Saturday, February 28, 2009

The Oracle Speaks

Warren Buffett's annual letters to shareholders are legendary. We were treated to another one on Saturday morning. This year's letter and 10-K provided some interesting insights. Buffett, who is a fan of higher taxes on the rich, was surprisingly critical of government. He says government intervention in the financial crisis "will almost certainly bring on unwelcome aftereffects." He thinks inflation is a very likely outcome. He also predicts municipalities will soon be looking for federal bailouts of their own. The good news is that Buffett says "America's best days lie ahead."

Berkshire's book value per share fell 9.6% in 2008, its worse performance ever. Yet I think the biggest surprise is that the company did not do worse. Given the financial crisis and Berkshire's heavy exposure to the finance industry, I think the results were actually quite commendable. The company turned a profit and even troubled subsidiaries such as General Reinsurance showed marked improvement.

Still, Berkshire lost a lot of ground in 2008. Gross unrealized gains in equity securities fell $16.5 billion. Gross unrealized losses grew by $4.9 billion. There was a $25 billion decrease in the value of equity securities on the balance sheet. The company also wrote down $6.8 billion of derivatives on the income statement. It is important to understand, however, that the write down had no effect on cash flow. It is simply the result of the same mark-to-market accounting rule that is making our nation's banks look unprofitable. Even though it took a toll on Berkshire, Buffett says, "We endorse mark-to-market accounting." It would have been nice if he explained exactly why. Maybe he realizes that because of mark-to-market, Berkshire and other financial companies will report much larger earnings in future periods when market conditions improve.

I was very disappointed by the kinds of questions posed by shareholders at last year's meeting. Instead of asking good questions about the company's business operations, we got questions such as "What should I do with the rest of my life?" Apparently, Buffett was fed up with those questions, too. He says in his letter that at this year's meeting, he will "steer the discussion back to Berkshire's business." That is welcome news indeed.