By Gaurav Ghose, Financial Features Editor
Published: March 06, 2009, 23:56 Dubai:
Last Saturday, Warren Buffett released his annual letter to shareholders, a much-awaited ritual every year at this time. It was vintage Buffett, explaining his company's results and his investment moves in his own humble, straightforward and honest way, laced with humour. Some observers, particularly in the US, had started to question whether some of his latest moves on certain stocks made sense as the shares of Berkshire Hathaway, his insurance and investment company, lost half their value since December 2007.
Last month, CNBC Mad Money host Jim Kramer said he was not sure about some of the "great man's" moves, warning ordinary investors not to follow Buffett's lead this time around. Also, Buffett's views on derivative contracts with tens of billions of dollars at risk, though their fate will be decided several years into the future, were eagerly awaited. Buffett did not disappoint analysts closer home. Looking closely at the company's results and the broader themes that the second richest man on Earth touched upon in the letter, they say, there are lessons for company managements and investors of the region.
Buffett admitted he "did some dumb things", which included buying shares of oil giant ConocoPhillips when energy prices were almost at their peak, and investing $244 million in a couple of Irish banks, which led to a loss of 89 per cent. But on the plus side, Buffett said, buying $14.5 billion in fixed-income securities issued by companies such as Wrigley, Goldman Sachs and General Electric was much to their liking as they carried high current yields. "Buffett's annual letters have set a benchmark over the years for the transparency and thought process of an asset manager," says Matthew Wakeman, managing director of cash and equity-linked trading at EFG-Hermes. "In addition to this, the kudos and respect that has taken Buffett a lifetime to build means that bad investments can be discussed as openly as good ones due to his investors having supreme confidence that he will win more than he will lose. This has historically remained the case and remains so." Prabhakar Kamath, partner and CEO of Morison Menon Limited, agrees. "He is very honest in conceding the errors or mistakes he has made in investments, and thats make him stands out."
Berkshire lost about $5.1 billion in the fourth quarter on several derivatives contracts entered into in the past few years. But it must be kept in mind that the contracts expire in 10 or 20 years. "On derivative markets, Buffett clearly states his dislike for their instruments and their lack of transparency and ability to distort financial positions and company performance," said Ian Munro, head of research at Mac Capital Advisors. "But he provides detailed clarity regarding the reasoning and extent of Berkshire's involvement in 251 derivative contracts." To Kamath, the letter had a clear message on derivatives. There are many who don't understand the risk associated with the derivative positions they have taken. "So, when next time your adviser comes with those structured products, the products that you don't understand, but guarantees you unbelievable returns, stay away," Kamath says.
The company results also provide some clues to his strategy, local analysts point out. Berkshire Hathaway has a strong balance sheet, one of the best in the country. The per share book value fell by 9.6 per cent for the year 2008 compared to 37 per cent in the S&P 500 index. For the company, it is only the second loss making year in the last 44 years as against 11 losing years for the S&P in the same period. "Putting aside the frenzy created by the fact that this is the second loss in the fund's history, the fact that Berkshire outperformed the S&P 500 Accumulation Index by 27.4 per cent during 2008 is nothing short of extraordinary," Munro says. Also, cash flow from operations is more important than net earnings, and in this respect the performance is excellent, Kamath says. The net income is $5 billion (it was $13.2 billion last year) whereas the cash flow is $11.2 billion. "In the previous year, the cash flow was $12.6 billion and so, that's a marginal decrease," Kamath says. "The main reason for this is losses are mainly owing to mark-to-market write-off of the put contracts. These losses are accounting losses without any cash being spent or expected to be spent over the next 13 years of the contracts.
The firm is earning cash for its investors. And don't forget, the company's cash flow is stable even in these times of recession." Avoiding losses is a matter of ethics that is clear from one of Berkshire's mortgage business, feels Kamath. "Well principled business decisions and the operations have helped him avoid losses in his mortgage business, when scores of such businesses have turned bankrupt," Kamath says.
One of its subsidiaries, Clayton Homes, which operates in the home lending market, had a foreclosure rate of just 3.9 per cent in 2008, up from 2.9 per cent in 2004. How could Clayton do it? "Simple: Stick to Lending 101," Kamath says. "Clayton lent to only those borrowers who bought home to live, who paid 10 per cent in down payment, who then compared their monthly mortgage payment to the actual monthly income. They bought homes for long term, not for speculative profits." Buffett's wisdom on financial markets and investments has implications for analysts here. Buffett argued the "investment world has gone from underpricing risk to overpricing it, which he said can be seen in a scramble for US Treasury bonds creating a bubble, reminiscent of the internet bubble of the 1990s and housing bubble of the 2000s. Buffett's acknowledgment of a US Treasury bill bubble, implies that risk aversion has become excessive within international markets, feels Munro. "Thus, the incentive for institutions to re-weight asset allocations towards higher returning equity and corporate bond assets classes could likely return soon, leading to a global market rally," says Munro. "A rally in developed markets is generally followed by an increasing flow of wholesale funds to emerging markets, particularly GCC exchanges where earnings are backed by petrodollars. This may lead to an increase in foreign buying volumes on UAE bourses during the second half of the year, especially if the oil price rallies." Buffett's views on spot oil being undervalued in the $40-$50 could also very well mean that there may be some relief for oil prices and thereby local markets.
The next Opec meeting is on March 15, thrusting the prospect of further cuts to supply back into spot price calculations. And according to Buffett, cash equivalents or long-term government bonds at present yields is "almost certainly a terrible policy if continued for long". Cash is not king as it is earning close to nothing, he added. Also, Buffett said that he is not too bothered by the dramatic drop in the market values of stocks and bonds that he holds. "Indeed, we enjoy such price declines if we have funds available to increase our positions& " Buffett said in his letter. Employing Berkshire Hathaway's renowned strategy of investing in straight-forward, cash-generating companies, Munro says he favours holdings in stocks such as DP World, DFM, Aramex, etisalat, Air Arabia, Gulf Navigation and Taqa. "Adding government backed companies into the stock universe, we include Aldar and Sorouh as core long-term holdings," he adds.
- Investment world has gone from underpricing risk to overpricing it
- US Treasury bond is now a bubble, so be cautious
- Cash is not King as it is earning close to nothing
- fixed income securities carrying high current yields have been a satisfactory investment
- Invest in cash-generating companies
-Invest for the long term
- Price declines are not always bad
- if funds are available, they allow an increase in positions
- Derivatives are dangerous
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