Warren Buffett Tells Shareholders He Did "Some Dumb Things" In 2008
In his annual letter to Berkshire Hathaway shareholders, Warren Buffett says he did some "dumb things in investments" last year.
The company's controversial "equity put" options are not included on that list. There has been some criticism of Buffett as the declining mark-to-market value of those contracts puts pressure on reported earnings. Fourth quarter net fell 96 percent to $117 million, largely due to 'paper' losses on those derivative positions. For the year, net fell to $4.99 billion from $13.21 billion the year before.
Buffett also predicts 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."
He's still optimistic for the long-term, however, again pointing out that "our country has faced far worse travails in the past" but always "we've overcome them." He says confidently, "America's best days lie ahead."
Buffett admits that "I made at least one major mistake of commission and several lesser ones that also hurt... 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."
The mistake of commission: buying a large amount of ConocoPhillips stock just as energy prices were near their peak. Buffett writes, "I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year." He still thinks oil will eventually go well above its current $40-$50 range, "but so far I have been dead wrong."
Even if energy prices do rise, "The terrible timing of my purchase has cost Berkshire several billion dollars."
Buffett also reveals that he spent $244 million for shares of two Irish banks that "appeared cheap" to him. At the end of the year, they were written down to their market price of $27 million, for a loss of 89 percent, and they've continued to drop.
"The tennis crowd would call my mistakes 'unforced errors.'"
But he says he's not bothered by the overall "significant decline" in Berkshire's portfolio. "We enjoy such price declines if we have funds available to increase our positions."
Buffett confirms that he sold some stocks he would have preferred to keep to fund Berkshire's purchases of $14.5 billion in fixed-income securities from Wrigley, Goldman Sachs , and General Electric . He calls the holdings "more than satisfactory" based just on the high current yields they are delivering. Equity participation is a "bonus."
Those sales primarily involved Johnson & Johnson , Procter & Gamble , and Conoco. (See last week's WBW post Why Warren Buffett Isn't a Hypocrite.)
"I have pledged - to you, the rating agencies and myself - to always run Berkshire with more than ample cash. We never want to count on the kindness of strangers in order to meet tomorrow's obligations. When forced to choose, I will not trade even a night's sleep for the chance of extra profits."
BERKSHIRE'S WORST YEAR
The letter also reveals a 9.6 percent decline in Berkshire's book value per-share last year, making 2008 the company's worst year since Buffett took over in 1965. Book value fell by $11.5 billion during the year.
There has been only one annual decline before this one. In 2001, book value fell 6.2 percent.
Compared to the S&P, however, Berkshire's drop is relatively small. With dividends included, the S&P's book value fell 27.4 percent, giving Berkshire its biggest "win" since 2002.
In the letter, Buffett notes that it was also the S&P's biggest decline during the past 44 years.
"By yearend, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game."
DEFENDING THE DERIVATIVES
In a lengthy section on derivatives, Buffett calls them "dangerous" but defends Berkshire's 251 contracts. "I believe each contract we own was mispriced at inception, sometimes dramatically so."
He says the derivatives "float" (payments made to Berkshire by the contracts' buyers minus losses paid by the company) totaled $8.1 billion at the end of the year, money that can be invested.
And "only a small percentage of our contracts call for any posting of collateral when the market moves against us."
He specifically addresses the "equity put" contracts that have caused some concern among investors, revealing that Berkshire has "added modestly" to them.
The contracts, which insure against stock market declines over a period of many years, total $37.1 billion. They're written against the S&P 500, the U.K.'s FTSE 100, the Euro Stoxx 50 in Europe, and Japan's Nikkei 225.
Berkshire is only required to make any payments when the contracts expire. The first comes due in 2019 and the last in 2028. The mark-to-market, or 'paper', loss on the equity put contracts totals $5.1 billion.
Buffett emphasizes a point that he says is often misunderstood. "For us to lose the full $37.1 billion we have at risk, all stocks in all four indices would have to go to zero on their various termination dates." If the indices are down 25 percent, Berkshire would owe about $9 billion between 2019 and 2028, and would have had use of the $4.9 billion premium all along.
Buffett's conclusion: "We have told you before that our derivative contracts, subject as they are to mark-to-market accounting, will produce wild swings in the earnings we report. The ups and downs neither cheer nor bother Charlie (Munger) and me. Indeed, the 'downs' can be helpful in that they give us an opportunity to expand a position on favorable terms. I hope this explanation of our dealers will lead you to think similarly."
EXCERPTS FROM BUFFETT'S LETTER
EXCERPT: BUFFETT ON THE BAILOUT AND ITS AFTEREFFECTS