Warren Buffett

Buffett losing his touch? Don’t bet on it

November 24, 2008

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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.

Buffett’s spot-on advice

October 20, 2008

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You may have heard about Warren Buffett’s op-ed piece in The New York Times titled, Buy American. I Am. In it, Mr. Buffett strongly counsels against seeking refuge in the “safety” of fixed income and start buying stocks as there is widespread fear and panic:

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

It is very rare for Mr. Buffett to write an article in a major newspaper or magazine on the level of the stock market. While the timing of his latest piece remains to be seen, the last time he publicly took an opinion on the stock market, his timing was impeccable.

In late 1999, investors were enthusiastically bidding up stocks to sky-high levels. It wasn’t just the dot-coms, which hadn’t earned a dime in their entire existence, going public and fetching multiples of their IPO price. Many blue-chip, growth stocks were trading at unheard of multiples. Mr. Buffett, written off as a fuddy-duddy who didn’t “get” the new economy, wrote this article in Fortune magazine making a strong case for lower equity returns:

Let me summarize what I’ve been saying about the stock market: I think it’s very hard to come up with a persuasive case that equities will over the next 17 years perform anything like–anything like–they’ve performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate–repeat, aggregate–would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that’s 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more.

He further reminded investors the sorry history of new-fangled industries destroying their wealth:

Move on to failures of airlines. Here’s a list of 129 airlines that in the past 20 years filed for bankruptcy. Continental was smart enough to make that list twice. As of 1992, in fact–though the picture would have improved since then–the money that had been made since the dawn of aviation by all of this country’s airline companies was zero. Absolutely zero.

Sizing all this up, I like to think that if I’d been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough–I owed this to future capitalists–to shoot him down. I mean, Karl Marx couldn’t have done as much damage to capitalists as Orville did.

Within a few short months, the dot-coms bombed and equity markets began a long, slow, painful slide that finally ended in 2002. Surely, investors who read that article would have wished they had taken Mr. Buffett’s advice (I read that column and was stupid enough to buy Yahoo! shortly thereafter). Could this time be any different?

News from the Berkshire Hathaway Annual Meeting

May 5, 2008

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Warren Buffett hosted the annual general meeting for Berkshire Hathaway shareholders in Omaha last weekend. The most anticipated part of the meeting is the Q&A session that Buffett and partner Charlie Munger hold with shareholders and this year the duo lived up to expectations and dished out wit and wisdom: