Business Context and Reporting Period
Company: Berkshire Hathaway Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Overview: Berkshire Hathaway is a holding company with diverse operations, primarily in insurance (primary and reinsurance), utilities and energy, manufacturing, service, retailing, and finance. The company operates on a highly decentralized basis with minimal corporate involvement in day-to-day operations. A significant event in 2006 was the full consolidation of MidAmerican Energy Holdings Company following the conversion of preferred stock to common stock in February 2006.
Key Financial Metrics
| Metric | 2006 | 2005 |
|---|---|---|
| Total Revenues | $98,539 million | $81,663 million |
| Net Earnings | $11,015 million | $8,528 million |
| Net Earnings Per Share (Class A equiv.) | $7,144 | $5,538 |
| Total Assets | $248,437 million | $198,325 million |
| Shareholders' Equity | $108,419 million | $91,484 million |
| Book Value Per Share (Class A equiv.) | $70,281 | $59,377 |
| Insurance Float | ~$50.9 billion | ~$49.3 billion |
| Statutory Surplus (U.S. Insurers) | ~$59 billion | ~$52 billion |
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 21% to $98.5 billion, driven largely by the consolidation of MidAmerican Energy ($10.6 billion in revenue) and growth in insurance premiums and manufacturing sales.
- Earnings Increase: Net earnings rose 29% to $11.0 billion. This was aided by a lack of major hurricane losses in 2006 compared to the $3.4 billion pre-tax underwriting loss from Hurricanes Katrina, Rita, and Wilma in 2005.
- Investment Gains: After-tax investment and derivative gains were $1.7 billion in 2006, down from $3.5 billion in 2005. The 2005 figure included a non-cash $5.0 billion pre-tax gain from the exchange of Gillette stock for Procter & Gamble stock.
- Underwriting Performance: The insurance group generated a pre-tax underwriting gain of $3.8 billion in 2006, a significant improvement over the $53 million gain in 2005.
- Acquisitions: Berkshire spent approximately $10.1 billion on business acquisitions in 2006, including PacifiCorp ($5.1 billion), Iscar Metalworking Companies (80% interest, $5 billion valuation), and Russell Corporation ($600 million).
Guidance, Outlook, and Risks
- Management Commentary: Management emphasizes that periodic investment gains/losses have no predictive value. The company maintains a strategy of holding equity investments for the long term and accepting short-term volatility. Underwriting discipline remains a priority, with a willingness to reject inadequately priced risks.
- Capital Allocation: Berkshire maintains significant liquidity ($38.3 billion in cash and cash equivalents excluding finance businesses) to cover obligations and seize opportunities. MidAmerican expects capital expenditures of approximately $3.0 billion in 2007.
- Key Risks:
- Insurance Volatility: Earnings are subject to volatility from catastrophe losses (estimated probable maximum loss of $6 billion from a single event) and estimation errors in loss reserves ($48 billion in reserves).
- Key Personnel: Investment and capital allocation decisions rely heavily on Warren Buffett (76) and Charles Munger (83). A succession plan is in place, but their unavailability could have a material adverse effect.
- Legal Proceedings: Ongoing investigations by the SEC, DOJ, and other authorities regarding "non-traditional products" and finite reinsurance transactions involving General Re. Several former executives are awaiting trial.
- Market Risk: Significant exposure to equity price risk (54% of equity portfolio concentrated in four investees) and interest rate risk.
Investor Verification Checklist
- Loss Reserve Adequacy: Verify the development of prior-year loss reserves, particularly for General Re and BHRG, given the $48 billion liability and the inherent uncertainty in long-tail casualty claims.
- MidAmerican Consolidation: Confirm the impact of the full consolidation of MidAmerican on debt levels ($16.9 billion in utility debt) and future capital expenditure requirements.
- Legal Contingencies: Monitor the status of the AIG transaction investigations and related civil litigation, as outcomes could result in fines or penalties.
- Investment Portfolio Concentration: Assess the risk associated with the high concentration of equity holdings in a few companies (e.g., GE, Coca-Cola, American Express, Gillette/PG).
- Float Cost: Review the cost of float (underwriting gain/loss relative to float) to ensure the insurance operations continue to generate negative cost of capital.