In his annual letter to Berkshire Hathaway shareholdersreleased this morning, Warren Buffett says more "major" acquisitions are needed to maintain growth in the company's non-insurance businesses at a "decent rate."
Buffett writes: "We will need both good performance from our current businesses and more major acquisitions. We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy."
At the end of 2010, Berkshire had a lot of ammunition for that elephant gun: $38 billion in cash.
In the letter, Buffett also updates the derivatives contracts written by Berkshire that have caused concern among some investors.
He compares them to selling insurance, as Berkshire gets "premiums for assuming risk that others wish to shed" with no counterparty risk.
One category involves mostly 5-year contracts written between 2004 and 2008 that guaranteed against bond defaults by companies "included in certain high-yield indicies." Premiums totaled $3.4 billion for that 'insurance,' while the financial crisis required Berkshire to pay out $2.5 billion. That gave Berkshire "the use of an interest free float that averaged $2 billion over the life of the contracts." Buffett also reports that "our exposure is largely behind us because most of our higher-risk contracts have expired."
As a result, "It appears almost certain that we will earn an underwriting profit as we originally intended."
Berkshire has also written contracts protecting the buyers from long-term losses in several global equity indexes. Buffett says that late last year, at the request of the buyer, eight contracts were unwound, with a net gain for Berkshire of $222 million.
That left 39 equity put options remaining at the end of 2010, for which Berkshire received $4.2 billion in premiums, another source of money to help fuel acquisitions.
Buffett says the "highlight" of 2010 was Berkshire's acquisition of the Burlington Northern Santa Fe railroad, "a purchase that's working out even better than I expected."
He's expecting that owning the railroad will increase Berkshire's "normal" earnings power by almost 40 percent pre-tax and "well over" 30 percent after-tax. He also writes that Berkshire "quickly replenished" the $22 billion in cash used to buy BNSF, so "the economics of this transaction have turned out very well."
LAGGING THE S&P
For the year, however, Berkshire's corporate performance lagged behind the S&P 500, as measured by per-share book value, a metric that Buffett calls an "understated proxy" for intrinsic value, which is hard to pin down.
Berkshire's per-share book value increased by 13.0 percent last year, 2.1 percent points behind the S&P's 15.1 percent gain, including dividends.
Berkshire's compounded annual gain from 1965 through 2010 of 20.2 percent is more than double the S&P's 9.4 percent advance. (Buffett started running things at Berkshire in 1965.)
'MEANINGLESS' NET INCOME