Buffett 'on the prowl'

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As Berkshire Hathaway goes, so goes the nation?

An auto company executive reportedly said a variation of that about General Motors in the 1950s. These days, Berkshire — which passed GM on the latest Fortune 500 list — may be headed for the same prominence.

Chairman and CEO Warren Buffett said Saturday in his annual letter to Berkshire shareholders that the company's expanding collection of giant operating businesses is dominating its financial performance and holds the most potential for growth.

"He's so positive about America and he so believes in it, and his company is a reflection of that," said Paul Lountzis of Wyomissing, Pa., whose investment funds hold Berkshire stock. "He feels that the future of America is just like the future of Berkshire, and it's brighter than ever."

In the letter, which is eagerly awaited by investors for Buffett's views on investing and the economy, Buffett said, "When you look at Berkshire, you are looking across corporate America."

The rise in profits by Omaha-based Berkshire's diverse companies, he said, "illustrates the comeback of much of America from the devastation wrought by the 2008 financial panic. Though housing-related businesses remain in the emergency room, most other businesses have left the hospital with their health fully restored."

Buffett last year said his investing "elephant gun" was loaded and "my trigger finger is itchy." The result was the $9 billion purchase of chemical company Lubrizol Corp., completed in September.

This year, he said, "We now have eight subsidiaries that would each be included in the Fortune 500 were they stand-alone companies. That leaves only 492 to go. My task is clear, and I'm on the prowl."

The letter was generally upbeat, despite the warning about the continued housing slump and an admission of a $1 billion-plus error he made several years ago. Buffett reported that Berkshire outperformed the overall stock market in 2011 for the first time since 2008.

The letter did not mention the financial crisis in Europe, the income tax issues Buffett has raised lately or last year's resignation of former Berkshire executive David Sokol. It praised the managers of several Berkshire divisions and discussed his board's enthusiasm for his successor as CEO, but did not name the candidate or two "backup candidates."

Buffett said he and Charlie Munger, vice chairman of Berkshire, "feel good about the company's progress during 2011," although Berkshire's net income declined in 2011 and in the fourth quarter due to a decline i the value of some investments on paper. He said insurance remains the company's "core operation" but it isn't likely to grow as much as the noninsurance side.

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That view indicates Berkshire is becoming a "conservatively slanted conglomerate," said Tom Lewandowski, an analyst with Edward Jones in St. Louis.

"This shift that's happening is an important one," said Lewandowski, a former Omahan, who does not own Berkshire stock. "I would expect him to continue to look outside of insurance" for acquisitions.

Berkshire's five biggest operating businesses each made record pre-tax profits in 2011, with a combined total of more than $9 billion. Each should set new records in 2012 with combined profits of more than $10 billion, unless the economy turns down, Buffett said in the letter.

The "fabulous five," he said, are BNSF Railway, Lubrizol, MidAmerican Energy Holdings and industrial companies Iscar Inc. and Marmon Group.

Of those, Berkshire owned only one — MidAmerican — five years ago, when its pre-tax earnings totaled $393 million.

Berkshire's insurance companies hold $70.6 billion in premiums, a "float" that can be invested while waiting to pay claims. "It's unlikely that our float will grow much — if at all — from its current level" because it's already "outsized" relative to premium volume, Buffett wrote in the letter.

Laura Rittenhouse of New York, a Berkshire shareholder who analyzes CEO reports for clarity and content, praised Buffett's confession that he lost more than $1 billion from his purchase a few years ago of bonds issued by Energy Future Holdings, a Texas utility.

"That was a mistake — a big mistake," Buffett wrote. The investment was tied in part to the price of natural gas, which declined sharply. He said he "totally miscalculated" the potential loss, which may worsen over time. "In tennis parlance, this was a major unforced error by your chairman."

Rittenhouse said CEOs rarely admit mistakes and almost never point out that their actions might cause future losses.

"He explains things so clearly, but there are principles that many people are just not wired to understand," she said, such as the idea that you should decide on an investment based on the "intrinsic value" of a company in relation to its price and then be happy if the stock price declines so that you can buy more.

For example, Buffett said that although he invested $10.9 billion in IBM last year, he hopes the price of that stock declines. That's because IBM's management plans to buy back some of its stock. If IBM's stock price declines, those repurchases would remove more shares, making Berkshire's percentage ownership of the company bigger.

If IBM ends up buying back all the shares except those owned by Berkshire, Buffett quipped, "I will abandon my famed frugality and give Berkshire employees a paid holiday" because Berkshire would own the entire company.

Saturday's report said net income for the fourth quarter was down 30 percent to $3.05 billion, or $1,846 a share, from $4.38 billion, or $2,656, a year earlier. For the full year, net income was $10.3 billion, or $6,215 per share, down 20.1 percent from 2010.

The 2011 net income decline was due to a $3 swing in the accounting value of Berkshire's derivative holdings. Buffett, however, prefers to measure the company's performance by its longer-term gain in book value, or net worth, and his estimate of its intrinsic value.

He pointed out that the investment company's per-share value rose 4.6 percent, compared with a 2.1 percent gain by the Standard & Poors index of 500 stocks, a reflection of the overall market. That's a 2.5 percentage point advantage.

The increase is far below Berkshire's 19.8 percent annual average increase, which is more than double the S&P's 9.2 percent average since 1965, the year Berkshire became publicly traded. That slowdown reflects Buffett's past warnings that, because Berkshire has become so large, it will be difficult to grow as quickly as in its early days.

Buffett makes his annual letter public in Saturdays partly to give investors a weekend to digest its contents and think about the company. Some years, the stock market reacts to Buffett's comments after the letter is published. Berkshire's stock price closed last week at $120,000 a share, down from $131,000 about a year ago.

Lountzis, the Pennsylvania investment manager, said he thinks the company's value should be at least $160,000 per share, and believes Berkshire can make many more acquisitions.

"I think Berkshire is beautifully positioned like it's never been," he said. "Berkshire's always going to do well on the investment side, but I really think the future power of Berkshire is buying entire businesses, both public and private."

Lewandowski, from Edward Jones, recommends buying Berkshire shares, although he doesn't own shares personally. "There's a lot of earning power there at the end of the day," he said Saturday.

Part of investors' uncertainty and the reason the price isn't higher, he said, is that Buffett, at age 81, is still such a key part of Berkshire's growth.

"He seems to be so coy about coming out and telling us who the successor is going to be," Lewandowski said.

He said the value of Berkshire's holdings likely will support the company's stock price once Buffett steps away. "But we need to know who's going to be in those shoes, because it's a really important part of the Berkshire investment story, longer term."

The World-Herald Co. is owned by Berkshire Hathaway Inc.

Contact the writer: 402-444-1080, steve.jordon@owh.com, twitter.com/buffettOWH

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Have a question for Steve Jordon about the Oracle of Omaha and his annual letter to Berkshire Hathaway shareholders? Send it in below and then check back from 11:30 a.m. to 12:30 p.m. Monday and Tuesday for more Buffett discussion with Jordon. Find the mobile version of the upcoming chat here.

Replay Saturday's chat with Jordon here.

Check with Omaha.com throughout the weekend or pick up Sunday's World-Herald for more news and analysis from this year's report.

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