To be clear, Buffett does not lose sleep over these quarterly moves, as long as they are not indicative of major long-term or permanent changes in business. He'd also rather not have investors obsess over the short-term.
“We make investment decisions solely on the basis of what we think the best investment decision is, not on the basis of how it'll affect earnings in any quarter or in any year," Buffett said during Berkshire Hathaway's annual meeting.
Having said that, let's take a closer look at what's going on at Berkshire Hathaway.
Berkshire Hathaway's Q1 operating earnings.
For the most part, the $360 billion company is considered an insurance conglomerate offering reinsurance and property and casualty insurance. But its portfolio of equity investments and wholly owned subsidiaries include a broad array of companies BNSF Railroad, Duracell, Fruit of the Loom, Lubrizol, Precision Castparts, and Clayton Homes.
“The basic underwriting at GEICO is actually improving,” Buffett said. “But we had some hail storms in Texas toward the end of the quarter. We've actually had some since the end of the quarter, too. So there were more catastrophe losses in the first quarter than last year.”
Buffett highlighted discussed the ongoing challenges in the insurance business being caused by persistently low interest rates.
“I think the business of the reinsurance companies generally is less attractive for the next ten years than it has been for the last ten years,” Buffett said during the meeting. “In part, that's because what's happened to interest rates. A significant portion of what you earn in insurance comes from investment of the float.”
What Buffett said about railroads
Berkshire's big industrial companies had a tough quarter, pressured by an array of factors including lackluster manufacturing activity, weak export growth, and falling demand for coal.
“Railroad earnings are down significantly and railroad car loadings throughout the industry," Buffett said. "All of the major railroads were down significantly in the first quarter and probably will continue to be down — almost certainly will continue to be down — the balance of the year.”
"We still have a lot of headwinds, specifically as the commodity supercycle is really coming to a close,” BNSF Rail’s Matt Rose said to Yahoo Finance. “The strong dollar is a headwind. Certainly the coal business is a headwind.” It isn’t all bad though. “The rest of the economy on the consumer side actually feels pretty good,” Rose added. “So we'll rely on our old standards. A lot of growth in domestic intermodal and agriculture should be pretty good for us. So that's the great part about us having a balanced portfolio."
Financial WMDs
There is an interesting nugget that regulators require the company to disclose. We're talking about Buffett's bets on "financial weapons of mass destruction."
Because they are put options, Berkshire would be obligated to pay the option buyer if the indices fall below their respective exercise prices. And because these are European-style options, the buyer can exercise these options only at maturity. As a general rule, the value of these positions increase when stocks go up and vice versa.
In Q1, the value of these positions fell by $796 million as volatility spiked and the markets spent most of the period in the red. To be fair, these are just paper losses, and Berkshire won't be obligated until the options mature. The maturities of these options span from 2018 to 2026. The weighted average life is 4.7 years.
A summary of Berkshire Hathaway's derivative gains and (losses).
It's not surprising that Buffett would make a bet that the market would be higher in the long-term. Indeed, derivatives are a cheap way of doing this. But it was interesting that he made that bet using derivatives, which in 2002 he characterized as "financial weapons of mass destruction."
To be fair, that reference was tied to Berkshire's acquisition of General Re, which came with a book of complicated over-the-counter derivatives. (CBOE's Russell Rhoads explained.) And taking positions in derivatives is a pretty standard way of repositioning risk in a large portfolio like those held by insurance companies.
“The aggregate intrinsic value of our equity index put option contracts was approximately $1.6 billion at March 31, 2016,” management said in a regulatory filing. “However, these contracts may not be unilaterally terminated or fully settled before the expiration dates. Therefore, the ultimate amount of cash basis gains or losses on these contracts will not be determined for several years.”
"Years."
Buffett would probably agree that "years" is a better unit of measurement than "quarters" for anything in business.
Click here to view a full replay of the 2016 Berkshire Hathaway annual shareholder meeting, which Yahoo Finance live-streamed exclusively. At this page you can also find our extensive coverage of the event.
