Saturday, February 28, 2009

Berkshire Hathaway Annual Report/Letter

The Berkshire Hathaway 2008 Annual Report and heavily read Annual Letter have just been released.

Some quick notes (text from the letter in bold):

Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.

We are completely screwed as a country if this continues. Rewarding bad companies at the expense of good companies can only lead to financial ruin.

In the past, Warren Buffett has referred to derivatives as "weapons of massive financial destruction." Therefore it is puzzling why Berkshire Hathaway began to play heavily in derivitives in the past few years:

To illustrate, we might sell a $1 billion 15-year put contract on the S&P 500 when that index is at, say, 1300. If the index is at 1170 – down 10% – on the day of maturity, we would pay $100 million. If it is above 1300, we owe nothing. For us to lose $1 billion, the index would have to go to zero. In the meantime, the sale of the put would have delivered us a premium – perhaps $100 million to $150 million – that we would be free to invest as we wish.

What a disingenuous example! Who would possibly buy a put contract (insurance) that pays out equal to the premium in the absolute worst case scenario?

Our put contracts total $37.1 billion (at current exchange rates) and are spread among four major indices: the S&P 500 in the U.S., the FTSE 100 in the U.K., the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan. Our first contract comes due on September 9, 2019 and our last on January 24, 2028. We have received premiums of $4.9 billion, money we have invested. We, meanwhile, have paid nothing, since all expiration dates are far in the future. Nonetheless, we have used Black- Scholes valuation methods to record a yearend liability of $10 billion, an amount that will change on every reporting date. The two financial items – this estimated loss of $10 billion minus the $4.9 billion in premiums we have received – means that we have so far reported a mark-to-market loss of $5.1 billion from these contracts.

I like the real life example better. So far Berkshire has taken a massive write down on their derivatives. I’m not saying the contracts will result in a long term loss for Berkshire, but right now they do not look pretty. Read the whole letter for Buffett's somewhat convincing arguments for these positions.

Besides that, I found the “folksy wisdom” scattered throughout the report really annoying. “As we view GEICO’s current opportunities, Tony and I feel like two hungry mosquitoes in a nudist camp. Juicy targets are everywhere.” Buffett has always written this way, but it seems like he turned it up a notch this year. Maybe I am just being cranky. Shrug.


Dustin said...

This is a great website. I really enjoy reading your material. I am not a serious investor. I am new to the game and gathering knowledge. I have really learned a lot from studying this site. Keep up the good work and thank you for your time invested keeping information current.

SoYouThinkYouCanInvest said...

Thanks a lot Dustin. I wish I had a lot of advice for beginning investors but it is rough out there. With the stock indexes all making fresh multi year lows, I can't recommend buying stocks.

My best advice would probably be to pay down any debts. Highest interest rates, such as credit cards, first, followed by debt at lower rates, such as subsidized student loans. After that, save up a cash cushion of at least six months. Even if the economy turns around tomorrow unemployment will continue to rise for the next year so almost no job is safe.

Dustin said...

Thanks for the advice! I am fortunate as a recent graduate that I will be able to pay back all my loans within the first year of repayment. Once they are paid off and CC debt is zeroed with a years worth of living expenses in the bank I should have about $20,000 to put forth for retirement in 30 years. This is a one time lump that I will be able to invest as I do not forecast making that kind of money again for a couple years. What do you suggest? I know I should contact a professional before investing so blah blah blah....

I was thinking of contacting Peter Schiff as his investment scheme makes sense to me and his foreign investments are way down right now much like here in the states. He is promoting the Canadian Oil Sands, utilities and high growth stocks in Asia on the play that the dollar crashes and China stops buying our treasuries. I like the high yields of these stocks.

I was also thinking of precious metals as a hedge against inflation and the security of having this at home as a "in case of" kit.

Then you came into the picture with these ETF's. I like them as well as something that I can manage with an online brokerage.

So That is my story...

SoYouThinkYouCanInvest said...

Congrats on graduating and being in such a great financial situation so early in life.

I actually don't put a lot of credence on contacting an investment "professional." Why? For the most part, unless you have a lot of money to invest, a really good professional will not have the time to talk to you. There are exceptions of course but odds are if they are good they only spend time with rich clients.

It's funny that you mention Peter Schiff. I am currently reading his latest book and will putting up a post about it in the next week or two. He has some good ideas but I would be very careful in following his investment advice 100%. I will talk more about his ideas in my upcoming post.

I am no expert on Canadian oil sands but my understanding is that they are basically not viable businesses with oil at current prices. A dividend is not safe if a company has no profits so a high yield can be showing that the market does not believe the dividend will hold up. In this environment no dividend is safe - I mean GE just cut their dividend for the first time since 1938 and Dow Chemical cut theirs for the first time since 1912.

My best advice for long term investors is to wait for the trends to present themselves before jumping in. Stocks are still making new lows and with the global banking system in shambles I see no reason to own any stocks. Certain commodities are starting to look interesting, though I noted a week or two ago that the precious metals have gotten awfully crowded awfully fast. Most of my money is still in cash so take that for what it is worth.