Berkshire Hathaway Accelerates Portfolio Risk Reduction by Dumpting Apple (BRK.A)(BRK.B)

BRK beats earnings estimates

Berkshire reported strong earnings in Q2 2024, generating about $93.6 billion in revenue from April through the end of June, up 1% year-over-year. Notably, this growth was primarily driven by higher insurance premiums, which rose from $65.6 billion in Q2 2023 to $68.4 billion in Q2 2024, up 4% year-over-year. Meanwhile, rail revenue fell $100 million to $5.7 billion (down 1-2% year-over-year), and energy revenue fell $1.6 billion to $18 billion (down 8% year-over-year). Services and other revenue was roughly flat at $1.5 billion. Overall, revenue was slightly below consensus estimates at $95.7 billion, according to data compiled by Refinitiv.

On the profitability front, Berkshire increased group operating profits by around 16% YoY to $11.5 billion. In line with the trends seen in topline results, growth was primarily driven by the insurance sector, with operating income from underwriting up 82% YoY and insurance investment income up 41% YoY. Rail and energy operating income declined slightly YoY.

Capital allocation insights point to risk avoidance

Investing in Berkshire Hathaway stock is about trusting Warren Buffett’s (and his team’s) ability to allocate capital. As such, the outlook for Q2 2024 is very interesting — as Buffett continues to convert billions of shares into cash and cash-like securities.

Balance Sheet: Cash Hits Another Record High

In the first quarter of 2024, Berkshire Hathaway’s cash reached a new record of $271 billion, significantly ahead of Warren Buffett’s previous forecast at the annual shareholder meeting in Omaha that cash could exceed $200 billion by the end of the current quarter. More specifically, cash and cash equivalents increased to $36.9 billion (compared to $33.7 billion at the end of December 2023), while short-term investments in U.S. Treasury bills increased to $234.6 billion (compared to $129.6 billion at the end of December 2023).

Equity outside, treasury bonds inside

In Q1, there were only about $19.97 billion in equity sales, suggesting that Buffett sold a staggering ~$77 billion in shares during the June quarter. Meanwhile, Buffett’s Berkshire Hathaway bought back just $4.3 billion worth of shares over the past 6 months, with $2.7 billion of that being bought back in Q1. So it’s fair to say that Buffett is significantly ramping up his stock sales while his stock purchases are slowing down. While it’s unclear which shares Buffett sold last quarter, regulatory filings suggest that his stake in Bank of America (BAC) was likely significantly discounted, coupled with the ongoing “sell” in Apple (AAPL) stock. Indeed, at the end of Q2, Berkshire Hathaway held about $84.2 billion worth of Apple shares, down from $135.4 billion at the end of Q1. Considering Apple shares were up 22.82% during the quarter, that suggests Buffett may have sold about half of his Apple shares in Q2. We’ll have a more detailed picture of Berkshire’s stock portfolio by August 15th thanks to its quarterly SEC 13f disclosure.

In pointing out Buffett’s net stock sales, it’s important to point out that most of the freed-up cash is flowing into fixed-income securities, particularly U.S. Treasuries. Berkshire has bought $229.5 billion of Treasuries over the past six months, more than double the $99 billion it bought during the same period a year earlier. Meanwhile, redemptions in the first half of 2024 have risen to $120.5 billion, compared to $59.8 billion in the first half of 2023.

When changing the perspective of the cash flow statement towards cash flows from financing activities, it is worth emphasizing that Buffett relative The aversion to equity securities extends to Berkshire’s securities: In Q2 2024, the pace of share repurchases slowed to $345 million, compared with $1.4 billion repurchased in Q2 2023. In H1, share repurchases totaled $2.9 billion (compared to $5.9 billion in 2023).

In my opinion, the expectation of a lower federal funds rate in the next 1-2 years is a major driver of Warren Buffett’s decision to swap stocks for fixed income. Here’s why: With expectations of rate cuts in 2024 having become decidedly dovish, Buffett is likely looking to allocate capital to “overvalued” Treasury yields.

Valuation: Set a price target of $404

As Buffett slows down his share buybacks, let’s try to calculate the fair value of the Berkshire conglomerate. In my opinion, companies with stable and relatively predictable business fundamentals, such as BRK, can be accurately and precisely valued using the residual earnings model. This model is based on the principle that a company should be valued equal to its discounted future earnings after taking into account the capital charge. According to the CFA Institute:

Conceptually, residual income is net income minus a charge (deduction) for the opportunity cost of common shareholders in generating net income. It is the residual income or income left over after taking into account the cost of all of the company’s capital.

With respect to my BRK.B share valuation model, I make the following assumptions:

• To forecast EPS, I rely on analyst consensus, which is available in Bloomberg Terminal through 2026. In my opinion, any estimates beyond 2025 are too speculative to include in the valuation framework. However, for 2-3 years, analyst consensus is usually quite precise.
• To estimate the capital burden, I assume BRK.B’s cost of equity at 8.5%, which is roughly consistent with the CAPM model.
• For the final growth rate beyond 2025, I assume 2%, which is roughly in line with estimated nominal global GDP growth and reflects Buffett’s tendency to focus on value over growth.

Taking these assumptions into account, I calculated that the base price of BRK.B stock is approximately $404 per share.

I acknowledge that investors may have different assumptions about these rates. That’s why I’ve included a sensitivity table to test different scenarios and assumptions (growth rates in columns, cost of equity in rows). See below.

Conclusions for investors

Berkshire Hathaway reported Q2 results and delivered overall solid operating results at the group level: Revenue for the June quarter was up 1% year-over-year, while operating income was up 16% year-over-year. Notably, Warren Buffett continued to convert equity holdings into cash and cash-like securities such as Treasury bonds. In fact, Berkshire’s cash reached other a record $271 billion, with Buffett likely selling a net $77 billion worth of stock in the three months ending in June. In addition, the pace of share buybacks slowed significantly to $345 million in the last quarter.

Synthesizing the implications of Buffett’s Q2 capital allocation decisions, it should be clear that the Oracle of Omaha appears to be positioning Berkshire to weather potential economic downturns or market volatility, which also suggests that Buffett may be waiting for more favorable conditions to allocate capital to equities. While I don’t share Buffett’s risk aversion to the market outlook, seeing a dovish interest rate cycle and productivity growth amid AI adoption as tailwinds, I do take into account Buffett’s long-standing investment philosophy of prioritizing financial stability and flexibility over aggressive capital gains.

After Q2, I value BRK.B shares using a residual earnings model based on consensus EPS forecasts through 2026, combined with an 8.5% cost of equity and a 2% terminal growth rate. This suggests that BRK.B shares could be overvalued by around 5-6% at a target price of $404. Hence, I assign a “Hold” rating.