Berkshire has its worst year; Buffett still optimistic

OMAHA, Neb. -- Warren Buffett says the economic turmoil that contributed to a 62 percent profit drop last year at the holding company he controls is certain to continue in 2009, but the revered investor remains optimistic.

Buffett released his annual letter to Berkshire Hathaway Inc. shareholders Saturday morning and detailed the worst performance in his 44 years leading the Omaha-based insurance and investment company.

Buffett wrote he's certain "the economy will be in shambles throughout 2009 -- and, for that matter, probably well beyond -- but that conclusion does not tell us whether the stock market will rise or fall."

In between the news of Berkshire's sharply lower profit and its nearly $7.5 billion investment and derivative losses, Buffett offered a hopeful view of the nation's future.

He said America has faced bigger economic challenges in the past, including two world wars and the Great Depression.

"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. America's best days lie ahead."

Within Berkshire, Buffett said the company's retail businesses, including furniture and jewelry stores, and those tied to residential construction, such as Shaw carpet and Acme Brick, were hit hard last year, and they will likely continue to perform below their potential in 2009.

But he said Berkshire's utility and insurance businesses, which includes Geico, both delivered outstanding results in 2008 that helped balance out the other businesses.

Berkshire's 2008 net income of $4.99 billion, or $3,224 per Class A share, was down from $13.21 billion, or $8,548 per share, in 2007.

The two analysts asked by Thomson Reuters on average expected Berkshire to report a 2008 profit of $5,534.50 per share. But the estimates typically exclude one-time items.

Buffett estimates Berkshire's book value -- assets minus liabilities -- declined 9.6 percent to $70,530 per share in 2008 -- the biggest drop since he took control of the company in 1965. Berkshire's book value declined only one other time under Buffett, and that was a 6.2 percent drop in 2001.

Berkshire's Class A shares remain the most expensive U.S. stock, but they fell nearly 32 percent in 2008 and have declined 48 percent since setting a high of $151,650 in December 2007. That high came after an exceptionally profitable quarter that was helped by a $2 billion investment gain.

The S&P 500 fell 37 percent in 2008.

On Friday, Berkshire's Class A stock gained $250 to close at $78,600 on the eve of the release of Buffett's letter. But earlier this week, the stock set a new five-year low at $73,500 as investors anticipated bad news in the report.

Buffett devoted nearly five pages of his letter to Berkshire Hathaway shareholders to explaining the role derivatives played in the company's investment losses last year.

Buffett said he initiated all of Berkshire's 251 different derivative contracts because he believes they were mispriced in Berkshire's favor.

"If we lose money on our derivatives, it will be my fault," Buffett said.

Berkshire has received $8.1 billion in payments for derivatives which can be invested until the contracts expire years from now.

But Berkshire has to estimate the value of its derivatives every quarter. Buffett says he supports that mark-to-market accounting, but the formula used to estimate that value can produce absurd results for long-term contracts.

Buffett said he made at least one major investing mistake last year by buying a large amount of ConocoPhillips stock when oil and gas prices were near their peak.

Berkshire increased its stake in ConocoPhillips from 17.5 million shares in 2007 to 84.9 million shares at the end of 2008.

Buffett said he did not anticipate last year's dramatic fall in energy prices, so his decision cost Berkshire shareholders several billion dollars.

Buffett says he also spent $244 million on stock in two Irish banks that appeared cheap. But since then, he's had to write down the value of those purchases to $27 million.

Berkshire owns a diverse mix of more than 60 companies, including insurance, furniture, carpet, jewelry, restaurants and utility businesses. And it has major investments in such companies as Wells Fargo & Co. and Coca-Cola Co.

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On the Net:

Berkshire Hathaway Inc.: http://www.berkshirehathaway.com

Warren Buffett's 2008 letter: http://www.berkshirehathaway.com/letters/2008ltr.pdf