Buffett: No Feasting on This Market
By Christopher Edmonds
Special to TheStreet.com
03/09/2002 01:19 PM EST
Warren Buffett says investors shouldn't get their hopes up.
Although prospects of an economic recovery may have rekindled notions of market
euphoria, Buffett says lofty expectations will only disappoint stock market
investors. As evidence, the chairman and CEO of Berkshire Hathaway
(BRK.A:NYSE - news - commentary - research - analysis) pointed to Berkshire's
equity portfolio.
"Our restrained enthusiasm for these securities is matched by decidedly lukewarm
feelings about the prospects for stocks in general over the next decade or so,"
Buffett wrote in his annual letter to shareholders released Saturday morning.
He continued: Berkshire Vice Chairman "Charlie [Munger] and I believe that
American business will do fine over time, but think that today's equity prices
presage only moderate returns for investors. ... A market that no more than
parallels business progress, however, is likely to leave many investors
disappointed, particularly those relatively new to the game."
Buffett's disclosure of his top equity holdings exemplifies last year's stock market
struggle. In the past, Berkshire would disclose individual equity positions that had a
current market value of $1 billion; in a measure of today's tougher times, that
disclosure level is now $500 million. Berkshire showed no changes in its large
holdings from last year, still owning the same number of shares of American
Express (AXP:NYSE - news - commentary - research - analysis), Coca-Cola
(KO:NYSE - news - commentary - research - analysis), Gillette (G:NYSE - news -
commentary - research - analysis), Wells Fargo (WFC:NYSE - news -
commentary - research - analysis) and the Washington Post (WPO:NYSE - news
- commentary - research - analysis).
However, Buffett added two large positions: nearly 16 million shares -- or about a
9% stake -- in H&R Block (HRB:NYSE - news - commentary - research -
analysis), in stock worth $715 million at the end of last year and 24 million shares
-- about 15% -- of Moody's (MCO:NYSE - news - commentary - research -
analysis), the credit rating agency, shares valued at $957 million at the end of
December.
"I violated the Noah rule: Predicting rain doesn't count; building arks does."
The total Berkshire equity portfolio was valued at $28.7 billion as of Dec. 31, 2001,
a decline of 23.7% from the $37.6 billion at the end of 2000. It isn't clear how much
of the decline came from stock sales and how much came from the decline in value
of shares in the portfolio.
A Difficult Year
Last year was challenging for Berkshire Hathaway. Profits sank nearly 76% and
gains from investment activity dropped nearly 65%. Berkshire posted profits of $795
million, or $521 for each Class A share vs. $3.33 billion, or $2,185 a share, in 2000.
Buffett took the poor performance personally. "Though our corporate performance
last year was satisfactory, my performance was anything but," he wrote to
shareholders. "I manage most of Berkshire's equity portfolio, and my results were
poor, just as they have been for several years. Of even more importance, I allowed
General Re to take on business without a safeguard I knew was important, and on
Sept.11, this error caught up with us."
General Re, Berkshire's major reinsurance unit, posted a $2.5 billion loss, largely
because of the claims it will have to pay in the aftermath of the terrorist attacks in
New York, Washington and Pennsylvania. Again, Buffett shouldered most of the
blame. "I violated the Noah rule: Predicting rain doesn't count; building arks does,"
he wrote. "I consequently let Berkshire operate with a dangerous level of risk -- at
General Re in particular."
"The war against terrorism can never be won. The best the nation can achieve
is a long succession of stalemates. There can be no checkmate against
hydra-headed foes."
Buffett said Berkshire will continue to write insurance to cover mega-catastrophes,
including terrorism, but will have to be compensated for the risk. "At Berkshire, it
should be noted, we have for some years been willing to assume more risk than
any other insurer has knowingly taken on," he wrote. "That's still the case. We are
perfectly willing to lose $2 billion to $2.5 billion in a single event if we have been
paid properly for assuming the risk that caused the loss."
And in a chilling comment about world events, Buffett hints further losses are
possible. "The probability of such mind-boggling disasters, though likely very low at
present, is not zero," he wrote. "The probabilities are increasing, in an irregular and
immeasurable manner, as knowledge and materials become available to those who
wish us ill. Fear may recede with time, but the danger won't -- the war against
terrorism can never be won. The best the nation can achieve is a long succession
of stalemates. There can be no checkmate against hydra-headed foes."
While Buffett seemed generally pleased with other Berkshire businesses, he
continues to manage expectations about the company's performance. "In the future
we won't come close to replicating our past record," he warns. "To be sure, Charlie
and I will strive for above-average performance and will not be satisfied with less."
Berkshire's size makes it difficult to find acquisitions large enough to have a
meaningful effect on the company's results. "We need 'elephants' to make
significant gains now," Buffett quipped. "And they are hard to find."
Accounting in the Rough
In his annual commentary on American business, Buffett was brief and direct.
"Charlie and I are disgusted by the situation, so common in the last few years, in
which shareholders have suffered billions in losses while the CEOs, promoters, and
other higher-ups who fathered these disasters have walked away with extraordinary
wealth," he wrote. "Indeed, many of these people were urging investors to buy
shares while concurrently dumping their own, sometimes using methods that hid
their actions. To their shame, these business leaders view shareholders as
patsies, not partners."
Buffett says the problems are widespread. "Though Enron has become the symbol
for shareholder abuse, there is no shortage of egregious conduct elsewhere in
corporate America," Buffett wrote. "One story I've heard illustrates the
all-too-common attitude of managers toward owners: A gorgeous woman slinks up
to a CEO at a party and through moist lips purrs, 'I'll do anything -- anything -- you
want. Just tell me what you would like.' With no hesitation, he replies, 'Reprice my
options.' "
Also on Buffett's hit list is pro forma accounting, for which Buffett offered a
"sub-par" illustration. "When companies or investment professionals use terms
such as 'EBITDA' and 'pro forma,' they want you to unthinkingly accept concepts
that are dangerously flawed," he notes. "In golf, my score is frequently below par
on a pro forma basis: I have firm plans to 'restructure' my putting stroke and
therefore only count the swings I take before reaching the green."
For corporate America, Buffett thinks there will be more companies forced to yell
"Fore!" |
