Growth5 Blog

Monday, May 11, 2009

Warren Buffet / Berkshire Hathaway First Quarter Losses

Berkshire Hathaway lost $1.53 billion in the first quarter. It seems like whenever this happens, there is noise about whether or not anyone should be listening to what Warren Buffet has to say because we're not sure if he is brilliant or just lucky.

I get the argument that Buffet was lucky to have been born in the perfect era to match how his brain is wired, he's said so himself, but shouldn't that mean we have more of a reason to listen to him than not?

With a 20.3% annualized return since 1965, here's three points that make the case against luck:
1. Brilliant: Buffet buys businesses that he understands and that have a sustainable advantage in areas that have a great chance of being relevant for a long time: razors, furniture, candy, etc... Not fancy, but reliable. When he can get these businesses at a great price all the better. When he can purchase these businesses privately, he doesn't have to worry about the volatile market getting around to recognizing their value. He can just take their profits and re-invest elsewhere, and then repeat the process.

Luck: investing in businesses or derivatives or trends you don't understand. See the Internet Bubble or the more recent Derivative Meltdown that has brought the economy to its knees.

Buffet didn't invest in Yahoo in the late 90's because he didn't understand how it would make money or better yet didn't believe that the P/E multiple it was trading at could be met as it would have meant that Yahoo's business would eventually have to be larger than the US GDP at the time.

Berkshire Hathaway (BH) has spent the last couple years unwinding the 20,000 derivatives held by their subsidiary General Re.

And yes, part of BH's first quarter losses were having to take paper losses on derivatives that won't mature for another 15-20 years. But Buffet points out that BH holds the cash backing those derivatives and invests it elsewhere to hedge against potential actual losses 15 years from now (much like he invests insurance "float"). Furthermore, these derivatives are based on where the markets will be 15-20 years from now, a topic I think we can agree that Warren Buffet does understand.

2. Brilliant: Buffet has a "buy and hold forever" philosophy. This avoids worrying about timing an unpredictable market at the exact right time, every time.

Luck: timing the market on a consistent basis.

3. Brilliant: keeping it simple, knowing what works and sticking it to it. In the market, for example, Buffet believes you should be fearful when those around you are greedy and greedy when those around you are fearful.

In March we blogged about Buffet's most recent shareholder letter, in it, he says, "Beware of geeks bearing formulas."

Luck: depending on complex algorithms that very few understand, are not transparent and don't allow for environmental changes: like, oops, we didn't factor in the fact that housing prices could go down, our bad.

See: Collateralized Debt Obligations, Credit Default Swaps and all sorts of other derivatives that investors around the world lost money on. You've all heard squawking from global markets blaming the US for putting these derivatives together in the first place. Which is exactly like blaming Vegas because you put $5,000 on the Patriots winning the Super Bowl when they were undefeated. We, the US, just put these derivatives on the board. World: you knew the risk or maybe you didn't because these derivatives had been so good to you for so long.

Either way World, I would argue you would've been better off listening to Warren Buffet about keeping it simple, greed & fear, geeks with formulas, etc...
Mr. Buffet, please keep sharing. It is highly improbable that you have been lucky for 44 years. I'm going to go out on a limb and predict that you actually know what you're talking about.

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