The Financial Crisis: Getting the Best of Warren Buffett?

Through November 21, 2008, Berkshire Hathaway's (BRK.A) year-to-date return was -36.4%. Since last December 11 when Class A shares hit a record high of $151,650, it has lost nearly half its value closing at $77,500 on Thursday; its lowest level since August 2003. This has not gone unnoticed by shareholders. Some investors have lost confidence in the ability of BRK to pay its debts.

After the collapse of AIG driven by derivatives, many investors fear the same could happen to other insurance companies including BRK.A. Berkshire could have to pay as much as $37 billion between 2019 and 2027 under some derivative contracts if the S&P 500 index and three other stock indexes are lower than when Berkshire entered the contracts.

Most insurance companies' shares are significantly down since October 1st compared to the S&P 500. During that period, AFLAC Inc. (AFL) is down 41.9%, Manulife Financial Corp (NYSE:MFC) is down 60.5% and BRK.A is down 34.7%, while the S&P 500 is down 31.1%.

Derivative exposure is not the only problem facing BRK.A. The stock price of General Electric Co. (GE) and Goldman Sachs Group Inc. (GS), have fallen, rendering Mr. Buffett’s warrants to buy common shares worthless for the time being.

Personally, I think the situation is playing to BRK.A's strength - a strong balance sheet. As its competitors lose capital, they will be more conservative in writing new business. BRK.A may well step in and fill the void. What BRK.A currently owns may be worth less, but Buffett will get more opportunities to buy things at cheap prices and once again come off looking like a genius.

Disclosure: Long AFL, MFC, GE

Reference:

• Has Warren Buffett lost his touch?

Comments

[texalope:]

You clearly don't understand Buffet's modus operandi. In the super cat business they make large bets against the possibility of cataclysmic events. It's hard to quantify potential exposure and the probabilities but the business has proven to be exceptionally profitable. There are few companies capable of competing and consequently premiums can be steep. His bet on the future of the S&P Index is based on over 100 years of steady climb. It's foolish to extrapolate that current events are more than a temporary turn relative to the future. In the interim he's collected 5Billion in premiums to buy cheap assets that will likely be worth considerably more in the future. I wouldn't bet against Buffet's judgement in the longer term. It can prove hazardous to your wallet.

2008 Nov 23 09:42 AM

[texalope:]

By the way, Buffet has made it clear the warrants were more or less a throw in by Goldman. They were not material to making the deal. He got a 10% yield in perpetuity on his investment unless Goldman decides to pay off the debt. In that case he'll get an additional year's worth of interest= 500 million, not chump change.I call that a very good deal, especially for a company that has cautioned future returns will not equal the past because their size and amount of capital functions as an anchor. Their ability to deploy large amounts of capital for outsized returns was limited. However, the worm has turned- financial events have presented opportunity and Buffet has sprung into action by deploying large amounts of capital for expected outsize returns.

2008 Nov 23 09:48 AM

[retired avi...:]

The recent criticisms of Buffet based on Berkshire shares falling or these so called derivatives he wrote are not well based. They are ignorant even. Buffet's genius lies in his ability to determine true risks and business moats, and to spot highly favorable math situations.

Though the insurance business is something of guesswork, which he admits, large premiums up front are super cheap capital which can be invested very profitably with his great expertise and the insurance business is thus not that risky.

BRK shares being down doesn't bother him. He knows that the businesses the shares represent will continue to grow earnings over time and have healthy and growing returns on equity, so if the market is beating down the companies he owns because of widespread pessimism, he'll be glad to buy more shares. Watch for his year end report and mark my words, you'll find he has been buying like crazy. That doesn't mean the shares won't fall further, but 5-10 years from now you can bet their earnings, book value, and eventually share price will climb very nicely.

As for the puts on the major indices starting around 2019, the buyer was an idiot! A dozen years out for at the money (current index level)! Any money manager of billions of $ ought to have better math skills and some knowledge of economic history. As long as GDP doesn't stagnate for a whole decade with little to no growth, the growing economy will be reflected in growing businesses that leverage even faster-growing profits. The beauty of an index bet is that you don't have to pick the winners. As long as the whole pie grows just as it has consistently (except during the Great Depression) since the days of the Pilgrims, Buffet will pay nothing on this bet.

The key is the simple and profound principle of long term compounding, which the stock market currently does not understand. The growth of an economy such as ours is by a percentage of the prior year rather than a fixed amount. That is why the DJIA grew 175-fold in the last century, from a value of 66 to 11,500, which is only 5.3% annually! The Dow was simply loosely tracking the GDP. Why anybody would pay serious money to protect against a stagnant or falling GDP after a dozen years is beyond me, given that history lesson. Buffet does not "play" in risky derivatives. Selling these puts was a steal.

2008 Nov 23 01:20 PM

[wagnermr14:]

Any updates on Aflac?

Feb 20 12:45 AM