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February 28, 2009

Berkshire Hathaway

Berkshire Hathaway's results were released this morning....and it tells you something when a company of Berkshire Hathaway's size decides to release their results on a Saturday monrning.

Just about everybody else releases their results when the market is open. So that people can see the results and then trade upon them as they wish. Usually the only reason for doing something different, releasing them after the market closes, or even on a day when all the markets are shut tight as Berkshire Hathaway has done, is because you know the results aren'tgoing to be good and you don't want people to start trading upon them immediately.

As, indeed, has happened. Berkshire Hathaway's results, while a great deal better than many other financial firms, are pretty appalling:

Warren Buffett's Berkshire Hathaway Inc. reported Saturday morning that 2008 was the legendary investor's worst year ever. It also reported a grim fourth quarter, though it eked out a slight gain.

Quite how bad can be seen from this:

his is an excerpt of Warren Buffett's annual letter to Berkshire Hathaway shareholders. See the full letter on the company's Web site.

To the Shareholders of Berkshire Hathaway Inc.:

Our decrease in net worth during 2008 was $11.5 billion, which reduced the per-share book value of both our Class A and Class B stock by 9.6%. Over the last 44 years (that is, since present management took over) book value has grown from $19 to $70,530, a rate of 20.3% compounded annually.*

The table on the preceding page, recording both the 44-year performance of Berkshire's book value and the S&P 500 index, shows that 2008 was the worst year for each. The period was devastating as well for corporate and municipal bonds, real estate and commodities. By yearend, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.

As the year progressed, a series of life-threatening problems within many of the world's great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: "In God we trust; all others pay cash

If you want to read the full letter you can get it from here.

This is some more of the Chairman's letter:

By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a
paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have
never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback
cycle. Fear led to business contraction, and that in turn led to even greater fear.
This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury
and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently
been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome
aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation.
Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities
and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political
challenge. They won’t leave willingly.
Whatever the downsides may be, strong and immediate action by government was essential last year if
the financial system was to avoid a total breakdown. Had that occurred, the consequences for every area of our
economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various
Side Streets of America were all in the same boat.
Amid this bad news, however, never forget that our country has faced far worse travails in the past. In
the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or
so panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression of
the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of
Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the
real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones
Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which
humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic
system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it
will continue to do so. America’s best days lie ahead.
*All per-share figures used in this report apply to Berkshire’s A shares. Figures for the B shares are
1/30th of those shown for A.
Take a look again at the 44-year table on page 2. In 75% of those years, the S&P stocks recorded a
gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie
Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our
usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will
be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell
us whether the stock market will rise or fall.
In good years and bad, Charlie and I simply focus on four goals:
(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of
excess liquidity, near-term obligations that are modest, and dozens of sources of earnings
and cash;
(2) widening the “moats” around our operating businesses that give them durable competitive
(3) acquiring and developing new and varied streams of earnings;
(4) expanding and nurturing the cadre of outstanding operating managers who, over the years,
have delivered Berkshire exceptional results.
Berkshire in 2008
Most of the Berkshire businesses whose results are significantly affected by the economy earned below
their potential last year, and that will be true in 2009 as well. Our retailers were hit particularly hard, as were our
operations tied to residential construction. In aggregate, however, our manufacturing, service and retail
businesses earned substantial sums and most of them – particularly the larger ones – continue to strengthen their
competitive positions. Moreover, we are fortunate that Berkshire’s two most important businesses – our
insurance and utility groups – produce earnings that are not correlated to those of the general economy. Both
businesses delivered outstanding results in 2008 and have excellent prospects.
As predicted in last year’s report, the exceptional underwriting profits that our insurance businesses
realized in 2007 were not repeated in 2008. Nevertheless, the insurance group delivered an underwriting gain for
the sixth consecutive year. This means that our $58.5 billion of insurance “float” – money that doesn’t belong to
us but that we hold and invest for our own benefit – cost us less than zero. In fact, we were paid $2.8 billion to
hold our float during 2008. Charlie and I find this enjoyable.
Over time, most insurers experience a substantial underwriting loss, which makes their economics far
different from ours. Of course, we too will experience underwriting losses in some years. But we have the best
group of managers in the insurance business, and in most cases they oversee entrenched and valuable franchises.
Considering these strengths, I believe that we will earn an underwriting profit over the years and that our float
will therefore cost us nothing. Our insurance operation, the core business of Berkshire, is an economic
Charlie and I are equally enthusiastic about our utility business, which had record earnings last year
and is poised for future gains. Dave Sokol and Greg Abel, the managers of this operation, have achieved results
unmatched elsewhere in the utility industry. I love it when they come up with new projects because in this
capital-intensive business these ventures are often large. Such projects offer Berkshire the opportunity to put out
substantial sums at decent returns.
Things also went well on the capital-allocation front last year. Berkshire is always a buyer of both
businesses and securities, and the disarray in markets gave us a tailwind in our purchases. When investing,
pessimism is your friend, euphoria the enemy.
In our insurance portfolios, we made three large investments on terms that would be unavailable in
normal markets. These should add about $11⁄2 billion pre-tax to Berkshire’s annual earnings and offer
possibilities for capital gains as well. We also closed on our Marmon acquisition (we own 64% of the company
now and will purchase its remaining stock over the next six years). Additionally, certain of our subsidiaries made
“tuck-in” acquisitions that will strengthen their competitive positions and earnings.
That’s the good news. But 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. I will tell
you more about these later. 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.
Additionally, the market value of the bonds and stocks that we continue to hold suffered a significant
decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines
if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you
pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise
when it is marked down.

February 28, 2009 in Finance | Permalink


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