NORTHWESTERN UNIVERSITY
Berkshire Hathaway Case: Assignment questions
Hints:
a. Sometimes, the totals in certain line items in Berkshire financial statements spreadsheets downloaded from S&P Capital IQ may not necessarily match with the sum of prior line items because of some missing items. However, none of these discrepancies should affect the answers to any of the following questions.
. Please note that you may have to refer to either one of or both the case (uploaded on the study.net) and the relevant excerpts of the firm’s annual reports (from S&P Capital IQ) uploaded on our Canvas site.
Please ignore the questions included in the case. Instead, answer the following questions as part of your case analysis.
A. Investments in Equity Securities
1. What is the ca
ying value of “investments in equity securities” as at December 31, 2018 in Berkshire’s books? How does Berkshire determine its ca
ying value of its “investments in equity securities”?
2. What fraction of the fair value of Berkshire’s total “investments in equity securities” as at December 31, 2018 was on account of its investments in Apple? (Hint: To answer questions 1 and 2, refer to footnote #4 of the firm’s annual report.) Would you characterize Berkshire’s investments in Apple as entailing an excessive concentration of risk in one security given that most asset managers would strive for some diversification in their portfolio?
3. (a) Record the necessary entries in Berkshire’s balance sheet equation (also refe
ed to as the FSET in the text book) for the quarter ended June 30, 2018 with respect to its equity security holdings in Bank of America Corp. (You may use the stock prices as of 3/29/2018 and 6/29/2018.)
(b) Record the necessary entries in the firm’s balance sheet equation (also refe
ed to as the FSET in the textbook) for the quarter ended June 30, 2018 with respect to its equity security holdings in American Express Company. You may use the stock prices as of 3/29/2018 and 6/29/2018. (Hint: To answer questions 3(a) and 3(b), refer to Exhibit 5 in the case for the relevant data in addition to the firm’s disclosures included in the case.)
4. How much cash did Berkshire receive from the sale and disposal of “Investments in Marketable and Equity Securities” for the year ended December 31, 2019? (Hint: Refer to the data from the spreadsheet downloaded from S&P Capital IQ.)
5. Assume that the unrealized gains on sale of investments in marketable and equity securities during the year ended 12/31/2019 were $61,200 million. Determine the ca
ying value of marketable and equity securities in the books of Berkshire before the firm sold such marketable and equity securities during the year ended 12/31/ XXXXXXXXXXHints: (a) Refer to the data from the Statement of Cash Flow or Income Statement spreadsheet downloaded from S&P Capital IQ. (b) Note that the “(Gain) Loss on Sale of Investments” includes both realized and unrealized gains and losses on such marketable and equity securities.)
6. If Berkshire were to have recognized zero “investment gains/losses” (i.e., both realized and unrealized gains on investments in equity securities) in each of fiscal years ended on December 31, 2017, 2018 and 2019, respectively, how much would its earnings before taxes (EBT) have been for each of those three years? Ignore the tax effects while answering this question. (Hint: Refer to the data from the spreadsheet downloaded from S&P Capital IQ. “Finance Division Operating Expenses” section of the income statement includes “investment gains/losses representing the sum of both unrealized and realized gains and losses on Berkshire’s investments in equity securities.)
7. Year-over-year growth in any key performance indicator (KPI) is computed as (end-of-the-year value – beginning-of-the-year value)/ beginning-of-the-year value. Compute such year-over-year growth in operating income as reported by Berkshire for each of the years ended 12/31/2018 and 12/31/2019. (Hint: For instance, if operating income for the years 2017 and 2018 are $100 and $110, respectively, then year over year growth in operating income for the year 2018 will be equal to XXXXXXXXXX)/100 =10%.)
8. Compounded annual growth rate (CAGR) in any KPI is computed as (end-of-the-period value / beginning-of-the-period value)^(1/n) -1, where “n” refers to the number of periods. Determine the CAGR over two years in Berkshire’s operating income (OI), as reported by the firm, for each of the years 2018 and 2019.
(Hints: (a) For instance, if operating income for the years 2016, 2017 and 2018 are $90, $100 and $110, respectively, then CAGR over two years in operating income for 2018 will be equal to (110/90)^(1/2)-1 =10.554%. One can cross verify the answer by deriving the end-of-the-period value from the beginning-of the-period value as 90* XXXXXXXXXX)^2 = $110.
(b) Another example: to compute CAGR over two years for operating income for 2018, determine the value of (OI in 2018/OI in 2016)^(1/2)-1.
9. If Berkshire were to have recognized zero “investment gains/losses” (i.e., both realized and unrealized gains on investments in equity securities) in each of fiscal years ended on December 31, XXXXXXXXXX, respectively, how much would its CAGR over two years in operating income have been for years 2018 and 2019? Ignore the tax effects while answering this question. (Hint: Refer to the data from the spreadsheet downloaded from S&P Capital IQ. “Finance Division Operating Expenses” section of the income statement includes “investment gains/losses representing the sum of both unrealized and realized gains and losses on Berkshire’s investments in equity securities.)
10. Compare your answers to questions 8 and 9 above and explain the reasons for any differences you might notice. Further, what are the reasons for any differences between the year-over-year growth in OI and the two-year CAGR in OI for years 2018 and 2019?
B. Equity Method of Investments
11. As of December 31, 2018, Berkshire owned 26.7% of the outstanding shares of Kraft Heinz. Consistent with its ability to “exercise significant influence, but not control” over Kraft Heinz, Berkshire uses the equity method of investments to account for its investments in Kraft shares. Record the effects of dividend receipts and equity method losses in Berkshire’s balance sheet equation (using the FSET) for the year XXXXXXXXXXYour presentation of FSET should include both the beginning and ending balances in the ca
ying value for the firm’s equity method of investments. (Hint: (a) Use footnotes #1 and # 5 from the case to answer this question. (b) There might be some small difference in reconciling the ca
ying balance at 12/31/2017 with the ca
ying balance at 12/31/2018. Based on publicly available data, we often do not have enough information on the magnitude of this “plug” you need to recognize in the FSET. Simply determine the ca
ying value at 12/31/2018 based on dividends and equity losses information provided in the footnotes.)
12. If Berkshire had received no dividends from Kraft Heinz during the year ended 12/31/2018, how much would its operating income have been as opposed to what is reported on its income statement? Ignore any tax effects in answering this question.
13. If equity method losses from its holdings in Kraft Heinz were exactly zero, how much its operating income would have been for the year ended 12/31/2018 per S&P Capital IQ presentation? Ignore any tax effects in answering this question. (Hint: For the purpose of answering this question, please take only $2,167 million as equity method losses as reported by S&P Capital IQ and not from footnote # 5 of the firm’s 10K. The difference between these two numbers are on account of certain special items not captured by S&P’s uniform and standardized format statements.)
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UV7776
Rev. Dec. 6, 2019
Potential Volatility Comes to Earnings:
A Look at Berkshire Hathaway’s Equity Investments
It was mid-Fe
uary 2019, and Maria rushed home. She knew that Wa
en Buffett’s annual letter to
shareholders had been posted to the Berkshire Hathaway Inc. (Berkshire Hathaway) website that morning, and
she was anxious to see what Buffett, known as the “Oracle of Omaha,” had to say about Berkshire Hathaway’s
2018 performance. She walked hu
iedly through the front door of her condo, opened her laptop, located the
letter on the website, and printed a copy to read.
Berkshire earned $4.0 billion in 2018 utilizing generally accepted accounting principles (commonly
called “GAAP”). The components of that figure are $24.8 billion in operating earnings, a $3.0 billion
non-cash loss from an impairment of intangible assets (arising almost entirely from our equity interest
in Kraft Heinz), $2.8 billion in realized capital gains from the sale of investment securities and a
$20.6 billion loss from a reduction in the amount of unrealized capital gains that existed in our
investment holdings.
A new GAAP rule requires us to include that last item in earnings. As I emphasized in the 2017 annual
eport, neither Berkshire’s Vice Chairman, Charlie Munger, nor I believe that rule to be sensible.
Rather, both of us have consistently thought that at Berkshire this mark-to-market change would
produce what I described as “wild and capricious swings in our bottom line.”
Our advice? Focus on operating earnings, paying little attention to gains or losses of any variety.1
Maria was struck by the words. “$24.8 billion operating earnings…a $20.6 billion loss from reduction in
the amount of unrealized capital gains…” She knew that Berkshire Hathaway’s XXXXXXXXXXK was its first 10-K
filed using the Financial Accounting Standards Board’s (FASB’s) new rules pertaining to financial instruments
(ASU XXXXXXXXXXIt must have been a humdinger—it hit Berkshire Hathaway with a $20.6 billion loss, and Buffett
was suggesting it wasn’t a sensible rule. Maria had to dig in.
Berkshire Hathaway Overview2
Berkshire Hathaway was a holding company that owned subsidiaries involved in a wide range of businesses.
Those businesses included insurance (GEICO), railroad (BNSF Railway Company), civil aviation (NetJets Inc.),
1 Wa
en Buffett’s annual letter to Berkshire Hathaway Inc. shareholders, Fe
uary 23, 2019, http:
www.berkshirehathaway.com/letters/2018ltr.pdf
(accessed June 7, 2019).
2 Berkshire Hathaway 10-K report, 2018.
This case was prepared by Luann J. Lynch, Almand R. Coleman Professor of Business Administration, and Mark E. Haskins, Professor of Business
Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation.
Copyright 2019 by the University