Scrutinizing Buffett : The Biggest Bubble Of All ?
Readers of this blog will have noted my fascination with Warren Buffett and not least so lately in such dire times of market collapses and faltering economies.
I came across this brilliant article on Fool.com (The Motley Fool as they are known remains one of my favourite financial sites and blogs), written by Anand Chokkavelu who intelligently questions Mr Buffett’s decisions and investment sanity of late.
Here follows some of the highlights from the same article which puts Buffett’s investment strategies and future in perspective :
Anand starts by asking provocative questions about Buffett’s acumen of late :
Has Warren Buffett just been lucky all these years?
It feels like sacrilege, but in light of recent events, I have to ask the question. After all …
- His company, Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), has reported $10 billion in writedowns on its equity put options — i.e., derivatives.
- His hefty positions in financial stocks, including Wells Fargo (NYSE: WFC), US Bancorp, and American Express (NYSE: AXP), have been absolutely throttled in this banking crisis.
- He loaded up on shares of oil titan ConocoPhillips at the height of the oil bubble last summer — a mistake for which he expresses regret in his letter to shareholders.
I’m not the only one questioning the Oracle of Omaha’s investing prowess. One of the ratings agencies took away Berkshire’s pristine AAA debt rating. The price of Berkshire credit-default swaps (which are basically insurance against Berkshire defaulting) is at levels more usually found with companies rated as junk. And finally, shares of Buffett’s holding company are trading at half of last fall’s prices.
Anand then goes on to ask the vital question of whether Buffett has just been extremely lucky through major risk-taking over the decades, or whether in fact he is sticking by his famous strategy that has made him one of the world’s most renowned investors and accumulators of capital :
Buffett’s entrance into derivatives, which he famously described as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal,” might lead you to believe he’s both hypocritical and risk-happy.
After all, since he made that claim in 2002, Berkshire has participated in four types of derivatives contracts, including taking $4.9 billion to write $37.1 billion worth of equity put options.
Still, believe it or not, Buffett’s not being hypocritical, he’s not being overly risky, and he hasn’t made terrible deals.
Unlike many investors (and investment banks), he uses derivatives very carefully. In the equity puts, for example, Buffett has bet that stock markets in the U.S., Europe, and Japan won’t utterly collapse over the long term. He gets the $4.9 billion up front, and he has to pay up only if the markets are lower when the various contracts expire between 2019 and 2028. But under mark-to-market accounting, he has to record those bets as losses because of the short-term plunge of the worldwide stock markets.
Buffett prices and monitors each contract himself. There are certainly risks involved, but those risks aren’t as dramatic as they seem. In the case of the $37.1 billion in equity put exposure, world markets would have to fall to zero for Berkshire to pay out the full amount — and the markets have between a decade and two decades to make up the $10 billion in paper losses. In the meantime, Buffett gets to invest and grow the $4.9 billion in premiums.
OK so Anand concludes he is not lucky or especially risk prone considering market facts and history etc - but he then moves on to question his recorded bad investment decisions of 2008 which cost Berkshire Hathaway billions :
The carnage so far this year has likely continued that drop in book value, but remember that investing in the stock of public companies is only one facet of Berkshire’s operations. It also includes the core insurance business (including GEICO and its reinsurance businesses), its other subsidiaries like its utilities and Dairy Queen, and Buffett’s aforementioned derivatives contracts.
Many of Buffett’s stock positions are much worse off than they were just months ago, but it’s worth noting that Berkshire’s own stock-price drop has more than priced in these missteps. Furthermore, Buffett has been doubted often in his nearly half-century at the helm of Berkshire Hathaway — you’ll recall the assertions during the tech bubble that Buffett’s investing style was obsolete — only to be proven right time and time again.
Even here Anand is Ok with what has happened and remains unconcerned about Buffett’s empire’s future on those grounds, however, he is concerned about two factors in Buffett’s portfolio - the first of these being his diversion into the reinsurance business :
The first is Berkshire’s reinsurance business. Quite simply, Buffett and his trusted associates are in the business of pricing catastrophic events, which feature “very large transactions, incredible speed of execution, and a willingness to quote on policies that leave others scratching their heads.”
Yes, Berkshire pools this risk and generates very attractive rates for it, but a few mistakes could blow the whole operation. Just like GE Capital has crippled General Electric (NYSE: GE), adverse events in Berkshire’s insurance operations could take down the whole conglomerate.
And the second hitting home even closer to many of us, namely Warren Buffett’s own mortality and undisputed role as head and brains of Berkshire Hathaway :
The second problem is that, contrary to the hype, Buffett is mortal. Even more so than Steve Jobs at Apple (Nasdaq: AAPL), Buffett is Berkshire Hathaway. It may not seem like it at these prices, but there is a considerable premium baked into Berkshire stock because he’s the one running it.
One of Anand’s conclusions to his article is not only that Buffett most likely remains the guru and oracle he has earned himself a name as, give and take, but that we as investors, private orinstitutional, must at all times question everything and everyone around us before we make major decisions investment wise, regardless of the status of the entity we are investing with (The Madoff scandal is another good example of that !) :
Buffett remains the greatest allocator of capital on this planet, and he’s getting some great opportunities thrown his way. Down-on-their-luck companies from Goldman Sachs (NYSE: GS) to GE to Harley-Davidson have sought his financial help and reputation, at very, very favorable terms.
There is plenty of risk in Berkshire stock, but at current prices, I believe that Berkshire Hathaway is worth the risk. In fact, the recent price drops convinced me to put my money where my mouth is — I recently bought Berkshire Hathaway stock.
Read the full article here - it is worth it.
Equity Investment, Investment Company, Investment Fund, Investment Management
