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Berkshire Hathaway's Portfolio Profits Go Poof (On Paper)

Friday, 8 Aug 2008 | 7:39 PM ET

First, the nuts and bolts of tonight's earnings release, then the case of Warren Buffett's disappearing paper portfolio profits.

Warren Buffett's Berkshire Hathaway reported net earnings of $2.88 billion in the second quarter of this year. That's down 7.6 percent from 2007's second quarter.

After taking out realized investment and derivative gains of $610 million, operating earnings came in at $2.27 billion, down 9.6 percent year-over-year.

Much of that decline is due to a reduction in earnings from Berkshire's insurance underwriting businesses. They fell to $360 million from $632 million last year, amid generally poor conditions for the insurance industry as a whole. That is, however, better than the $181 million for insurance underwriting in the first quarter of this year,

Berkshire's operating earnings per share of $1465 is above the recently reduced consensus forecast of $1370 from the handful of analysts who follow the stock.

In the first quarter, Berkshire had an unrealized loss of $1.6 billion on some long-term derivatives contracts that it holds, depressing the quarter's net income. That is, if Berkshire had to sell those contracts right away, they would bring in $1.6 billion less than their purchase price. Buffett, however, makes clear he has no intention of selling them now, and expects a big profit from them years from now.

In the meantime, the "paper loss" from those contracts fell by $654 million to $962 million for the first half of the year. Under accounting rules, unrealized gains and losses from derivatives must be included in net earnings.

What's not included in the earnings numbers are unrealized gains or losses from the marketable securities, such as stocks, that Berkshire holds. (Gains and losses are only "realized" when a security is actually sold.)

Those "paper" gains did take a big hit during the first six months of the year, dropping by $10.7 billion, or 33.6 percent, to $21.1 billion. That's partially due to big stock price declines for some of Berkshire's core stock holdings. Short seller Doug Kass has referred to them as the "bombs in Buffett's book."

Three of the four "bombs" have been rebounding in recent weeks:

Berkshire's "Bombs" Rebound

'08 First Half June 30 to Aug. 8
Coca-Cola Down 15.3% Up 6.6%
Wells Fargo Down 21.3% Up 27.0%
Kraft Foods Down 12.8% Up 15.3%
American Express Down 27.6% Up 0.4%

As Buffett told us last December, and has been saying for years, he doesn't get upset when stocks he's bought go down in price:

"As long as you're a net buyer of stocks, which we are at Berkshire, we want them to be cheaper. I mean, if they reduce the price of hamburgers at McDonald's today, I feel terrific. Now I don't go back and think, gee, I paid a little more yesterday. I think I'm going to be buying them cheaper today. Anything you're going to be buying in the future, you want to have get cheaper."

We already know that Buffett has been putting some money to work by helping to finance some big deals, like Dow's purchase of Rohm and Haasand the Mars-Wrigley merger.

It will be interesting to see if Buffett took advantage of reduced stock prices during the first six months of the year by picking up some new or additional hamburgers of his own.

We should get at least some idea next week when Berkshire reveals its portfolio snapshot as of the end of the second quarter. Since Buffett sometimes gets SEC permission to withhold information on stocks he's actively accumulating, that snapshot can be blurry.

Current real-time stock prices:

Berkshire Class A:

Berkshire Class B:

Coca-Cola:

Wells Fargo:

Kraft Foods:

American Express:

Questions? Comments? Email me at buffettwatch@cnbc.com

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