Friday, August 31, 2012

Oracles don’t go wrong. Buffett does!

The ghosts from Buffett’s derivative investments have returned to haunt Berkshire Hathaway’s report card in the second quarter. It may well be time to give up the portfolio, says Deepak Ranjan Patra

In an interview published in B&E nearly two years ago (Issue dated November 27, 2008, titled: Is everything alright with Warren Buffett?), the Oracle of Omaha Warren Buffett had words of assurance as usual for investors of Berkshire Hathaway, who were worried about the fact that the company’s class A stocks had declined by nearly 9% in value at the Wall Street in 2008 at that time. His words were, “I personally think that the stock will be $200,000 a share by the end of 2010. So, the appreciation you’re talking about is basically better than 50% in a few years. That does seem pretty good to me.”

It would have been better than good, if only it had happened! The share was trading at $100,700 per share at that time (November 26, 2008), and today (August 17, 2010) it’s trading at $115,260 a share; which is an appreciation of just 14.4%. And after looking at the company’s report card for the second quarter of the current fiscal, the prospect of the promised appreciation seems more distant than ever.

Berkshire Hathaway, which maintained a quarterly profit level of over $3 billion through out even the most troubled days of the global meltdown, booked a net profit of less than $2 billion in the quarter ending June 30, 2010. On a year-on-year comparison, the company’s net profit has dropped by a mind-boggling 40% to $1.97 billion during the quarter from $3.29 billion for the corresponding quarter in the previous financial year. Worse still, the outlook for the company for the remaining six months of the year does not provide much inspiration either. So much so that equity research firm Stifel Nicolaus & Company has given the Berkshire scrip a ‘sell’ recommendation. As confirmed by a Thomson Reuters analyst, this is the first time that any analyst has put the company on the ‘sell’ list since 2006.

Has the king of markets lost his Midas touch for good? Or is it just an exaggerated pessimism? Well, matters look absolutely different for the company when one evaluates its situation without taking the derivatives business into consideration. In that context, the company’s revenue has in fact surged by 7% yoy during the quarter to $31.7 billion. Moreover, in terms of market performance, the company has offered 20% return to its stock holders at the bourses as compared to a negative return of 5% offered by the benchmark S&P 500 index. However, when performance of the company’s derivative business is clubbed into the total, it’s a different story. The business, which allowed the company to breathe more freely during the second quarter of financial year 2009 with a huge profit of $1.53 billion, has had an asphyxiating effect during the last quarter with an equally huge loss of $1.41 billion. As per the company, fall in stock prices during the quarter affected the value of its derivative contracts. Buffet himself admitted long ago, “Derivatives are financial weapons of mass destruction.” In that light, the high exposure to derivatives is indeed surprising in Berkshire’s case.


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