, Berkshire has maintained very steady revenue growth. For instance, between 2006 and 2023, its revenue grew from $98.5 billion to $364.4 billion, a cumulative increase of 2.7 times, with an annual compound growth rate of approximately 8%. Over nearly two decades, Berkshire only saw revenue declines in two years: 2008 during the financial crisis and 2020 amid the COVID-19 pandemic. Even in these challenging years, the revenue drop was less than 10%, demonstrating remarkable resilience.

Berkshire Hathaway's net profit can be divided into two main components: operating profit and investment profit.

Operating profit primarily comes from its insurance and other business operations. The growth trend in operating profit closely mirrors the revenue trend. From 2006 to 2023, Berkshire's operating profit increased from $9.3 billion to $37.4 billion, a cumulative growth of approximately three times, with an annual compound growth rate of about 8.5%, slightly higher than the revenue growth rate. Over these 17 years, Berkshire has consistently been profitable in terms of operating profit, with declines in only four of those years. During this period, the cumulative operating profit reached around $338.1 billion, making it the main contributor to the company's overall net profit.

When looking at asset allocation, we can think of Berkshire Hathaway’s operating businesses and their profits as the defensive part of the portfolio. In contrast, the company’s equity investments and investment profits may represent the aggressive part.

Berkshire’s investment profits are more closely tied to market performance, which naturally draws a lot of attention. Warren Buffett’s moves in the US stock market are primarily reflected in this area. Given the volatile nature of the stock market, it's challenging to make a profit every year, so the stability of investment returns is a relative concept.

Comparing Berkshire Hathaway to the S&P 500 over the past 17 years, Berkshire only had losses in 4 years, whereas the S&P 500 declined in 5. This comparison underscores the relative stability and consistent profitability of Berkshire’s investment strategy.

Comparing Berkshire Hathaway's performance over time, the cumulative investment net profit for the first nine years (2006-2015) was approximately $19.1 billion. In contrast, the cumulative investment net profit for the following eight years reached about $146.8 billion, a staggering 7.7 times increase, highlighting the explosive growth in profitability during the latter period.

Looking ahead to Berkshire Hathaway's future performance, we may need to monitor the stability of its recurring business revenue and net profit. Additionally, the sustainability of its investment profits will be crucial. With Charlie Munger's passing and Warren Buffett's advancing in age, the issue of succession has become a significant variable affecting the outlook for investment profits. This may be a key factor that warrants long-term attention.

2. Cash reserves and portfolio changes

Another key aspect to watch with Berkshire Hathaway is its cash reserves and portfolio changes.

We may define a useful metric: Cash Ratio = (Cash + Short-Term Investments) / (Cash + Short-Term Investments + Equity Investments). Changes in this ratio can impact Berkshire's investment profits and can also serve as an indicator of market sentiment.

First, looking at Berkshire itself, when the cash ratio gradually decreases, it indicates an increase in the proportion of stock holdings. This could lead to greater volatility in investment profits, implying higher potential returns and risks. Conversely, when the cash ratio increases, it suggests a lower risk appetite, leading to more stable but potentially lower investment returns.

In recent quarters, Berkshire's cash ratio has been trending upward, reflecting the latter scenario. Since the first quarter of 2023, Berkshire's cash ratio has generally been on the rise, reaching about 49.3% in the second quarter of 2024, the highest level since 2019.

We can also track changes in the cash ratio and Berkshire Hathaway's portfolio to gain insights into Warren Buffett and Berkshire's market outlook. The continued increase in the cash ratio over recent quarters might suggest that Buffett is not particularly optimistic about the future of the U.S. stock market. By maintaining a higher cash reserve, Berkshire can better withstand potential market risks.

Regarding portfolio changes, Berkshire discloses its holdings every quarter through its 13F filings. Any minor adjustments in Berkshire's portfolio quickly become a focal point for market observers.

For instance, using the institutional tracking feature "Berkshire Hathaway Inc." on moomoo, we can see that Berkshire disclosed its holdings as of the end of the second quarter of 2024. The report revealed that Berkshire reduced its stake in Apple by 389 million shares in Q2 2024.

This recent reduction, the third time involving more than half of its position, might indicate that Buffett's confidence in Apple's future prospects has somewhat diminished, potentially signaling a bearish outlook for the market.

3. Cash flow and share buybacks

Warren Buffett has often stated that the intrinsic value of a publicly traded company is the discounted sum of its future free cash flows. This makes it important to examine Berkshire Hathaway's own free cash flow.

Since 2006, Berkshire Hathaway has consistently generated positive free cash flow each year, showing an overall upward trend. Over this period, the cumulative free cash flow was approximately $316.9 billion. In comparison, Berkshire's total operating profit during the same timeframe was around $333.1 billion. This indicates that free cash flow has been roughly in line with operating profit, reflecting a healthy financial state.

A company generally has two common uses for its profits: expanding its business or returning value to shareholders. Before 2017, Berkshire Hathaway rarely engaged in shareholder returns such as dividends or share buybacks. Instead, the incoming cash was primarily used to expand its physical businesses or increase its investment holdings.

Warren Buffett mentioned in his 1985 letter to shareholders that dividends would only be considered if Berkshire could not offer attractive returns through its own business model. Up until 2017, Berkshire's stock performance far exceeded that of the S&P 500 Index, and this approach of not paying dividends or buying back shares was a testament to Buffett's commitment to his principles.

However, from 2018 onwards, while Berkshire's overall performance continued to outpace the S&P 500 Index, the margin of outperformance was not as significant. During this period, Berkshire also started to focus more on shareholder returns, primarily through share buybacks.

In 2018, Berkshire repurchased shares for the first time, spending $1.3 billion. Over the next five years, the company continued this practice, cumulatively repurchasing approximately $75 billion worth of shares, which amounts to roughly half of its total free cash flow during this period.

In future financial reports, we can continue to monitor whether Berkshire Hathaway maintains a healthy free cash flow and pay attention to its share buyback activities. If Berkshire continues to increase its share buybacks, it might indicate that the company has exhausted its high-growth opportunities. However, this may be welcomed by conservative investors who prefer stability and consistent returns. Given Berkshire's current massive scale, a return to rapid growth may be unrealistic.

Having read this far, you may now have a deeper understanding of how to interpret Berkshire Hathaway's financial reports. It's noteworthy that the release of earnings reports from prominent companies may present unique trading opportunities for different types of investors.

For instance, if an investor, after analyzing past reports and considering recent developments, believes a company's latest earnings will send positive signals and boost the short-term stock price, they might consider taking a long position. This could involve buying the underlying stock or purchasing call options.

Conversely, if the investor expects the earnings to be unfavorable and potentially pressure the stock price, they might consider taking a short position, either through short selling or buying put options.

If the report's outcome is unclear but volatility is expected, they might use a straddle strategy, buying both calls and puts.

However, investors should carefully assess their risk tolerance, particularly when considering high-risk trades like short selling or options, before making any trading decisions.

Summary

To summarize, when analyzing Berkshire Hathaway's financial reports, we can focus on three main aspects: the stability of performance, changes in holdings and cash reserves, and cash flow and share buyback activities.

1. Performance stability: We need to observe the consistency of revenue and net profit from Berkshire's recurring businesses, as well as the continuity of investment profits.

2. Holdings and cash reserves: By monitoring changes in the proportion of cash holdings, we can assess the volatility of Berkshire's investment profits and Buffett's outlook on the market's future.

Cash flow and share buybacks: We should examine the stability of Berkshire's free cash flow and the consistency of its share buyback activities.