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Buffett Still Has the Touch

Wednesday, 05 August 2009 02:27 PM

For one quarter at least, Warren Buffett may look like the Oracle of Omaha again.

Berkshire Hathaway, Buffett's insurance and investment company, may end six straight quarters of lower earnings, including its first quarterly loss since 2001, when it reports second-quarter results on Friday.

Operating earnings excluding investments may still decline. The main reason that overall earnings may rise is the same reason that earnings have been falling—derivative bets tied to levels in world stock markets.

That, and investments in such companies as American Express , Goldman Sachs and Wells Fargo , help explain why Berkshire's Class A shares this week crossed above $100,000 for the first time in eight months.

Much had been written over the last year over whether the world's second-richest person had lost his investment touch. Buffett, 78, gave them fodder last October when he published a widely-read editorial urging investors: "Buy American. I Am." His timing stunk. The market did not bottom until five months later.

Even now, Berkshire shares must rise another 50 percent or so to get back to their December 2007 peak. Still, stock market rallies have since March probably sliced Berkshire's paper losses on its derivatives bets.

"Short-term movements are not terribly important with a company such as Berkshire," said James Armstrong, president of Henry H. Armstrong Associates in Pittsburgh. "Investors should focus on the quality of businesses it owns and investments it makes. And I couldn't be happier with those."

Time will tell how well Buffett has positioned Berkshire, and perhaps his successor, for the aftermath of what he called the "economic Pearl Harbor" the world faced last September.

Buffett's naming on Tuesday of David Sokol as chairman and interim chief executive of Berkshire's NetJets Inc unit has renewed speculation that Sokol could be the internal executive in line to replace Buffett in running the Berkshire empire.

Sokol is also chairman of Berkshire's MidAmerican Energy Holdings unit. He is 52, several years younger than others whom analysts say could also be heirs apparent, insurance executive Ajit Jain and Geico chief executive Tony Nicely.

Berkshire has close to 80 businesses that sell such things as car insurance, ice cream, paint and underwear, and perhaps $80 billion of stocks and bonds.

"I can tell you that the movie we are watching has a happy ending," Buffett said on Fox Business Network on July 24. "I just don't know how long the movie will be."

Equities Recover

Berkshire has said it has derivatives contracts tied to where four indexes trade between 2019 and 2028: the Standard & Poor's 500 , Britain's FTSE 100, Japan's Nikkei 225, and Europe's Dow Jones Euro Stoxx 50.

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Each of these indexes had a big second-quarter gain, with the 8.2 percent posted by the FTSE being the lowest. Berkshire sold the contracts for $4.9 billion, and can invest that cash as it wishes. It pays out only should the indexes end lower than they were when Berkshire entered the contracts.

Accounting rules require the company to report gains and losses on the contracts with earnings, adding much volatility. As of March 31, Berkshire had a $10.19 billion paper loss on the contracts. It also had a $3.67 billion liability on derivatives tied to the credit quality of junk bonds, a bet that Buffett has said may lose money.

The contracts are a reason Berkshire's book value per Class A share fell 6.1 percent to $66,248 in the first quarter.

Yet Steven Check, chief investment officer of Check Capital Management Inc in Costa Mesa, California, estimated that book value could have risen to $75,000 by June 30, and $80,000 now.

"Even last year, when book value fell 9.6 percent, was one of Berkshire's best on a relative basis," compared with the 37 percent drop in the S&P 500 including dividends, Check said. "In retrospect," he added, "it could be one of Berkshire's best years, because of the investments that the environment enabled it to make."

Other Investments May Help Too

Berkshire bought $8 billion of Goldman and General Electric preferred shares, which together throw off $800 million of annual dividends. GE is the parent company of CNBC. Warrants to buy Goldman stock are now worth more than $2 billion.

Buffett has also touted Geico's success adding customers, helped by advertising featuring caveman and talking geckos.

This could help Berkshire offset its usual caution in providing reinsurance coverage and writing insurance policies to cover catastrophes such as hurricanes.

"This is an ideal atmosphere for Geico because consumers are shopping for value," said Haruki Toyama, president of Toyama Capital Management LLC in Wauwatosa, Wisconsin. "In the rest of the property-casualty area," he added, "Berkshire has been cutting back because it doesn't believe prices are adequate. At some point, that cycle will turn."

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Such caution, and weaker performance at some of Berkshire's more economically-sensitive businesses, are among the reasons quarterly operating profit may fall to $1,238 per share from $1,465 a year earlier, according to Reuters Estimates.

The Goldman and GE investments, plus multi-billion dollar investments in such companies as Dow Chemical Co and Swiss reinsurer Swiss Re, left Berkshire with a cash stake only twice the $10 billion minimum that Buffett prefers.

Yet Buffett has sold shares of oil company ConocoPhillips and credit rater Moody's Corp, and according to reports eyed acquisitions involving consumer finance company CIT Group and reinsurer IPC Holdings .

"There may be deals Berkshire can do in the next 12 months, after owners had been paralyzed by uncertainty," Armstrong said. "The easy money has not flowed back to private equity firms, so competition will be less than a few years ago."

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For one quarter at least, Warren Buffett may look like the Oracle of Omaha again. Berkshire Hathaway, Buffett's insurance and investment company, may end six straight quarters of lower earnings, including its first quarterly loss since 2001, when it reports second-quarter...
Wednesday, 05 August 2009 02:27 PM
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