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Why Berkshire's Cutting Back on Reinsurance

I believe that Buffet said this in one of his interviews that he will write less cat insurance in the near forseeable future to mute Berkshire's overall risk exposure. It's a good lever to be able to use -- less volume also likely means better pricing on the contracts that they actually end up writing.
Contary to writer's opinion, I'm not sure that Moody's AAA or CDS spreads have anything to with Berkshire's perceived counterparty risk. IMO, there aren't any better options, not even close.
Wall-strret types who consistently juiced their balance sheet 8-10x, live their lives obsessing with CDS spreads or AAA-rating, because it is a way to justify their leverage to regulators and risk managers. Not sure it's a valid measure for a non-levered company with a decent cash cushion and generating more cash every quarter. As long as you don't confuse cash flow with reported earnings.

Explaining the Berkshire Share Price

Felix - Your point is well taken. There are multiple ways to analyze an investment and a good investor should use multiple models to evaluate potential investments (to borrow a Munger favorite). Ultimately, the point of all investment is to buy something for less than it's worth using a range or probabilistic outcomes. (For that reason, I love the current share price)

Now, the CDS market could be on to something here. It could simply be a case of someone spreading the risk of BRK as a counterparty to others. I think the price (and underlying probability of default) could be useful if these levels persist or if the name of parties becomes known (or really their motivation).

I disagree with you that Berkshire is a much riskier investment that a few months ago. A number of risks have already materialzed and have impacted competitors much more leaving BRK in a position to cherry pick some amazing opportunities. I think this is rear view driving at its best.

paultaut - Can you substantiate your assertion that Buffet's index puts are a time bomb waiting to explode. He has covered this in pretty gory detail in the recent report and his logic made sense to me. Wondering if you could fill the rest of us in here on why you consider this dangerous.

Berkshire Hathaway: Worst Year Ever, and CDS Too

I'm not sure why Buffet initiating derivative positions is such a big deal. He's primarily a handicapper with years of experience. These contracts are not that much different in nature than the super cat insurance policies he takes out.

A chainsaw in a kids hand is dangerous but not so much in the hands of professional. The point he made re: derivates was proved right by AIG and others last year.

If Buffet is pooh poohed by the folks at Leucadia, it can make a little bit of sense given their respective track records over the last 20 years. One bad year seems to give everyone a license to second guess the man. Insane!!

Berkshire Hathaway: Failing Business Model Points to a 35% Decline

Rakesh,

A central tenet of Buffet's success is that he's figured out better than most which risks to take, which ones to avoid and more importantly adequate compensation for taking on those risks -- whether on the underwriting side or equity investing side. He's been prepared to walk away from business when premiums are inadequate. In my book, if current premiums understate risk, it'll be great thing for long term Berkshire shareholders (with oodles of short term volatility) as the competition will not be able to survive such an event.

Frankly, Berkshire's index puts have been discussed ad-nauseum on this web-site in various degrees of negativity -- accounting/non-cash losses, impact from increased volatility etc. I'm not sure what the brouhaha is. Non-cash charges don't mean anything in my book. The puts are not priced on the basis of volatility. Their maturities are staggered over a long period of time and they are written on different indexes. The stock market has bever seen such an extended period of underperformance. If the market does underperform over such a long period of time, Berkshire will generate lots of capital to invest at depressed/attractive levels.

I personally am not wired to be short things, but have no problems with people who can figure it out. In the short term, I don't see a lot of reasons to be long anything, however most money is made by investing during such times in durable franchises. As regards valuation -- equity prices are really driven by future cash flows. The fundametal mistake that people made recently is to assume that the long term future will very much resemble the recent past. Perhaps, people are repeating that same mistake in assuming that no one will ever make any money in business again.

I have read (and enjoyed) some of your other articles. It's rare on this stie to see good/forthright analysis. Thanks.

Aashish

Credit Where Credit Is Due

We have to think about credit as a continuum, not as a 0 or 1 game. There are critical parts of our economy that are dependent on availability of credit (short term borrowings by GE, IBM or other blue chip companies; states/municipalities financing infrastructure spending). On the other end of the spectrum, there is irresponsible use of credit by a section of consumers. I'm not even sure I would call all forms of consumer credit as bad or irresponsible.

We need credit to be free flowing but at the same time have to ensure it never becomes cheap as in recent times. If the cost of credit is appropriately high, it should automatically take care of a good chunk of the credit excesses that the article warns us about.

Burlington Northern Santa Fe: What's Buffett's Strategy?

Good, insightful article.

ConocoPhillips: More Than Just a Great Stock

Where do I begin....

Let's think logically here for a minute. Commodities are good diversifiers because inordinate increase in commodity prices typically means bad things for consumers and the economy and by that token stock prices and vice versa. (Think 70s, 80s and 2000s). Also, commodity prices typically follow long supply demand based cycles.

Two of the components of the commodity index are oil and natural gas. To me, it makes logical sense that the stock performance of any oil and gas E&P company (esp. in bubble periods) would tend to move in lock-step with commodity price changes. Since, we had a bubble in pretty much all commodities, we had a short term phenomenon where the fortunes of some of these E&P companies moved in sync with actual commodity prices.

Stocks prices are a function of long term cash flows while commodities prices are largely driven by supply demand imbalances. A 3% delta in returns over a long period of time would add up, not sure how it'll make a great difference here.

Remember, we got to the current crisis by assuming that the future will very much resemble the past. Analyses (if I can call it that) like this proves that we don't really learn, do we?

Highest Yielding Stocks Going Ex-Dividend in December

Surely, you mean traders or speculators here and not investors. While, it might appeal to some to chase the 1-2% return (on average) that is implied in this trade, there is not a single example out there of building wealth by following these type of arbitrages.

Sure, the extra 1-2% is gravy if someone has a primary long term strategy and is in cash right now and looking for the next big opportunity (Buffet's loaded gun, elephant hunting analogy). If this is the long term strategy, then good luck!!

Cautionary note here...In theory, someone could do this every quarter and accumulate their way to millions. In reality, the market is really efficient about these sort of arbitrages and as soon as enough people start doing it, the excess return goes away.

St. Joe Deal Goes Sour

I'm not sure I buy this reasoning. Land prices (of all things) do not change incrementally from less desirable to more desirable area, To the contrary, land prices in desirable areas are likely 10x-20x times the prices in not so desirable areas.

IMO, a small chunk of St. Joe's portfolio is responsible for the bulk of their EV. It's definitely not for the "have to make money this month even though I might miss the forest for the trees" type. Last comment is not meant to imply anything about the author.

Consumption, Cacophony and Clarity

Flash Gordon: Spending in the US has grown at a rapid pace since the Reagan years. It has been fuelled by rising asset prices, low inflation, reduced savings and increasing debt as opposed to increase in incomes. Over the next few years, we expect inflation to be high, debt availability to be scarce and asset appreciation to be low (possibly negative).

In contrast, people in emerging economies have growing incomes, low debt and high savings rates. They are on the same path that the US was say 20 years ago.

There are fours main reasons for why now:
1. High valuations across all asset classes
2. Unsustainable debt burdens for most consumers
3. Flat income levels (negative adjusted for inflation)
4. High inflation fueled by rising affluece in emerging countries

I want to make one additional point about inflation. In years/decades past, inflation (particulary energy and food related) was kept in check by poorer countires where demand was tied to prices. Small increases in prices destroyed demand causing prices to fall. This dynamic has changed forever and the equillibrium has shifted. We need substantially higher prices to destroy demand now.

The question I have for people here - for both individuals and countries, What's wrong with living within your means?

Starbucks: Understanding the Business Model

Nice article. I disagree with the author's assertion that SBUX has lots of room to grow because coffee is the second most popular drink in the world and they are the leading brand in coffee.

I would argue that SBUX is dispensing an upscale experience to the majority of SBUX regulars. Convenience is important but without the feel good value of the upscale experience is not worth much.

SBUX does have lots of room to grow. It will grow by converting non-coffee drinkers to wannabe coffee drinkers who don't mind shelling out $5 to be seen walking into work or around the mall with a SBUX cup in their hand. The same beverage in a non-SBUX cup is likely worth less than $2 and more importantly a lot less life style points.

I will concede that there is a population of coffee connoisseurs who shop at SBUX for convenience. I will argue that their average purchase price is a lot less than the life style SBUX shopper.

The feel good aspect of the SBUX experience will resonate with newbie affluent consumers in emerging economies. Of all things "luxurious" SBUX is the cheapest to buy, easiest to access and can be consumed frequently to assert adherence to a particular lifestyle. Over the long haul, SBUX will grow and be omnipresent like MCD. All SBUX has to do is follow the phenomenally successful MCD model (franchise) and become just a brand and step away from being a retail operation.

Bernanke Blames Saving Glut for Housing Bubble

The Savings glut that he refers to is partly a result of monetary policy.
The US imports 2 billion dollars of stuff everyday (net of exports) and force feeds countries a steady supply of bonds that have lost money in inflation adjusted terms. I find it funny that his academic expectation is that the other countries should find a way to spend that money instead of trying to save it.
Bernanke's "cheap and easy money" policies stimulate spending and contribute to the deficit and eventually to the savings glut.

Am I missing something here?

Credit Card Spending Surges, While Retailers Slump

Despite all its reported troubles - Sears has generated a billion dollars in FCF annually in the past 2-3 years. It has a 600 million in buy back authorization remaining and an undervalued share price (and heading lower likely) to boot. What's not to like?

I give Eddie Lampert credit - the worst thing he could do is to spend money like crazy to try and make Sears into a WMT or COST. Clearly, no amount of money will make it into COST ot WMT.

I don't believe the Sears story is about reinventing the retail outfit. It will be about reinvesting the cash flow from operations and from sales of assets profitably. It will take a long time. These problems were not created overnight and won't be fixed in a hurry.

In the meantime Eddie Lampert gets to buy back stock at good prices. If it went down another 50%, I don't think he'll complain. Cheaper the price, better it is for a buyer.


Unless the chronic underinvesting starts hurting the FCF significantly, we should be in good shape. As someone pointed out, Sears' share price troubles are shared by many other retailers despite retail investment in their stores. In this environment, I'd rather have an asset allocator at the helm rather than a retail turnaround specialist.

Doug Kass's Killer Shorts - Barron's

I like Mr. Kass's shorts, at least he's original...
Quick note re: Fastenal. Shorting Fastenal is a tough way to make a living. I'd much rather short HD, LOW or even homebuilder stocks. If FAST has a bad day, HD and LOW will likely suffer in sympathy. But, wait, these stocks are probably shorted by everyone and their brother, so Mr. Kass is worried about losing money on a short covering rally.

One correction that I'd like to suggest...Berkshire did not lose 1.6 bilion on derivatives contracts. It sold equity puts on major US indices for 20 year periods and got premiums upfront. These contracts are essentially like selling an insurance policy to someone. Buffet gets to invest the float for 20 years and may not even have to pay anything (and will likely make 3x-4x by investing the float). The The 1.6 billion "loss" is just the fair value accounting at work and will likely fluctuate up and down every now and then. Outside of the up-front premium, no money changes
hands till contracts are settled.


Pasting from Berkshire's 10-Q:
"The estimated fair value of the equity index put option contracts at March 31, 2008 was approximately $6.2 billion, an increase of $1.6 billion since December 31, 2007. The increase was primarily due to fair value losses of $1.2 billion as well as $383 million in premiums from new contracts entered into in 2008. There were no cash payments made under the equity index put option contracts.
The aforementioned contracts are not traded on an exchange. The contracts were entered into with the expectation that amounts ultimately paid to counterparties for actual credit defaults or declines in equity index values (measured at the expiration date of the contract) will be less than the premiums received. The contracts generally may not be terminated or fully settled before the expiration dates (up to 20 years in the future with respect to equity index put option contracts) and therefore the ultimate amount of cash basis gains or losses will not be known for years.
Berkshire does not actively trade or exchange these contracts, but rather intends to hold such contracts until expiration. Nevertheless, current accounting standards require derivative contracts to be carried at estimated fair value with the periodic changes in estimated fair value included in earnings. Fair value is estimated based on models that incorporate changes in applicable underlying credit standings, equity index values, interest rates, foreign currency exchange rates, risk and other factors. The fair values on any given reporting date and the resulting gains and losses reflected in earnings will likely be volatile, reflecting the volatility of equity and credit markets. Management does not view the periodic gains or losses from the changes in fair value as meaningful given the long term nature of the contracts and the volatile nature of equity and credit markets over short periods of time."

Is Berkshire Hathaway Now a Bargain?

There are two distinct pieces to any Berskshire related discussion .
Let's talk about intrinsic value first. Despite its present size, berkshire's oerating businesses should grow earnings at a 10+% clip over a full business cycle. Performance will be lumpy (insurance pricing, super cat performance, housing and economy), but for someone with a long term view, these businesses will grow earnings. This portion of berkshire does not have a huge dependence of Buffet as performance is driven by talented and motivated managers. Moving to investments, it's investment portfolio is positioned superbly. If I'm doing my math right, Buffet deployed 20 billion in bonds recently and still has a war chest of 20+ billion remaining (growing by 8+ billion every year). Most of the existing 70+ billion equity portfolio is invested in 15+% ROE opportunities. It's safe to say that intrinsic value over longer periods of time will grow at 15% but growth will be lumpy.
The stock price will be affected by two factos: lumpy growth and how markets value liquidity. Lumpy growth has been a way of life at berkshire and is one of things I like about berkshire. When liquidity is freely available and the rest of world is levering (tons of stupid money chasing all kinds of model driven gains), berkshire's stock price will languish. When the opposite happens and the leverage is unwound, people will disregard buffet's age and embrace the war chest and AAA rating.
If your edge is patience and a longer time horizon, a long position in berkshire at today's prices can double your money in the next 5-6 years. Beyond that, there are any number of ways to make something simple more complicated.