Insurance, Utilities Lead the Way for Berkshire

 Berkshire Hathaway (BRK.A) (BRK.B) reported fourth-quarter and full-year 2009 earnings Saturday morning, which included a solid further advance in book value per share. The results were largely in line with our expectations. Solid positive results in insurance and utility operations coupled with more gains on derivative positions to lead the way, while results in the diverse, but generally economically sensitive, set of operating subsidiaries remained relatively weak.

Book value per Class A equivalent share rose at an annualized pace of 17% in the fourth quarter, a very good result after large-scale 40+% annualized increases in the second and third quarters. The chairman's letter to shareholders in the annual report included an interesting in-depth discussion of the meaning of the book value metric, noting the limitations and ambiguity underlying the reported amount but also how changes in that amount were a good yardstick to measure progress. For 2009 as a whole, book value per share rose about 20%, in line with the company's long-term average, and a significant improvement over recent years.

We like to watch operating cash flow at Berkshire, too. Berkshire's overall operating cash flow has been on a significant upward trajectory since mid-2008, despite continuing weakness in the aggregate results of the firm's collection of noninsurance subsidiaries. Berkshire has generated significant incoming premium in its insurance operations, serving as a port in the storm in recent years, and cash found its way in the door in similar ways in Berkshire's derivatives transactions. Operating cash flow continued to rise significantly in the fourth quarter, with a 35% year-over-year increase and a solid seasonally adjusted advance from the third quarter.

How about those noninsurance operating subsidiaries? They are an economically sensitive bunch and were certainly not spared from the Great Recession despite all their economic moatiness. Their operating profitability fell significantly, in aggregate, in 2008. The developing economic recovery has helped, but housing and related activity haven't picked up as significantly as they have in previous recoveries, and Berkshire's subsidiaries have a relatively outsized sensitivity to trends in that area. In fact, our Great Recession was Great in large part due to the massive downturn in housing starts, which have stabilized but remained very small in recent months.

The total revenue in Berkshire's operating subsidiaries looked pretty flat from the third quarter to the fourth quarter, on a seasonally adjusted basis, and the modest recovery earlier in 2009 appears to have lost some momentum in the fourth quarter. In turn, their operating profitability continued to trend downward. Berkshire's overall book value growth looks all the more impressive in light of the muted contribution from these fundamentally good companies, and the combination of a better recovery in their results with continued positive results in the insurance and utility operations could lead to outsized returns in 2010.