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Berkshire Hathaway’s Annual Report March 2, 2009

Posted by shaferfinancial in Finance, Uncategorized.
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Great reading as usual.  Highly recommended for all.  Now for those who had no clue how Berkshire Hathaway makes money here is a very brief synopsis.  Berkshire Hathaway owns several insurance companies which provides them with significant “float.”  The float is premiums paid in advance, that must be set aside to pay out potential claims.  That float is then invested to hopefully get returns above what is eventually paid out in claims.  It requires two skill sets, underwriting at a price that will generate profits and investing for a good return.  Those two skill sets, explain the remarkable returns Berkshire has offered its investors.

First the bad news, Berkshire Hathaway’s book value dropped 9.6% over 2008.  It was its worst year ever.  Only the second negative year out of the last 44 years.  I would imagine the critics will be out in full regalia to do their thing, but few will bother to take a look at his letter or take to time to understand the company.  Although I prefer its normal double digit returns, last year for me was not anywhere near as bad as the critics will make it out to be.

First, the entire loss in book value is not realized losses, but accounting losses.  They came in two areas; derivatives and stocks of other companies owned.  Mr. Buffett devotes a whole section to his report on the derivatives situation, but suffice it to say that most people would not take the accounting losses too seriously.  In fact most investors, even the conservative analysts would have to come to a conclusion that there is a very high probability of these investments being profitable.  The drop in value of the common stock owned was well known in advance and again represents accounting losses, not real losses.  Now some will say he should have sold his financial stocks, but he is Warren Buffet, the person who personified buy and hold.  And despite some people’s expectations he has no working crystal ball.  As bad as a 9.6% loss in book value is, compared to most other companies it is downright good!  State Farm, another insurance based company, saw a 16% drop in their equity portfolio to give a comparison.  State Farm also had an operating loss, as opposed to the operating gains Berkshire made.

Now that we got through the bad news, there is much good news.  As I pointed out there are two components, the investment component and the underwriting component.  As Warren Buffett pointed out in last years letter, many players in the insurance market were undercutting their prices to a point that Buffett predicted real risk issues.  Berkshire refused to play that game, as a result sold less insurance (with the exception of Geico which had a fabulous year gaining market share).  Those companies that priced their insurance too low for the risk are now in real trouble, leaving Berkshire standing virtually alone in some markets.  This should be positive for the future.  And as a result of their underwriting discipline there was a $2.8 Billion operating profit from insurance.

Over the last few years Berkshire has made a major move into energy.  Not only are these companies extremely profitable, but they are gaining market share and becoming the largest wind generated power companies in the US.  He also purchased shares of Conoco/Phillips, which he called a one of his two mistakes last year.  I don’t believe it was a mistake, but he did admit to buying shares a couple of months before oil prices came down driving down the share price.  So short term it was a little premature, but long term I think it will work out fine.  Add this  to his purchase of shares in a Chinese company that is involved in battery technology and makes electric/hybrid cars and you see Berkshire is well positioned to benefit from future energy needs as the price of oil increases. 

The rest of companies owned by Berkshire Hathaway (63) had mixed results last year, with real estate/construction oriented companies having poor years, while others had much better years.  The overall earnings on a per share amount dropped from $4,093 in 2007 to $3,921 in 2008 or 4%.  Not bad in one of the worst years in recent memory for corporate profits!

Berkshire opened up a new line of insurance (BHAC) in 2008, which insures municipal bonds.  All the companies that were in this business prior to 2008 have had substantial problems because price competition caused them to reach into other areas including insuring residential real estate backed mortgages.  These companies re-capitalized, but remain very weak as opposed to Berkshire which is among the strongest companies in the world.  Buffett spends some time in his letter discussing this business.

His second self-admitted mistake was buying into two Irish banks.  This was a real mistake as the value dropped 89%.  Even Buffett makes some mistakes sometimes!  The selling of stocks in 2008 were done to keep liquidity up as it made other investments.  Berkshire still has almost $28 Billion in cash.

Note that Berkshire Hathaway stock price has dropped substantially.  But there is no rational reason for the 40%+ drop.  Book value dropped less than 10% and that is accounting issues and issues with the broader market.  Operating income only dropped 4%.  The two largest businesses, insurance and energy had reasonably good years.  And investments made in 2008 are significant and will provide excellent double digit cash flow going forward.

Bottom line is that Berkshire is positioned to increase its market share in the two main business areas, insurance and energy, while enjoying the cash flow of over 60 different businesses (which returned 17.9% on net worth last year).  It has $58 Billion dollar float on which to invest with last year that cost them less than $0.  It invested $14.5 Billion in three companies (Wrigley, Goldman Sachs, GE) that not only pay double digit returns but have warrants attached that could pay off if these companies stock values go back up over the next 3-5 years.

I couldn’t have been more pleased with the report.  It allayed any concerned I had with the market pushing the stock price down.

 

**************David Shafer and Shafer Financial are not registered investment advisors and they give out NO investment advice.  This blog is for amusement purposes only.  Before putting money in any investment, do your own analysis.  Always get a second opinion. ***********************************************************

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Comments»

1. Joshua - March 2, 2009

Great Report!


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