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Who cares what the cost of the capital was that was used to purchase these businesses. The financial results shows that such redeployment had a positive result. We can pick over capital costs or imaginary capital costs all day, but the important thing is that Buffett is being successful.

If I see operating earnings growth of 44% for a quarter, and 36% for a half year, it is sure going to catch my attention. I refuse to dismiss it just because some other part of the company is not doing well. As far as I am concerned, if we could get 36% annual growth in operating earnings I don't give a hot damn if General Re ever has an underwriting profit. I don't have any fixed ideas on just exactly what stars must be in what line in order for me to be happy with the financial outcomes of Berkshire Hathaway. If we could sell T-shirts and velvet paintings of Elvis and do 36% a year, who cares?


I strenuously, arduously, but respectfully, disagree. Growth in operating earnings is not meaningful unless you place it in context. And that context is necessarily the cost of capital. Not as in some imaginary, abstract or quantitative formula derived from the capital asset pricing model, but as in whether the increase in operating earnings actually represents an increase in wealth or merely a shift in wealth. And if it did increase wealth, did it do so buy the amount that Berkshire owners require?

We already knew that Buffett had billions of dollars stashed in bonds, earning relatively low returns. No Berkshire investor is simply hoping that Buffett holds low-yield bonds for perpetuity. We also know that at any moment, anyone running Berkshire with access to a brokerage account can immediately give operating earnings an enormous jolt. Simply take $15 billion in bonds yielding 4.5% after tax and purchase several businesses for 10 X earnings. Suddenly, operating earnings are juiced by $375 million, a few hundred % increase year over year. The loss in interest income would be significantly less, especially if some equities were converted into fixed income in the interim (but even if none were). The growth in operating earnings would be enormous, but would be empty of important information for two reasons.

First, the very immediate results from those accretive acquisitions and their impact on operating earnings were known the day(s) of the deal announcements. And those results don't say anything about whether these businesses will prooduce superior returns over time. Buying high yielding businesses is always going to be immediately accretive. Now, we may both expect that Buffett's investments will prove to be worthy capital vehicles and far superior to what any shmo with a working knowledge of the word accretive could do, but this quarter's operating growth tells us absolutely nothing to the end. In fact, because the increase in operating growth was actually less than what I expected based on the acquisition activity, the degree of the increase seems closer to bad news than good, because it indicates an operating decline in other already-owned businesses, such as retail.

Second, the quarterly results don't reflect a sustainable source of wealth creation, but a shift in resources. Sure, Buffett will always have capital with which to redeploy into operating businesses, but you can't know what to make of a given periods growth rate - in terms of what it means for the future - without regard to the amount of capital used to generate that growth. Sometimes it can be difficult to track the capital flowing through Berkshire, especially as equity positions are converted to bond positions to replete capital used to juice non-insurance operations, while equity prices dropping likewise hurt the equity account, making it difficult to see tangible evidence of the cost of earnings increases. But I think the costs are crucial to watch because they are what will determine shareholder wealth over time, and the best way to track them is simply to examine earnings growth in the conext of the capital used to create that growth.

My point is that we already knew that operating earnings were going to increase, because we knew that Buffett shifted $5-$6 billion from high PE bonds to lower PE businesses (or from equities to bonds to businesses - or from float to businesses at the expense of additional bond income). By investing in Berkshire, we aren't betting that Buffett can copy the CEOs of the 1980s by making "accretive" short term acquisitions. Anyone with a telephone and stock screener can pull that off. We are betting that he can allocate dollars toward superior capital returns over time, as in, returns greater than what any old CEO could acheive by simply selling bonds and buying moderately priced stocks. It is impossible to judge whether Buffett's recent acquisitions have taken the steps toward that goal yet. But if forced to, I just don't see how this quarter's OE growth can be met with a lukewarm reception, judging from level of growth in relation to the capital used to create that growth.

If I as an individual sell a stock, and replace it with a different stock that has better results, should this not be satisfactory? Or should I be dismayed since I may not be able to do this every quarter and therefor all future periods may not have an equally good increase in the value of my portfolio?

If you shifted the 20% of your portfolio sitting in bonds and bought stocks (ELVS), subsequently juicing your year over returns, I'd probably you should hold off celebrating, and I wouldn't use your year over year growth as a meaningful indicator of things to come.
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