Berkshire's Letter & Report; Pain Yesterday, More Pain Tomorrow (BRK-A)

Berkshire Hathaway Inc. (NYSE: BRK-A) has just released its 2008 annual report, along with the ever-important letter to shareholders from the Oracle of Omaha, Warren Buffett.  Last year was Buffett’s toughest ever.

We are sorry to say it, but Mr. Buffett sounds like an aged boxing champion that decided to fight a much younger and larger rival.  In that spirit, Mr. Buffett was beaten so bad that he had to go to the hospital and his own prognosis is for 2009 to be a very tough year.

Here are the metrics that matter the most……  Berkshire’s 2008 net worth fell $11.5 billion while per share book value dropped 9.6%.  Investments fell from $90,343 per share to $77,793, and the second segment of value fell from pre-tax earnings of $4,093 per share to $3,921.  Buffett called the drop from all classes of securities for all investors as “bloodied and confused, much as if they were small birds that had strayed into a badminton game.” Another comment was “A freefall in business activity ensued, accelerating at a pace that I have never before witnessed.”

• As always, you can see a list of the FULL STOCK HOLDINGS on file from last quarter.  Interestingly enough, the most recent short interest data showed that traders were lightening up on betting against Buffett’s top holdings.

On the potential for government action, Buffett noted “will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation.” He also worries about how industries and municipalities now under government assistance will ever become financially independent again.

Warren sounds like an old sage in a new card game.  He talks about 75% of the last 44 years having positive annual returns, and suspects the same will about be true in the same period ahead.  He talked about the history of America and all of its challenges we have risen from.  And now for what to expect….

He and partner Charlie Munger said, “We’re certain… that the economy will be in shambles throughout 2009… and.. probably well beyond… but that conclusion does not tell us whether the stock market will rise or fall.”

So here are some of Buffett’s outlying goals in hard times: maintain excess liquidity, acquiring and developing new varied streams of earnings, expanding and nurturing its cadre of operating managers.  While there is never any financial guidance, Buffett noted that the business units earned below their potential in 2008 and “that will be true in 2009 as well.”

The company also gave some loose plans for 2009 (or later).  Berkshire’s focus will be on the earnings,  just as it has been for several decades.  It likes buying underpriced securities, but likes fairly-priced businesses even more.  The company is interested in making an acquisition in the $5 to $20 billion range.

We can bash Warren all day if we wanted to, but he does a pretty good job of this himself.  He noted, “there’s another less pleasant reality: During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt… Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.”

There has also been a lot of talk among traders recently about the put contracts that Buffett engaged in for premiums, and he outlined them as follows:   The company’s put option contracts total $37.1 billion across four major indexes, with the first contract due on September 9, 2019 and the last on January 24, 2028. It has received premiums of $4.9 billion, and based upon a $10 billion year end liability it reported a mark-to-market loss of $5.1 billion from these contracts.  For those to be a loss, the equity index levels would have to go to zero and if the markets stay as they are right now then Buffett would owe about $9 billion between 2019 and 2028.

The company also wrote some credit default swaps in 2008.  At year end it had written $4 billion in contracts on 42 corporations, for which it receives annual premiums of $93 million.  Buffett says they are unlikely to expand this business.

What you saw is actually worse than a bloodied Buffett.  This was frankly the most cautious letter we have seen from the Oracle of Omaha.  Berkshire Hathaway’s stock price closed out 2008 at $96,600.00, and that is down from a high of $147,000.00.  Its shares closed yesterday at $78,600.00.

Following Obama’s example, Buffett commented “America’s best days lie ahead.”

Here is also where you can see a copy of the FULL ANNUAL REPORT.

Jon C. Ogg
February 28, 2009