Buffett and Berkshire Newsfeed

Warren Buffett's 2008 letter to Berkshire Hathaway shareholders says the economy will remain in a "shambles" at least throughout this year.  Buffett, Berkshire's longtime chairman, points out America's resilience throughout past panics and crises and says America's greatest days still lie ahead.

"Though the path has not been smooth, our economic system has worked extraordinarily well over time," Buffett wrote. "It has unleashed human potential as no other system has, and it will continue to do so."

He predicted the S&P will rise in three-fourths of the next 44 years -- the same performance it has notched since Buffett took Berkshire's reins in 1965.  He also noted that a market rebound and an economic rebound don't always share a direct correlation.

Buffett -- himself the son of a Nebraska congressman -- is a supporter of and unofficial economic adviser to President Barack Obama.  Buffett gave his nod to the government's actions to repair and stimulate the economy, though he says the downside of the moves will be inflation. 

"Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown," Buffett wrote. "Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat."

The Oracle of Omaha saved his criticism for a group he has never cut any slack -- managers who post lackluster performance.  Though he allows that fear lead to contraction, which spawned more fear, he nevertheless chastised financial companies' weak balance sheets and overuse of derivatives, which made them too dependent on one another. He offers a lengthy discourse on derivatives, which he describes as dangerous. (You can read the full text of the shareholder letter here.)

Buffett, revered for his plainspoken talk about sophisticated financial issues, tempers his optimism with realism. He opened this year's letter with the exact phrasing he has used for years to describe the change in Berkshire's book value. The only difference was that shareholder equity fell this year. That's something that has happened only once before. Book value decreased -9.6%, the worst year on record, though Berkshire's two most important businesses -- insurance and regulated utilities -- are mostly immune to the economic cycle.

The 22-page missive -- part textbook, part narrative, part confession -- pulled no punches. Buffett admits he screwed up by buying shares in ConocoPhillips (NYSE: COP) when oil was at its peak. He beats himself up for buying two banks that were subsequently written down by -89%. And he reports he sold stakes in Johnson & Johnson (NYSE: JNJ), Procter & Gamble (NYSE: PG) and ConocoPhillips that he would have preferred keeping. (He needed to raise cash for deals with Wrigley, Goldman Sachs and General Electric.)

The Future

Buffett's hopeful read on the nation's economic prospects is atypical: The shareholders letter, by its nature, looks back. But in addition to his economic optimism, he also included what I think is a hint as to the future leadership of Berkshire.

Now, one of Buffett's favorite things about Berkshire -- other than the people he works with -- is "float." Float is the key to Berkshire's success. This is the money that policy-holders entrust to an insurer to hold until claims are presented. Most insurers pay more in claims than they receive in premiums but make money in the meantime by investing the cash.

A few lucky companies, like Berkshire, actually get paid to hold other people's money, an outcome known as an "underwriting profit." Berkshire generated nearly $3 billion this way last year. Buffett's success has been built on using float to make other investments that generate cash, then to use that cash to buy more companies, and so forth. Without float, Berkshire would likely be good, but not great. It wouldn't have any legs. Buffett absolutely reveres the managers who make this happen.

One in particular -- and the time has come for investors to read between Buffett's lines. Here's what he had to say about Ajit Jain, who runs General Re: "From year to year, Ajit's business is never the same. It features very large transactions, incredible speed of execution and a willingness to quote on policies that leave others scratching their heads. There isn't anyone like Ajit."

Buffett is 78 and in good health, but no one lives forever, and Buffett has said he will step down if his abilities or energy slips. To that end, Berkshire's succession plans have been made -- but they have not been disclosed.  This kind of plug, which Jain receives regularly, is the best clue as to who the next Berkshire chairman will be.
 

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