Warren's Unhappy New Year

Posted Barron's: Warren's Unhappy New Year

Amazing how quick these critics are!

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Warren Buffett's affinity for a group of financial stocks probably is dragging down Berkshire Hathaway's vaunted equity portfolio this year.

EVEN GREAT INVESTORS MAKE MISTAKES. Warren Buffett's affinity for a group of financial stocks, including American Express (ticker: AXP), Wells Fargo (WFC) and U.S. Bancorp (USB), is likely hurting his equity returns in 2009.

Buffett's Berkshire Hathaway has sizable holdings in that trio, and the sizable declines in their share prices this year are dragging down Berkshire's (BRKA) vaunted equity portfolio, which totaled $76 billion at the end of the third quarter, the latest reporting period.

We estimate Berkshire's equity portfolio could have dropped 14% in 2009 through Thursday, against an 8% decline in the S&P 500.

Our estimate is based on the change in value of Berkshire's 16 largest equity holdings. These holdings historically have accounted for over 85% of Berkshire's portfolio. The tough 2009 follows a good showing in 2008, when Berkshire's equity positions declined -- by our estimate -- about 25%, 13 percentage points better than the S&P 500. Our calculations for 2009 are based on Berkshire's reported holdings on Sept. 30. There admittedly may have been some changes since.

Wells Fargo is Berkshire's biggest loser in 2009, as shares of the California bank were down nearly 50% through Thursday to about 16. Buffett couldn't be reached for comment, but his view on the financial sector has been to buy quality. At Berkshire's annual meeting last May, Buffett said: "We like the culture at Wells Fargo, M&T and U.S. Bancorp. In all three cases, I understand the DNA of management. That doesn't mean they won't have problems," according to a meeting attendee. (Berkshire owns a stake in Buffalo's M&T Bank [MTB].)

Our guess is that if any of these companies needs an equity investor, Berkshire stands ready to help. And the stocks are so volatile they could turn higher at any time.

The paper losses on Berkshire's equity portfolio this year, plus losses on its short position in some $37 billion of equity puts, have depressed Berkshire class A shares, which finished Friday at $86,250, down 10% in 2009. Barron's wrote bearishly on Berkshire in late 2007 when the stock traded at $144,000 and we turned bullish in late November with the shares just above current levels.

When it reported third-quarter results in November, Berkshire said shareholder equity fell by $9 billion, or nearly $6,000 a share, through the end of October given weak markets. We estimate book value probably ended 2008 around $70,000 a share. Current book value may have dropped close to $67,000 a share. If we're right, Berkshire trades for a still-reasonable 1.3 times book value and 14 times projected 2009 earnings of around $6,000 a share.

After a flurry of high-profile investments in early October, including $5 billion in Goldman Sachs preferred carrying a 10% dividend, and a similar $3 billion deal involving General Electric , Berkshire hasn't unveiled any big new investments. Why? Our guess is that its once-enormous cash hoard has been depleted.

Berkshire's insurance cash holdings, which stood at $27 billion on Sept. 30, likely fell to $13 billion after the Goldman (GS) and GE (GE) deals, as well as a $6.5 billion investment in junk bonds and preferred stock of Wrigley, which was bought by Mars. Berkshire also is on the hook for a $3 billion convertible preferred-stock investment in Dow Chemical (DOW) if it completes its purchase of Rohm & Haas (ROH). Some investors say Berkshire likes to keep $10 billion of cash to deal with unexpected insurance claims arising from an earthquake or hurricane. This wouldn't leave Berkshire much cash for a big investment unless it sells something or takes on debt.

Our guess is that if Berkshire did make more fourth-quarter investments, they were focused on the battered junk-bond market. Berkshire will disclose more on investments in its annual report, due around March 1.