(By category -- note that this is a draft. We'll clean up and edit before the meeting.)
Berkshire's 2008 Annual Report
- MidAmerican has kept electricity rates unchanged since our purchase and the first increase won't happen until after 2013. How is it possible to hold electricity rates so steady for so long despite rising costs and inflation? How can Berkshire earn an adequate return on its investment? Will rates jump in 2013?
- Berkshire's management style has been to acquire businesses, suck all the excess cash out of them every year, and invest in higher return opportunities. MidAmerican has consumed all its cash and has borrowed money to invest in opportunities it sees. What types of internal rates of return are available to MidAmerican, a regulated business, that trump what you (Buffett) can see available at the parent company level?
- Aside from "green" credentials, what is it about wind power that makes it a superior investment compared to traditional power generation technologies like gas-fired power plants?
- A lot of companies have taken goodwill write-downs in the fourth quarter of 2008. Berkshire hasn't. Why has Berkshire's goodwill so far proven impervious to write-downs?
- Why does it make sense to look at returns on tangible net worth, when you've paid for the goodwill? Isn't return on tangible net worth just an academic exercise if you've bought in above that price?
- Berkshire had originally offered to pay 1.5% to take over $822bn in bond guarantees. You subsequently realized that you had underpriced this insurance, and mention the insight that a universe in which all municipal bonds are insured is substantially riskier than a universe in which very few or no municipal bonds are insured. This is a very interesting analysis. Who brought it to your attention?
- You mention ConocoPhillips as a major mistake of commission, and several smaller ones. Which were the smaller ones, aside from the Irish banks?
- Did we have realized investment losses on ConocoPhillips, and how big were they?
- In 2008 Berkshire had $1.8bn in non-cash losses relating to "other-than-temporary impairments of certain investment securities." Which are these securities, and do you think they'll bounce back?
- For the past two years, cash balances at the Finance and Financial Products segment has been about $5.4bn. In 2008 this amount dropped to about $1bn. Where did the cash go?
- Berkshire's management gets to decide which investments are held to maturity and which are marked to market. What percentage of Berkshire's investments are in the held to maturity versus mark to market category?
- During 2008, Berkshire bought $10.1bn of equity securities, according to its cash flow statement. In the notes to the financial statements, there are $5.8bn of unrealized losses in equities, most of which are on positions held for less than 12 months. Does this mean that Berkshire has had a nearly 60% drop in the value of these recent purchases?
- Berkshire realized $530m of investment losses in 2008. What were these?
- Berkshire received a premium of $4.9bn to insure against a drop on $37.1bn of various world stock indices. If you were to sell exactly the same insurance today, all else being equal, would the premium received be much higher because of the massive drop in the indices recently?
Loss of the Triple-A Rating
- Berkshire recently lost its AAA-rating. What are the short-term and long-term ramifications of this?
- Does the bond insurance business get permanently crippled now? Wasn't the entire point of this business that clients were buying the triple-A guarantee?
- How does this affect pricing for Berkshire's very important super-cat insurance business?
Berkshire's Holdings & Business Activities
Moody's
- Until last year, when substantial media coverage began unveiling this fact, Moody's had a separate, more stringent scale for rating municipal bonds than for corporate bonds. This difference in rating scale was beneficial to the ratings agencies because it increased their importance in assessing where a municipality stood on this arbitrarily fine scale. Thus, they earned more fees. This also raised the borrowing costs for municipalities and forced them to buy insurance for their bonds at higher prices than they would otherwise have to pay. As a large shareholder of Moody's, Berkshire can be viewed to have endorsed these practices. Why didn't Berkshire speak up and demand that Moody's end this self-serving practice and begin rating municipalities like it rates corporates?
- A number of investors were, and some still are, short the stock of Moody's. They rightly saw a cratering in revenues and earnings from ratings of strutured finance products, and a large erosion in franchise value due to the extreme folly of its corporate practices. Some also expected regulatory action to withdraw its enshrined status as an oligopolistic arbiter of creditworthiness. Arguably, these problems should have been obvious to Berkshire. Why didn't Berkshire either compel Moody's management to change course, or sell its shares before the inevitable fall?
BYD
- BYD is a recent Berkshire investment, and they manufacture electric batteries and electric cars. The automobile industry has been -- since its infancy -- a terrible investment. Electric cars are easier to manufacture and can therefore be thought of as having even lower barriers to entry by competitors. Why did Berkshire decide to invest in BYD?
Business Activities
- Mr Buffett, much of the value in Berkshire Hathaway is
represented by float, or your insurance premiums investable prior to
payout. As you have pointed out - in most years this float has cost you
nothing, and in many years you have been paid to hold these upfront premium
payments. There are few businesses in the world which can grow their
revenue generating assets without making capital expenditures. One is
insurance, and another is money management. Why have you preferred
insurance and refrained from money management? Is it the fickle nature of
the crowd, such that you can't control at what price and what amount they
invest, while in insurance you have control at all times over the price of the
premia and the volume of business you write? Question submitted by Peter Boodell, Yonkers NY
Berkshire's Recent Moves
- Between Q3 and Q4 of 2008, Berkshire sold 162,800 shares of Wells Fargo, which was less than 1% of its position in the company. Was this because you had a target sell price but the market moved away too quickly?
- Have sales been made because you now feel that the moats
protecting the Johnson & Johnson, ConocoPhillips and Procter & Gamble
franchises have been flooded?
- If those moats were flooded, how do you rationalize still holding
290 million shares of Wells Fargo and 151 million shares of American Express,
two financial companies that seemingly lost their proprietary character and
market-leading positions several years ago?
- Why has Berkshire substantially depleted its $40 billion cash hoard with a
pell-mell plunge into purchases of General Electric, Goldman Sachs and other recent investments? What was the rush, and why was the cash "burning a hole in your pocket?"
- Are you seeking a margin of safety in building up cash in light
of the precipitous drop in the value of Berkshire's portfolio?
- While the losses from your massive short index put position have resulted
in ever larger non-cash charges/losses, have you had second thoughts
regarding these derivative bets, and have you decided to use the cash raised to
hedge the short position?
- Rail volumes are collapsing, yet you keep increasing your position in Burlington Northern Santa Fe. Certainly rail volumes will eventually return, but why will the economic future of the railroads be different from their unprofitable past?
- General Electric is an overleveraged bank with an industrial conglomerate attached to it. How did you handicap the odds of GE not failing when you decided to lend them money?
- You have sold credit default swaps on certain issues because you believe them to be overpriced. Similarly, you could have bought credit default swaps on institutions you felt would fail because at one point, these swaps were very underpriced. Why didn't you buy CDS on banks like Bear Stearns, Lehman Brothers, and Washington Mutual?
- If Berkshire is being forced to write down its equity index puts, is a counterparty being forced to write them up?
- In the last two annual reports, Berkshire Hathaway has warned in no
uncertain language about the danger of the Eight Percent Myth in
pension plans. Now Berkshire is aggressively insuring the debt of
municipalities that have woefully underfunded pension plans? Does
Berkshire Hathaway Assurance take into account pension plan funding
levels and actuarial assumptions when pricing policies?
Ajit Jain / Gen Re, and others
The questions in this section were all submitted by Sahil Singh Gujral, a Rice University undergraduate student:
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The Institutional Risk Analyst has posted a request from a broker from
the publicly traded and disgraced Australian company FAI Insurance to
Ajit Jain, asking him to engage in a reinsurance transaction that will
be nullified by a so-called side letter. Such "side letter" agreements
may take many forms but, in many cases including this one, the letter's
intent is to deceive shareholders. That is, the public company appears
to buy reinsurance, which helps it smooth its own earnings in the near
term, while the secret "side letter," undisclosed to shareholders,
auditors, and regulators has effectively nullified the economic content
of the arrangement. Accusations of fraudulent side letter transactions
were also at stake in the criminal and civil General Re/AIG litigation
in which the parties have been involved. Clearly, we can see how a side
letter arrangement might be economically beneficial for a group like
Ajit Jain's to enter into with a sufficiently desperate public company
trying to "make the numbers." But, legal questions aside, is it really
ethical? How is it any different than aiding and abetting fraud if such
a side contract is not disclosed publicly? It has been reported
publicly that BRK did a fair amount of business with FAI. Do you deny
this? Do you accept this but deny specifically that Mr. Jain entered
into a deceptive side letter transaction with FAI? How do we reconcile
such behavior with the "small town newspaper" and other ethical writing
with which you and Mr. Munger have spent the last three decades of your
careers evangelizing presumably for the world's benefit? Do you see any
contradiction?
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What are the comparative advantage of investing in a commodity company versus a commodity itself?
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What is the average, effective price BRK has paid per share of Comdisco
today? Why was the transaction price, apparently a result of the
bankruptcy legal process, not disclosed as BRK normally does even with
private placements? The company's shares themselves are presumably
valuable as Grahamanian net nets with the built in liquidation
catalyst. How do you think about valuing the Comdisco rights by
comparison?
Current Opportunities
- What opportunities you see in large, fixed assets like pipelines and commercial real estate? I know
you bought a couple of pipelines in the past and that back in 1999 (I believe
it was 1999) you did some real estate loans. It would seem like this would be
the time you could buy some of these large assets with pretty good returns
using little to no leverage. Or perhaps you might provide commercial real
estate loans, given that the toughest area to get new loans is the very large
loans.
- Given the bubble in US Treasuries in late 2008 and recent months, do you believe there's an opportunity to short long-term Treasuries as both an inflation hedge and an opportunity to make outsized gains?
Investment Process
- It is said that you tend to look at the
catastrophic risk of an investment before you allocate capital. Has the
cat risk for the financial institutions you own (particularly Wells
Fargo) proved to become more significant than what you had originally
estimated? If so, what lessons have you learned from this historic
environment about cat risk that will help you adjust your strategy from now on?
- Could you tell us a bit about your due diligence process? Do you listen to quarterly conference calls? Do you watch webcast investor presentations?
- In your letters to shareholders, you have
outlined filter steps on how you frame an investment decision for
businesses and their stocks or bonds. How do you
"frame a decision" when you enter a derivative or insurance contract like
the ones BRK is involved in? Are there any filter steps involved? Question submitted by Bud Labitan of Schererville,
Indiana.
Merger Arbitrage
- Rupert Murdoch substantially overpaid for Dow Jones at about 10x sales. He will probably never earn a decent return on this investment. How did you handicap the odds of this deal closing when you entered into a merger arbitrage position on Dow Jones stock in 2007 given that it was such a bad deal for News Corp shareholders?
Other - Unrelated to Berkshire But Still Interesting
- Have you read Malcolm Gladwell's new book Outliers and based on
your own and Charlie's experience, do you believe that constant focused
meaningful effort over a long period of time is responsible for success more than
innate talent?
- Where do you think the United States stands today compared to Japan in 1990? What's similar and what's different?
- If Salomon had been allowed to fail, do you think the excesses
we are currently suffering from would have been avoided? If so, whether
due to the law of unintended consequences or not do you feel any
responsibility for the current situation?
- Did you know about Madoff before he confessed, and did you try to warn the authorities?
- Iceland has essentially imploded because it became a huge hedge fund with massive leverage and currency risk. Are there any opportunities for Berkshire in that country?
- Given what has happened to stock brokers recently (Lehman, Bear, etc), should Berkshire shareholders continue to hold their shares in street name?
- You have said numerous times that you wouldn't want to second-guess the Fed Chairman or Treasury Secretary because they're in a very tough spot. Yet recently, Bernanke and Paulson have acted in a very secretive and coercive fashion towards Bank of America. How would you have acted differently? Do you think they made a mistake?
- For Charlie Munger: Based on everything that has happened in the financial markets since
August 2007, would you take a few minutes to pontificate on the great proverb
that warns us, “As a dog returns to its vomit, so a fool repeats his
folly”? By the way, "I have nothing to add" is not acceptable. Question submitted by William A. Stanly, III of Jacksonville, FL.
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