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Berkshire Hathaway
Solid 2002 ... what about 2006?

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By EightTrack
March 12, 2003

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As Chairman Buffett wrote in his Annual Report, "In all respects 2002 was a banner year." The future looks good ... but is Berkshire Hathaway setting itself up for the kind of positives that lead to 7% increases in intrinsic value compounded annually a year or 12% a year?

Some concerns:

Another bogey from General Re.

Fortunately, BRK skirted a mega-catastrophe over the past year by reducing NCB (nuclear, chemical, and biological) risk. Still, another charge in 2002.

Buffett writes, "Finally, we are making every effort to get our reserving right. If we fail at that, we can't know our true costs." Although current management is getting the house in order, it's probably premature to write-off the possibility of another reserve adjustment.

With the admission of the unfortunate degradation of General Re's culture and underwriting discipline prior to the acquisition, it seems appropriate to finally admit that the General Re acquisition - albeit made with overpriced stock - was a failure.

Given the losses over the past few years, it will take substantial General Re profits in future years to make this acquisition a winner. And how many years of a 'hard market' do we have left?

The combination of low interest rates and a unattractive equity market makes "passive" investments difficult.

Low Treasury/risk-free interest rates make low-cost float all the more necessary. Can Berkshire Hathaway achieve a negative cost of float going forward? Given the size of BRK's float, I would say: doubtful.

A very low cost of float, 1-3% would be fantastically impressive in a world of 7-9% long treasuries, but we're in a world of below 4% treasuries (although that may be the low point, unless you fall in the deflation camp).

Also, remember Buffett's "pro-forma" statement. 2002 was absent a mega-catastrophe. It's doubtful that the future will be so fortunate.

Buffett's inability (so far correct) to find large passive equity investments is frustrating. Admittedly, this might change in 6 months, but the large amount of capital he needs to commit really limits purchases to very large cap stocks.

And unfortunately, although Buffett's patience in the market is legendary, the Grim Reaper is not so kind ... it's really unfortunate that Berkshire Hathaway can't take full advantage of Buffett's equity acumen in the foreseeable future.

"It's hard to teach a new dog old tricks."

Great line! In four years, Berkshire will have 8 managers over 75 years-old -- God Willing!

This would make a nice advertisement for the AARP, but it's a little worrying, isn't it? The next operational chairman - Ajit Jain? - could face the need to replace a number of key managers. Surely a lot of this planning has already been made, but will the next generation prove as good as today's? Will the next chairman have the ability to hire (or replace) superb management?

Who is the next operations chairman anyway? Ajit Jain? We don't know, of course. Mr. Jain oversees a small team now, does he have the ability to oversees the ten of thousands of Berkshire employees? The disparate parts ... from boots to bricks to insurance (this is an obvious yes) to fast food to premium chocolates to real estate brokerages? What a job!

And how much ability does Howard Buffett possess?

Dr. Jekyll and Mr. Hyde disclosure

Buffett's Letters to Shareholders are true capitalist gems. No argument there.

But the complexity of the business -- just in insurance alone -- and not counting finance products or the more "normal" businesses, deserves more disclosure.

Certainly the 2002 annual report is a step forward. But I wish Mr. Buffett would make even more disclosures ... because the call for increased disclosure will become louder after his passing. Better to start disclosing more now.

For example, consider Value Capital L.P. (see Notes to Consolidated Financial Statements/note 9).

This limited partnership started up in 1998. Although the downside is limited to the carrying value of the investment ($603 million ... not the smallest chunk of change), it's not something I was really aware about before this year.

Because it is a "variable interest entity" it will be integrated into Berkshire books as of the third quarter ... increasing Berkshire reported assets and liabilities by about $20 BILLION.

A $20 BILLION change to the books, and how many of us are aware of this entity? Of those who are aware, how many of you know what is does? Who runs it?

*******

Overall, a great 2002, but some concerns for 2003 and beyond.

ET


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