Warren Buffett’s Berkshire Hathaway (BRK-B) reported third quarter results Friday that failed to impress. Net earnings attributable to Berkshire shareholders fell almost 24%. Insurance-underwriting and its non-insurance businesses performed well in the period (due primarily to a lower-earnings-quality reserve release, though), and insurance-investment income fell from the same period a year ago. However, a huge spike in derivative losses ($1.53 billion) sent the firm’s net earnings significantly lower. Berkshire suggests that the derivative losses in any given quarter or year are meaningless since they are driven by a long-term bet the firm made to sell put options on a number of global stock indices, which fell during the third-quarter. These European-style options don’t expire until June 2018, so Berkshire has time to make up its losses (and hence, Mr. Buffett feels quarter-to-quarter and year-to-year changes are meaningless). The firm’s book value increased a mere 1.5% since year end, a pace that should garner the firm a less-than-market multiple on its earnings stream. Book value on its Class A shares were $96,876, which is meaningfully below its share price of about $115,000.
We think we can do better than an investment in Berkshire at these levels. After all, the firm’s net earnings will largely be determined by its derivative bets on the equity markets. We prefer to identify undervalued stocks that will outperform the markets in coming years, as opposed to broadly betting they will be higher by the end of this decade.