It has been some time since my last post. Last weekend, Warren Buffett released his annual letter to shareholders for the 2008 performance of Berkshire. Thought I would do a quick summary here.
The start of the letter shows a comparison of Berkshire versus the S&P. Since 1965, the per-share book value of Berkshire has only gone down twice (on an annual basis). 2001 saw a 6.2% drop while 2008 saw a 9.6% drop. The book value has risen from $19 to $70,530, or 20.3% compounded annually. $2000 invested with Berkshire in 1965 would have grown to almost $7 million today.
The share is currently trading close to book value at about $70,000.
S&P had 11 years where it went down, with a total 8.9% compounded return. It had a 37% drop in 2008.
Here are some points from the rest of his letter:
- The extent of the economic response to the crisis is unprecedented. This will almost certainly bring about unwelcome aftereffects. One possible outcome is an onslaught of inflation.
- However, the response was neccessary to prevent a total breakdown of the system.
- The country has faced far worse challenges in the past and has always overcome them. Standard of living has gone up seven-fold during the 1900s.
- In the last 44 years, the S&P had gone up in 75% of those years. No one can predict the winning and losing years in advance no matter what the economic situation is.
- Berkshire’s retail businesses were hit quite badly in 2008, but his utility and insurance businesses continue to deliver outstanding results.
- There were also opportunities to buy businesses and securities at prices that would be unavailable in normal conditions.
- Price declines in his portfolio does not bother him. It gives him opportunities to increase his positions at good prices.
- Berkshire has a company Clayton which deals in manufactured homes. Unlike most of their competitors, their foreclosure rate has not changed much despite Clayton’s borrowers having a worse credit rating. The reason is because most of their borrowers bought their homes with the intention of paying them off with their regular income. And not by means of refinancing, some teaser rate or selling the home at a profit if the mortgage payments becomes unmanageable.
- The point is most homeowners do not walk away just because housing prices drop. They walk away when they can’t make the monthly payments.
- There is a big spread between the borrowing costs at Treasury rates and normal rates. Ironically, lenders with shaky balance sheets are able to get “cheap loans” from the government and this makes it hard for companies like Clayton to compete profitably.
- Investors should be skeptical of history-based models. Beware of geeks bearing formulas and always look at the assumptions behind the models.
- Derivatives are dangerous as they often go unsettled for years or even decades. Your risk is not only with your counterparty, but also includes their counterparties. It took Warren Buffett 5 years and $400 million of losses to unwind 23,218 derivative contracts of General Re when they bought it in 1998. And that was in benign markets.
- Despite the pitfalls of derivatives, Berkshire does have some positions in them. One type is the long term equity put option. Due to the use of mark-to-market accounting, wild swings in reported earnings (losses) might be reported. He expects most of them to be profitable in the long run.