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Buffett losing his touch? Don’t bet on it

November 24th, 2008 ·

A recent Reuters story headlined Is Warren Buffett losing his touch? based its case on two thin reeds:

  • Recent price action — Berkshire Hathaway shares have fallen some 23% since the beginning of this month. The report speculated that the fall in BRK price might be due to mounting losses on its derivative contracts. BRK had previously entered into contracts insuring against the default of some junk bonds and had sold put options on some market indicies (i.e. betting that markets will be higher at contract expiry than when the contracts were entered into).
  • The cost of insuring BRK’s AAA-rated debt has soared recently.

The reporter didn’t seem to have read the Berkshire Hathaway annual reports. In the 2007 report, Warren Buffet mentioned that he expects the derivative contracts to be profitable on premium revenues alone and noted that investors should be cognizant of the accounting treatment of derivatives:

Two aspects of our derivative contracts are particularly important. First, in all cases we hold the money, which means that we have no counterparty risk.

Second, accounting rules for our derivative contracts differ from those applying to our investment portfolio. In that portfolio, changes in value are applied to the net worth shown on Berkshire’s balance sheet, but do not affect earnings unless we sell (or write down) a holding. Changes in the value of a derivative contract, however, must be applied each quarter to earnings.

Thus, our derivative positions will sometimes cause large swings in reported earnings, even though Charlie and I might believe the intrinsic value of these positions has changed little. He and I will not be bothered by these swings – even though they could easily amount to $1 billion or more in a quarter – and we hope you won’t be either. You will recall that in our catastrophe insurance business, we are always ready to trade increased volatility in reported earnings in the short run for greater gains in net worth in the long run. That is our philosophy in derivatives as well.

You would think that business reporters would have a stronger case before writing off Buffett but fools continue to rush in where angels fear to tread.

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18 responses so far ↓

  • 1 Richard // Nov 24, 2008 at 10:41 am

    The best line is “we are always ready to trade increased volatility in reported earnings in the short run for greater gains in net worth in the long run” - there’s a lot of classic Buffet sayings but this is a new one that describes exactly what so many people do wrong.

  • 2 Four Pillars // Nov 24, 2008 at 11:20 am

    I don’t know - it’s hard to argue against his track record but I’m skeptical that anyone can beat the market over the long run. Why is he the only one? Maybe his string of successful coin flips was just unusually long.

    That said, I have no intentions of going out and shorting BRK! :)

    Mike

  • 3 blogger // Nov 24, 2008 at 11:26 am

    He is a good business man — and able to buy sound business where majority of people buy mythical paper (stocks) which goes up and down in value every day. This is the reason why he makes money when everyone else is running around in circles.

  • 4 Dividend Growth Investor // Nov 24, 2008 at 11:44 am

    His exposure to those index puts is about 35-37 billion. Buffett received 4.85 billion now, the strike prices were close to what the markets finished 2007 at.
    The options don’t start expiring untill 2019 and there is not early exercise right for the put option holders. In the meantime Berkshire gets prefered stock in GS and GE, yielding 10% annually. If this could continue ( 10% preferred dividends) untill 2019, then Berkshire will have tripled the 4.85B it received as premiums by 2020.

    Buffett has always bet on “sure” things where he gets an advantage over the average investor. I doubt that we will see BRka ruined in his lifetime..

  • 5 Canadian Capitalist // Nov 24, 2008 at 1:23 pm

    Richard: I find it incredible that Buffett is written off because BRK fell a lot in value in two weeks! Probably by the same people who wrote him off during the tech bubble as someone who doesn’t get the new economy.

    Mike: I doubt that Buffett’s record could be put down to luck. Being a great businessman is part of the reason but I have no trouble accepting that there are investing Gods out there.

    DGI: When Buffett says he expects to make a profit on the premiums alone, it’s best to believe him. You’re right that he will be growing the float at a decent clip as well. In other words, he is already making a profit with very little downside risk whatever the accounting treatment might be.

  • 6 canadianstockstrader // Nov 24, 2008 at 1:24 pm

    I respect Buffet’s record and his trading method. I would bet with him not against him.

  • 7 NN // Nov 24, 2008 at 1:33 pm

    Buffett himself has used the coin analogy, and I doubt he will feel offended if anyone mused that perhaps he was just ‘lucky’. However, if you flip a coin 100 times and get 100 ‘Heads’, it is very likely that the coin is not fair, perhaps it does not have a ‘tails’ at all!

    The biggest difference between Buffett and other investors is his patience and willingness to take a long term view. The journalists doubting him now is very likely considering the BRK retrun over a maximum period of 12 months, if not a quarter. I seriously doubt whether annual figures are of any concern to Buffett, or his shareholders.

  • 8 Aleks // Nov 24, 2008 at 2:16 pm

    The article is based largely on the panic selling of people and companies other than Buffett, driving down the price of both the stock and the derivitives. Buffett says nothing has changed and he expects to make a profit. So either Buffett or the other investors are wrong. I know who I’m betting on (I just wish I’d waited another month to make that bet).

  • 9 A.J. // Nov 24, 2008 at 2:25 pm

    If I had a buck for every time a story like this about Buffett pops up in the business media. I guess his name sells copies.

    Reply to Mike. I think your wrong, but I’ll tell you what; I’d rather be lucky then smart any day of the week.

  • 10 Four Pillars // Nov 24, 2008 at 4:07 pm

    The biggest difference between Buffett and other investors is his patience and willingness to take a long term view.

    That and the fact that he has access to companies and deals that normal investors don’t have. Ie the GE deal as previously mentioned.

  • 11 NN // Nov 24, 2008 at 5:25 pm

    Indeed, FP. But he didn’t start out with this access, and I would argue that he achieved considerable, unusual investing success without it.

  • 12 Richard // Nov 24, 2008 at 5:25 pm

    The time frame is a good point (and why I like Buffet’s reponse). The harder you try to never have a losing quarter, the more likely it is you’ll lose everything!

  • 13 The Financial Blogger // Nov 24, 2008 at 11:11 pm

    Since Warren Buffet is a long term investor, there is no point of looking at his short term performance.

    Unfortunately, most business reporters write about finance to get paid, not because they know that much more than anybody else. The proof is obvious: how many of them show their investment track record?

    It would probably add a lot of value to their articles and they could make a lot of money (if they can beat the market!)

  • 14 Dividend Growth Investor // Nov 25, 2008 at 10:30 am

    FB,

    I agree with you. The headlines that sell well are the ones like “Has Buffett lost his touch”. If most financial columnists wrote about buy and hold forever and portfolio allocation they could write only a handful of articles and after a while it could get boring for the reader..

    As a blogger posting content i have found that articles that discuss things appealing to the public have the highest readership, whereas things that could really be beneficial to the public are discarded as waste :-(..

  • 15 Mike // Nov 27, 2008 at 11:43 am

    Just thought I would post a link to an article written by Buffett several years ago _ Superinvestors of Graham and Doddsville, in response to Four Pillars comment about no one beating the market over the long term. IF the link doesn’t work google the title…its an excellent read.

    http://www.sandmansplace.com/Superinvestors_Graham_Dodd.html

    The last time I can remember that people were commenting on how Buffett lost his touch was in the dot com bubble and look what happened there.

    Cheers
    Mike

  • 16 The Well-Heeled | Creating Wealth Through Knowledge // Nov 28, 2008 at 12:12 pm

    [...] The Canadian Capitalist: Buffett losing his touch? Don’t bet on it [...]

  • 17 bubba // Nov 30, 2008 at 3:19 am

    You would think that business reporters would have a stronger case before writing off Buffett but fools continue to rush in where angels fear to tread.

    Only a fool would believe in the future of the US greenback.

  • 18 LinkStuff Dec 1 // Dec 1, 2008 at 6:04 am

    [...] Capitalist thinks that Buffett is not losing his touch.  I’m not so [...]

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