Berkshire Hathaway
Berkshire's Puts

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By rclosch
January 22, 2009

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The mark to market charge for the put options Buffett sold seems to have scared the bejesus out of Mr. Market. As of the end of the third quarter Berkshire has written of $6.8 billion, and that total could go well over $9.0 billion by the end of the fourth quarter. This is a non cash charge for a position that almost certainly will turn out to be hugely profitable for Berkshire by the time the options expire in 12-17 years.

Keep in mind that this nine billion dollar charge works both ways and it will be added back into Berkshire's earnings reports as the market recovers. While Berkshires earnings will suffer in the fourth quarter of 2008 because of the charge, 2009 could be a very different story. If the market does start to recover the year over year earnings growth is likely to look spectacular. For instance a year long rally that takes us back to where we were a year ago would add a couple of billion a quarter of artificial earnings from these put contracts.

In the third quarter Berkshire received showed $1.1 billion in investment income next year they will receive $200 million additional per quarter just from the GE and Goldman Sachs preferred they purchased in October. There will be additional dividend income from his purchases of Conoco Phillips and Burlington Northern. Judging by what we read about the chaos in the debt markets it would surprise me if we do not get some news from this field of play in the chairman's letter, so does not take much imagination to figure the Berkshire's return on its' fixed income portfolio will improve over the figures from 2008.

Underwriting profit suffered in 2008 because of a weak reinsurance market, but derivative problems at insurance companies (think AIG) have tightened up insurance market nicely so barring a bad storm season or other major disaster Berkshire's underwriting profit will experience a strong recovery in 2009.

Virtually the only part of Berkshire were we cannot expect improvement next year is the operating companies whose earnings are likely to remain weak at least until the end of 2009, but even with that and given the market does start to recover it will be easy for Berkshire to register big year over year earnings gains in 2009. This will be in an environment where most company's earnings will be going south. Where Berkshire is concerned what the market took away from us in 2008 it is likely to give back in 2009, and the company's performance relative to the rest of the market should be very strong.