Warren Buffett's annual shareholder letter:
berkshirehathaway.com
In Letter, Buffett Is Frank but Optimistic
By DAVID SEGAL
Published: February 28, 2009
At a time when every rule of investing has been turned on its head, there is apparently one constant: the renowned investor Warren E. Buffett has kept his sense of humor and his gift for plain-spoken investment wisdom.
In his annual letter to shareholders of his holding company, Berkshire Hathaway, released Saturday morning, Mr. Buffett sifted through the wreckage of his worst year in four decades at the helm.
He found much to criticize about his own performance — including a reported 62 percent drop in 2008 net income — and far more to criticize about the performance of other top executives, particular those in private-equity investing and mortgages.
He also found reasons for optimism.
“As we view Geico’s current opportunities,” he wrote, referring to the insurance company that Berkshire Hathaway owns, he and his company’s chief executive “feel like two hungry mosquitoes in a nudist camp. Juicy targets are everywhere.”
The letter, as ever, gives shareholders an overview of the previous year’s activity, but it also doubles as a folksy state-of-the-economy address from one of the country’s most revered investors.
The letter made clear that Mr. Buffett is appalled by much of what has happened in the markets lately. Reviewing the performance of Clayton Homes, a Berkshire Hathaway subsidiary that sells manufactured homes, he noted that its lending arm had managed to keep foreclosure rates to less than 4 percent, even among subprime borrowers, or those with weak credit ratings.
He contrasted that relative success to the failures of just about everyone else in the mortgage business.
“The stupefying losses in mortgage-related securities came in large part because of flawed, history-based models used by salesmen, rating agencies and investors,” he wrote.
He went one: “These parties looked at loss experience over periods when home prices rose only moderately and speculation in houses was negligible. They then made this experience a yardstick for evaluating future losses. They blissfully ignored the fact that house prices had recently skyrocketed, loan practices had deteriorated and many buyers had opted for houses they couldn’t afford.”
Also blissfully ignored, he wrote, were the perils of relying on mathematical models devised without worst-case situations in mind. Too often, he wrote, Americans have been enamored of “a nerdy-sounding priesthood, using esoteric terms such as beta, gamma, sigma and the like.” Some skepticism about these models is overdue, he added.
“Our advice: Beware of geeks bearing formulas.”
Mr. Buffett was just as scathing on the subject of derivatives, which he famously likened to weapons of mass destruction long before they started eviscerating the balance sheets of banks around the world. In his letter, Mr. Buffett explained that the danger of derivatives was not merely the difficulty in assessing their value; rather, it was the “web of mutual dependence” they create among financial institutions. Derivatives contracts keep various parties entangled for years.
Once those assets start deteriorating, “Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with.”
Mr. Buffett, in the letter, delved into the derivatives owned by Berkshire. He explained that they were structured in ways that required counterparties to make payments to Berkshire when the contracts were initiated, providing his company with an advance of $8.1 billion, referred to as a float. “This float is similar to insurance float,” he wrote. “If we break even on an underlying transaction, we will have enjoyed the use of free money for a long time.”
Mr. Buffett’s report was greeted with sighs of relief among some shareholders. “I’m delighted,” said Janet Tavokoli, a derivatives expert and author of “Dear Mr. Buffett,” a look at the credit crisis of 2008. “Of course it was a tough year — the toughest year of his life. But I was concerned about the impact in operating earnings and I was prepared for much worse.”
Matching his reputation for bluntness, Mr. Buffett was unsparing about his own mistakes. He bought a block of ConocoPhillips shares just as oil and gas prices were reaching their highest levels. The move was timed so poorly, he wrote, that even with a rebound in prices, the cost to Berkshire will probably be several billion dollars.
He also bought shares of two Irish banks for $244 million, which subsequently have decreased more than 89 percent. “The tennis crowd,” he wrote, “would call my mistakes ‘unforced errors.’ ”
nytimes.com |
