Has Warren Buffett Lost His Touch?
By Eric Wahlgren
Billionaire investor Warren Buffett's annual letter to shareholders contained at least two mea culpas this year. The chairman and chief executive of Berkshire Hathaway (BRKA , BRKB ) took the blame for the $46.2 million in pretax losses that the Dexter shoe business incurred as part of the Omaha insurance and holding company's footwear operations.
Of far graver consequence, though, was the more than $2 billion in losses at General Re, the largest U.S. reinsurer, stemming from the September 11 terrorist attacks. Buffett, known as the Oracle of Omaha for his sage investment decisions, also took the blame for letting General Re assume a "dangerous level of risk" for a "mega-catastrophe."
"I violated the Noah rule," writes Buffett in a typically folksy letter that includes a book recommendation and information on his favorite steakhouse. "Predicting rain doesn't count. Building arks does."
Berkshire wasn't the only insurance company hit by the terrorist attacks that destroyed airplanes, buildings, and thousands of lives. But Berkshire's insurance losses, combined with declines in a vast stock portfolio that includes Coca-Cola and American Express, was a blow to Berkshire, which has a sparkling reputation for providing dependable gains to investors.
Profits in 2001 dropped 76%, to $795 million, or $521 per class A share, on revenue of $37.6 billion, which was 11% more than in 2000. Prior-year profits of $3.3 billion paid $2,185 per class A share. Excluding $842 million in realized investment gains, Berkshire had a $47 million operating loss for the year, about $30 a share.
Of more interest to investors, perhaps, was news that Berkshire's book value (shareholder's equity or assets minus liabilities on a per-share basis) -- which has grown to $37,920 per share from $19, or at a 22.6% annually compounded rate since 1965 -- fell in 2001 for the first time in Buffett's 37 years at the helm. It dropped 6.2%. That's still better than the approximate 12% decline in the Standard & Poor's 500-stock index including dividends. But Buffett sees no solace. "Though our corporate performance last year was satisfactory, my performance was anything but," he writes.
"ABOVE-AVERAGE" OR BUST.
The question for investors: Is Buffett, the world's second-richest man behind Microsoft's Bill Gates, losing his Midas touch? In his letter, Buffett concedes that Berkshire's growing size and the higher prices it must pay for acquisitions mean "we won't come close to replicating our past record." But he adds that Berkshire won't be satisfied with anything less than "above-average" performance.
Wall Street experts remain confident that Buffett will deliver on his pledge. "The rate of return will be above the market," says Matt Sauer, a portfolio manager at Oak Value Capital Management in Durham, N.C., which has a position in Berkshire. Sauer says Berkshire is mainly an insurance company -- it also owns reinsurance firm National Indemnity and auto insurer GEICO -- and that prospects are looking up. For one, since September 11, Buffett has made underwriting changes at General Re. Sauer also says reinsurance pricing could rise 30% this year. "They are going to be bringing in a lot of profitable business," he says.
David Braverman, senior investment officer at S&P (like BusinessWeek Online, a unit of The McGraw-Hill Companies), continues to rate Berkshire accumulate -- basically a recommendation to buy the stock, but not aggressively. Braverman, who lowered his rating on Berkshire from strong buy earlier this year, points to a $221 million underwriting profit at GEICO in 2001, vs. a $224 million loss in the prior year as one of the encouraging factors that warrant keeping a positive rating on the stock.
Berkshire stock clearly isn't for everyone, if only for the simple reason that most investors simply can't afford it. Due to the company's distaste for splits, class A shares closed at $72,000 on Mar. 14. Class B shares, which Buffett created in 1996 to thwart attempts by outsiders to put the stock in trusts which they could sell in smaller tranches, closed on Mar. 14 at $2,400 -- about 1/30 the value of class A shares. Although class B shares have 1/30 the value, they have only 1/200 of the voting rights of class A shares and cannot be converted to class A shares. But Berkshire is a mainstay in many mutual-fund portfolios.
Timothy Vick, senior investment analyst with private money-management firm Arbor Capital Management in Munster, Ind., is confident that Berkshire earnings will come back strong. But he believes current prices are at the high end of valuation. Although he says he wouldn't buy shares right now, he plans to hold onto the ones he already owns. "If this stock went down to $2,100 or $2,000, I would jump all over it," says Vick, who's the author of How to Pick Stocks Like Warren Buffett.
Vick thinks Berkshire will continue to outperform the S&P 500, which he sees posting gains in the high single digits over the next several years. Part of Vick's confidence comes from Buffett's strong record of buying undervalued companies -- in cash -- and turning them into profit generators.
In his letter, Buffett says three of Berkshire's major acquisitions last year -- carpetmaker Shaw Industries, insulator Johns Manville, and paint maker Benjamin Moore -- together generated about $659 million in pretax earnings. "I know that Mr. Buffett is capable of finding good values and building a strong company," Vick says. Buffett's far-flung empire today includes businesses as varied as pilot-training company FlightSafety International and fast-food chain Dairy Queen International.
Vick maintains that the troubled Dexter shoe unit is more the exception than the rule. Buffett in his letter says he has made management changes and that it will become "reasonably profitable." Says Vick: "I don't know of any manager who hasn't made mistakes. Buffett doesn't make huge mistakes. He doesn't waste shareholder money."
Not everyone is a fan of Buffett's investing style. Donald Luskin, chief investment officer of investment-research firm Trend Macrolytics, says he believes many companies in Berkshire's portfolio are fully appreciated. And, he says, Buffett holds onto big stakes in companies -- 11% in Amex for instance -- when he might have done better by his investors if he had sold them. "Basically, he makes a virtue out of necessity," says Luskin. Since getting rid of such holdings now could destabilize markets, Luskin says, Buffett's rationale for holding tight may be self-protection.
Others argue that Berkshire is a unique company that provides a lot of value to shareholders. Sauer says it shouldn't be viewed as a conglomerate but rather as an insurance company that uses its float -- the money received from premiums before losses are paid -- to buy new companies. The returns can be better than at rival insurers, Sauer says. "When you look at the investments of other insurance companies, Berkshire is ahead," Sauer says.
Vick says he knows Buffett won't be able to reproduce the gains of years past. But he adds: "With Buffett, you know you can get earnings you can trust. And you know you are going to get a CEO who is going to try to maximize value for the shareholders."
In a time when top managers at some companies have maximized their own take while individual investors lost out, Berkshire could still be a good bet -- if you have the cash lying around to buy a share or two.
Wahlgren covers the markets for BusinessWeek Online in New York
Edited by Douglas Harbrecht