At REITer's Digest, we have never covered Berkshire Hathaway (NYSE:BRK.B), primarily because it falls outside of the scope of real estate and income producing investments. However, Buffett's masterpiece sits as a core holding for millions of investors, myself included. In fact, according to the 2023 Annual Report, the company has over three million individual shareholders. BRK.B is a legendary money making machine, which has made millionaires out of thousands of Americans over the span of decades.

BRK.B is a large and complex conglomerate created by two of the brightest minds in investing, Warren Buffett and the late Charlie Munger. In fact, BRK.B's extraordinary success over a period of decades stems from the complex execution of a remarkably simple goal:

We want to own either all or a portion of businesses that enjoy good economics that are fundamental and enduring. Within capitalism, some businesses will flourish for a very long time while others will prove to be sinkholes. It's harder than you would think to predict which will be the winners and losers. And those who tell you they know the answer are usually either self-delusional or snake-oil salesmen.

Today, we are going to examine the recent performance of BRK.B against recent news including an increased investment in Occidental Petroleum (OXY) and Apple's (AAPL) venture into the world of artificial intelligence.

Recent Underperformance of S&P 500

BRK.B's long-term performance is unquestionably and legendarily strong. The company has outperformed most every index through a combination of prudent investment, conservative balance sheet management, and a legendary share buyback system that consistently reduces the denominator of BRK.B's share level metrics.

If we look more recently, specifically at the period following the pandemic, BRK.B has underperformed the large capitalization market (SPX). Over the past five years, BRK.B has underperformed SPX by approximately 7% in terms of total return, assuming dividends had been reinvested into the index.

The deviation from long-term performance comes largely on account of diverging performance within the broader equity markets. Over the past five years, a small number of mega capitalization technology stocks have powered a substantial portion of the index's total return. These are known as the Magnificent Seven.

Magnificent Seven

• Microsoft Corp. (MSFT)
• Amazon.com, Inc. (AMZN)
• Meta Platforms, Inc. (META)
• Apple Inc. (AAPL)
• Alphabet Inc. (GOOG, GOOGL)
• Nvidia Corp. (NVDA)
• Tesla Inc. (TSLA)

Each of these well-known companies has experienced unprecedented earnings growth following the pandemic. While investors have consistently warned of a bubble resulting from swelling valuation multiples. However, many doubters have been proven wrong as each stock has expanded their earnings per share significantly over the past four years.

In fact, many of these companies have changed dramatically over the past four years. NVDA has become one of the largest companies by market capitalization, pioneering the technology behind AI. META continues to grow and recently initiated a dividend.

However, the success of the Magnificent Seven has been largely missed by BRK.B. Aside from Buffett's enormous investment in AAPL, the Oracle of Omaha lacks a major investment in the remaining names. Buffett's style of investing is notoriously value oriented, focusing on things like earnings growth, balance sheet strength, and capable management teams. This often means looking for "classic" businesses which fit the bill of a traditional investor. While Buffett avoided the carnage of the tech bubble in the early 2000s, he also avoided the tech earnings renaissance of the post-pandemic era.

Over the past three months, BRK.B's performance has trailed the S&P 500 even more significantly. BRK.B shares are virtually even, while the large capitalization index has increased by 6.5%. As the index continues to rally, BRK.B shares have headed south.

There have been two recent developments that have had a significant impact on BRK.B's portfolio.

1. Apple Ventures Into AI

Last week, AAPL announced a venture into AI which included several key updates to iOS. Seeking Alpha recently covered the news in depth:

Apple kicked off its highly anticipated developer's conference with a keynote address on Monday, unveiling a slew of artificial intelligence-centric updates to its operating systems as it seeks to keep pace with the competition.

Known as "the next big step" for Apple, Apple's AI system, Apple Intelligence, offers personality and privacy built in….

The writing tools can write, summarize and condense text (like other chat tools such as ChatGPT), while being able to create original images using photos from a user's library. (Apple offered the example of calling "mom a hero" and the AI creating an image of a superhero.)

Additionally, Apple Intelligence can be integrated across apps, allowing users to give prompts such as "pull up the files" or play the podcast my wife sent me last week and the device performs the action. It's able to do this via on-device intelligence, Apple said.

Other tasks may need Apple's own servers and the device automatically decides if the task can run on the device or if it needs to run on Apple's servers, using private cloud compute.

Siri also received a major AI-centric upgrade. The updated voice assistant can now take actions across apps and answer questions on how to use devices and offer "on-screen awareness," so that a user can say add an address to a contact and it will do that, via the new App Intents API.

Without espousing the well-known virtues of AI, the announcement marks a critical step for AAPL, who has begun integrating the technology into their ubiquitous mobile phone platform. More importantly for investors, AAPL's share price has appreciated 12% over the past week.

AAPL is BRK.B's largest investment, valued at nearly $175 billion at the end of 2023. This accounts for around 20% of Berkshire's $875 billion market capitalization. Price movements in AAPL shares should have a material impact on the movement of BRK.B shares. However, over the past week, BRK.B shares have declined in the face of AAPL exuberance.

This either means an obvious buying opportunity has emerged, or there are other factors counteracting the good news from the conglomerate. Let's move into another recent corporate development from BRK.B.

2. Berkshire Boosts Investment In Occidental Petroleum

On June 16, public filings indicated that BRK.B had increased their investment in OXY by several million shares. Over the past week, BRK.B increased their ownership to over 250 million shares of OXY, valued at over $15 billion. The increased stake gives BRK.B a 28.5% stake in OXY. The investment in OXY begins in 2019 with a $10 billion investment in 8% preferreds. In 2022, Buffett began acquiring shares of OXY common stock.

BRK.B's investment in OXY has drawn sharp criticism from a wide range of investors. As Buffett continues to confidently invest in fossil fuels, many question whether he is accurately predicting the future of society. With an international push towards renewable energy, some believe fossil fuels are facing the end of their dominance as a global source of energy.

Before discussing demand drivers, BRK.B's investment in OXY is somewhat odd, only considering the long-term performance of OXY shares. As OXY's long-term performance erodes shareholder value over the long term, Buffett's confidence in their assets, operations, and outlook continue to grow as BRK.B increases their investment. Even still other blue chip energy companies like Texas Pacific Land (TPL) would have seemed more aligned with Buffett's philosophy from the outside.

Following the follow-on investment, OXY accounts for nearly 5% of BRK.B's portfolio value.

OXY's performance has improved following the initial Berkshire investment in 2019.

The doomsday outlook around oil is likely overblown, given the diversified sources of demand for petroleum-based products. We recently authored an article exploring the impacts of the expiration of Saudi Arabia's long term Petro-Dollar agreement with the United States. As Saudi Arabia and other international energy producers commit to an independent global economy, the importance of domestic energy producers is increasingly important.

Fossil fuels are used for a variety of purposes beyond producing gasoline for cars. Even as the adoption of renewables for energy increases, petroleum continues to be a critical piece of the manufacturing process for various goods. According to data from the EIA, around one third of petroleum demand is outside of transportation entirely.

Petroleum has historically been the most-consumed energy source in terms of total annual U.S. energy consumption. We use petroleum products to propel vehicles, to heat buildings, and to produce electricity. In the industrial sector, the petrochemical industry uses petroleum as a raw material (a feedstock) to make products such as plastics, polyurethane, solvents, and hundreds of other intermediate and end-user goods.

The EIA projects stagnating demand for petroleum over the coming decades as other energy sources are progressively adopted. However, this does not necessarily align with the doomsday outlook assigned by some progressive investors.

…the U.S. Energy Information Administration projects U.S. total consumption of petroleum and other liquids in 2050 to be nearly equal to the projection for 2023. Petroleum and other liquid fuels will decline from about 37% of total U.S. energy consumption in 2023 to about 34% of total annual U.S. energy consumption in 2050.

As some believe the industry will fade away entirely as a result of electric vehicles, reality may be more accommodating the world's largest fuel source. As the United States, continues to lead demand for oil, domestic producers like OXY are key to guaranteeing energy security.

Putting demand for oil aside, OXY is also looking forward to the future. Understanding that demand is unlikely to increase materially in the coming decades, OXY is investing outside of fossil fuels. For example, OXY and BHE Renewables recently formed a joint venture to extract lithium.

Occidental and BHE Renewables, a wholly owned subsidiary of Berkshire Hathaway Energy, today announced they formed a joint venture for the demonstration and deployment of TerraLithium's Direct Lithium Extraction (DLE) and associated technologies to extract and commercially produce high-purity lithium compounds from geothermal brine.

TerraLithium, a wholly owned subsidiary of Occidental, has patented DLE technologies that have the potential to process any lithium-containing brine into a responsibly sourced supply of high-purity lithium. BHE Renewables operates 10 geothermal power plants in California's Imperial Valley, which process 50,000 gallons of lithium-rich brine per minute to produce 345 megawatts of clean energy. The joint venture has begun a project at BHE Renewables' Imperial Valley geothermal facility to demonstrate the feasibility of using the TerraLithium DLE technology to produce lithium in an environmentally safe manner.

Venturing into lithium extraction and refinement is a critical step for OXY to secure their place in a diversified future. As the world moves away from an oil dominated lifestyle, OXY is diversifying their business to fit into the future.

Berkshire Valuation

Berkshire maintains one of the strongest and most conservatively managed balance sheets on Wall Street. Over time, Berkshire has amassed a notorious cash pile which surpassed $180 billion in the first quarter, combining cash and short-term U.S. Treasury Bills. From a balance sheet perspective, BRK.B is well protected, remaining net cash positive with more cash than long-term debt.

For 2023, BRK.B reported earnings per share corresponding to a 23.6x price earnings multiple at year-end. In the first quarter, BRK.B reported earnings per share of $5.20, surpassing analyst forecasts by $0.29. As earnings rise, but the share price stagnates, BRK.B's price earnings multiple has softened to 20.6x forward earnings. BRK.B's contracted multiple is below the five-year trailing average of 22.3x. Based on current and historical data, this means there is room for multiple expansion, which could boost share prices by 10%-15%. Additionally, consensus earnings per share forecasts for 2024 are 14.2%, meaning earnings growth is forecasted to be similarly strong.

In contrast to earnings metrics, BRK.B is expensive relative to historical book value. BRK.B shares are currently trading at 1.5x price to book value, which is 12% above the company's trailing five-year average. BRK.B has historically traded well above book value. Typically, BRK.B shares trading above 1.6x price to book value is a possible sign that shares are richly valued. Berkshire's premium to book value peaked during the start of the year. The softening performance of BRK.B over the past three months has reduced the premium and opened a buying opportunity.

There is a case to be made the shares of BRK.B have additional embedded growth from recent investment and increased earnings on the short-term treasury investments. The combination of double-digit earnings growth and a contracted multiple positions BRK.B to rebound. Longer-term earnings per share growth is driven by another critical factor for Berkshire.

Rather than pay a dividend, Berkshire invests the capital in existing investments, new investments, shares of BRK.B, or the repayment of debt. One of the largest drivers of BRK.B's rising valuation tide is the notorious share repurchase program. In BRK.B's first quarter filing, management provides details on the company's share repurchase activity.

During the first quarter, Berkshire repurchased more than 4,000 shares of BRK.A, corresponding to over $2 billion of accretion. Importantly, Buffett has no limitation in the number of shares to be repurchased and there is no expiration date on the program. By removing shares from Berkshire's bottom line, share level metrics continue to rise.

Interestingly, Buffett also provides an alternative valuation measure in Berkshire's 2023 Annual Report, which is worth considering:

Among its disclosures many owners, along with financial reporters, will focus on page K-72. There, they will find the proverbial "bottom line" labeled "Net earnings (loss)." The numbers read $90 billion for 2021, ($23 billion) for 2022 and $96 billion for 2023.

We, however, are left uncomfortable. At Berkshire, our view is that "earnings" should be a sensible concept that Bertie will find somewhat useful - but only as a starting point - in evaluating a business. Accordingly, Berkshire also reports to Bertie and you what we call "operating earnings." Here is the story they tell: $27.6 billion for 2021; $30.9 billion for 2022 and $37.4 billion for 2023.

Berkshire is a conservatively managed business with minimal debt and value oriented portfolio investments. As such, Buffett believes in relying on less complex measures of success for the business, in this case "operating earnings". Berkshire achieved 21% growth in operating earnings between 2022 and 2023 and appears positioned to continue this growth trajectory. With cash amassing and Berkshire deploying capital, operating earnings will continue to grow, supporting shares of BRK.B.

Conclusion

BRK.B shares are mostly flat following a week of significant events for the company's portfolio. As the largest investment takes off, appreciating more than 10% in less than a week, BRK.B shares have modestly declined. As BRK.B deploys cash from their enormous pile into new shares of OXY, the market has virtually no reaction.

As attention for the market centers around the Magnificent Seven and the earnings renaissance taking place in tighter corners of the market, shares of the world's largest public conglomerate are unresponsive. Given the news and recently tepid performance, there is a unique opportunity to take advantage of undervalued shares of BRK.B.

A direct purchase of shares of BRK.B is almost always a prudent long-term investment. The company accumulates cash at an increasing pace, some of which is used to repurchase shares when management believes it is prudent. This rising tide of cash and buybacks provides consistent, year over year appreciation of BRK.B shares. Oddly enough, rising interest rates have proven fruitful for BRK.B's cash pile, which now owns over $100 billion in treasury securities. Another option for those looking to avoid purchasing shares of BRK.B at the current price is selling put options. Writing out of the money puts generates an attractive yield against undervalued shares of BRK.B. Should share prices decline, the investor would acquire shares at a further discounted price.

With AAPL's recent announcement and BRK.B management continuing to deploy capital into their portfolio, BRK.B deserves appreciation from the market. However, the short-term divergence in performance against the S&P 500 means there is value hiding in BRK.B shares. Currently, BRK.B earns a "Strong Buy" rating as a long term, core holding.