Not even the sage of Omaha, Warren Buffett, could escape the impact of the subprime crisis, credit crunch and slowing economy in the last quarter of 2007, and although the year as a whole was another when his Berkshire Hathaway company outperformed the broader market as measured by the S&P 500.
Despite an 18% fall in fourth-quarter profit as his insurance and housing related businesses took a battering, net profit for all of 2007 rose 20% to $US13.21 billion.
Fourth quarter net earnings fell to $US 2.95 billion, or $1,904 a share, from $US3.58 billion, or $2,323, in 2006.
The last quarter weakness stemmed from weaker results in insurance, Berkshire’s main business, and in companies linked to housing, including businesses that make bricks and carpet, and that offer real estate brokerage services. Those are businesses that have been hit by the housing slump.
"Our gain in net worth during 2007 was $12.3 billion, which increased the per-share book value of both our Class A and Class B stock by 11%. Over the last 43 years (that is, since present management took over) book value has grown from $19 to $78,008, a rate of 21.1% compounded annually," he said in his now famous letter to shareholders.
"Overall, our 76 operating businesses did well last year. The few that had problems were primarily those linked to housing, among them our brick, carpet and real estate brokerage operations. Their setbacks are minor and temporary. Our competitive position in these businesses remains strong, and we have first-class CEOs who run them right, in good times or bad."
That 11% improvement in Berkshire’s net worth compared to the 5.5% rise in the S&P 500 (including dividends reinvested), a rare case of 100% outperformance.
Berkshire spent $US32.51 billion on stocks and bonds in 2007, leaving Berkshire sitting on $US44.33 billion of cash. On Christmas Day the company signed a deal that saw it make its biggest ever buy. It paid $US4.5 billion for 60% a company called Marmon Group which makes and leases railcars and has other businesses. The remaining 40% will be paid for on the basis of performance over the next few years.
Berkshire is the biggest shareholder in Burlington Northern, one of the US’s top three railways and it has shares in another major operator. Some investors say the current environment of weak stocks and sluggish capital markets offers the 77-year-old Buffett plenty of opportunities to expand his business, but his chairman’s letter makes it clear that that’s not necessarily the case.
In his widely read, 20-page annual letter to shareholders, Buffett said "the party is over" in insurance, where margins are tightening after Berkshire was for a time able to boost premiums after Hurricane Katrina in 2005.
He said insurance earnings will likely be lower for a few years.
Insurance is Berkshire’s profits largest single area of business and earnings and generates the huge multi-billion dollar ‘float’ that the company invests across markets. The float is the surplus of invested funds and premium income and according to the letter "funds" $US59 billion of investments.
Buffett said he is looking to invest more outside the United States, after paying $US4 billion for a controlling stake in Israel’s Iscar Metalworking Companies (the first deal outside the US) early last year and buying shares in South Korean steelmaker Posco, French drugmaker Sanofi-Aventis SA and British retailer Tesco Plc. He has mostly sold out of Petro China at a substantial profit. Buffett was pressed at last May’s AGM over the stake in Petro China over its drilling in the Dafur region of Sudan.
The company also invests in such multinational companies as Coca-Cola Co, Johnson & Johnson, Kraft and Procter & Gamble Co, and has media holdings as well.
Buffett said in the letter that Berkshire plans to still focus mainly on US investments, despite the country’s "many imperfections and unrelenting problems." That includes housing, where Buffett ladled blame on lenders who weakened their underwriting standards in the false belief that housing prices would go up and keep going up.
"Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out — and what we are witnessing at some of our largest financial institutions is an ugly sight."
In December, Buffett moved to diversify further by creating his own insurer to guarantee municipal bonds, at a time other bond insurers are suffering from exposure to risky debt. He offered to buy the municipal bond businesses of three major bond insurers last month. These moves were not mentioned in the shareholder letter.
In his letter, Buffett criticised companies that assume their pension funds can return 8% a year, even in an era of low interest rates. He said that return was the average assumption of 363 companies in the Standard & Poor’s 500 that have pension plans. Berkshire Hathaway’s figure is 6.9%.
"What is no puzzle, however, is why CEOs opt for a high investment assumption: It lets them report higher earnings. And if they are wrong, as I believe they are, the chickens won’t come home to roost until long after they retire."
Buffett also confirmed Berkshire still has three internal candidates to eventually succeed him as chief executive, and four candidates to replace him as chief investment officer.
Mr Buffett’s took aim at critics of so-called Sovereign Wealth Funds which are state-owned financial investment funds or companies held by countries as diverse as China, Kuwait, Australia, Dubai and Singapore. Many have invested in struggling US and European banks and financial groups in the past few months at the invitation of be
