A Brace of Insights for the Berkshire Faithful
by Associated Press staff
Warren Buffett (BRKA) Chairman and CEO Warren Buffett and Vice-Chairman Charlie Munger spent more than five hours on May 2 answering questions from shareholders at Berkshire's annual meeting in Omaha, Neb. Here is what the Berkshire brain trust had to say on a variety of topics:
Newspapers' dwindling value
Berkshire owns The Buffalo News and it has a sizable investment in the Washington Post Co. (WPO). Buffett reiterated on May 2 that Berkshire won't be adding to those newspaper investments.
"For most newspapers in the U.S., we would not buy them at any price," Buffett said.
He said most newspapers face the possibility of unending losses because the industry has lost its essential nature. "They were only essential to advertisers as long as they were essential to the reader, and that is changing," Buffett said.
Credit rating problems
Buffett said he doesn't think the conflicts of interest at credit rating agencies caused their problems, or the problems with the complicated collateralized debt obligations that turned out to be worth much less than ratings agencies estimated.
Buffett said Moody's (MCO), Standard & Poor's (MHP), Fitch Ratings and other credit rating agencies all seemed to buy into the faulty notion that house prices would continue increasing indefinitely and based their ratings models on that. "They made a major mistake in analyzing the instruments," Buffett said. "But they made a mistake a great many people made."
Berkshire owns 48 million shares of Moody's, comprising a stake of more than 20%. But Buffett said he never tried to influence the way Moody's developed its ratings because Berkshire generally doesn't do that. "When we own stock, we are not there to change them," Buffett said.
Buffett said he still believes that derivatives can create huge problems for society, but he also believes the derivatives that he's written for Berkshire will eventually generate money for the company because they were mispriced. "I think our shareholders are intelligent enough to realize how beneficial they are if we explain them," Buffett said.
Buffett emphasized that Berkshire's derivatives require very little capital to be posted, and the company has the use of the full premium for them for years until the contracts mature.
Berkshire had received $8.1 billion in payments for derivatives throughthe end of 2008, which can be invested until the contracts expire years from now. Buffett devoted nearly five pages of his letter to shareholders to explaining the 251 different derivative contracts he's initiated.
The derivatives Berkshire offers operate similar to insurance policies. Some of them cover whether certain stock market indexes—the S&P 500, the FTSE 100 in the United Kingdom, the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan—will be lower 15 or 20 years in the future. Others cover credit losses at groups of 100 companies, and some cover credit risks of individual companies. Munger said there's a limit on how many derivatives Berkshire should write, but the company is nowhere near that limit.
Berkshire has to estimate the value of its derivatives every quarter even though they don't mature for years and the company does not plan to sell them. The drop in the estimated value of the derivatives has weighed on Berkshire's earnings in recent quarters.
Buffett said he and Munger don't use fancy formulas or spreadsheets to determine how much a company is worth and whether it's a good investment at the current price.
Instead, Buffett said it all boils down to the concept Aesop explained in fables. Buffett said they just determine whether the bird in hand is really worth more than the birds in the bush and whether there are more birds in a different bush.
He said many of the worst business decisions ever made are based on elaborate formulas and projections. "It should be so obvious that you don't have to carry it out to tenths of a percent," Buffett said.
Investing in financial institutions
Buffett said that if investors were to study the annual and quarterly reports major banks file with the Securities & Exchange Commission, they'd be able to recognize the differences between the banks.
Buffett said he believes Wells Fargo (WFC), in which Berkshire owns a large stake, has the best competitive advantage among large banks. He says investors should be able to tell the difference between Wells Fargo and a highly leveraged bank like Washington Mutual from the filings, but it can be hard for an investor to sort that out without spending a lot of time on it.
Munger said the accounting rules make it harder for investors to determine the health of banks. "A lot of the new regulation that's coming wouldn't ever have been needed if accounting had done a better job," he said.