Buffett As The Wizard of Oz

Forget about the businesses, it's the magic of the man that accounts for the premium value of Berkshire Hathaway.Martin Sosnoff

 

Is there anything more to be learned from Warren Buffett? Maybe yes, maybe no.

The "yes" has to do with his good feel for macro events like financial panics, the dollar, interest rates, stock market valuation and preferred asset categories throughout the world. 

The "no" is more my judgment after scanning Buffett's equity portfolio and Berkshire Hathaway's ( BRK - news - people ) stable of operating properties that cover insurance, retailing, manufacturing, utilities and services businesses like NetJets.

The shrinkage in operating earnings year to date is massive for what is characterized in the condensed financial statements as "other business."

Pretax earnings contracted from $1.56 billion to $322 million. 

Meantime, Berkshire's insurance properties moved in disparate directions.

General Re did better, but Geico's numbers were halved, and other reinsurance properties lost money.

Reinvestment and derivative gains/losses, pretax earnings in total declined from $6.6 billion to $5.1 billion for the first half of 2009.

Jim Oberweis bought Baidu.com @ $80 in 2006, and said it was still a buy at $115 this year. It's at $330 now. 

The question is whether this earnings shortfall, largely cyclical in nature, is worth grumbling about.

I always regarded Buffett's love for his operating properties and their managers as a personal conceit that goes back to the good ol' days 40 years ago when he'd discover properties selling below net worth or even liquidating value.

Berkshire Hathaway is the name of the textile mills he owned and later liquidated as obsolescent, needing enormous capital investment to remain competitive. 

The Kings of Wall Street have long coveted the absolute supremacy they now enjoy over the largest economy in the world.

The debt is a problem, but vast change is necessary throughout the banking sys....

The issue today is more a balance sheet item.

There is almost $34 billion in goodwill on Berkshire's balance sheet.

Only time will tell whether these purchased businesses will snap back and validate Buffett's template of owning properties with consistent earnings, good returns on equity and able managers.

Future write-downs of goodwill remain an open question. 

Stepping back from the operating properties, the semi-annual earnings shortfall of even $1.5 billion doesn't make or break this story stock or diminish Buffett's "value added" to Berkshire going forward. His timely intervention during the financial panic as a lender of next-to-last resort already is bearing fruit. 

After all, how many honchos can out-negotiate Goldman Sachs ( GS - news - people ) in acquiring a 10% yielding preferred stock block for $5 billion with warrants till 2013 for 43.5 million shares exercisable at $115? Already, the unrealized gain is north of $2 billion. 

Similarly, Buffett bought from GE ( GE - news - people ) a $3 billion block of 10% preferred with warrants good for 134.8 million shares of common stock exercisable at $22.25 a share.

GE trades near $14 but the warrants run through 2013.

Peons like me held their breath (and nose) and waded into the Goldman Sachs common stock and publicly traded preferreds of Bank of America ( BAC - news - people ) and JPMorgan Chase ( JPM - news - people ) when nobody wanted them.

Morgan's preferred touched down at $14.40 and Bank of America at $5.40.

There were no warrants attached to these positions, just residual fear of default.

Currently, both preferreds trade near par and yield just under 8%.

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Money managers are called by disparaging nouns and adjectives when they've disappointed--perhaps even buried--their loyal clientele

. Madoff, of course, was a greedy psychopath who had it coming.

Decades ago, when I ran with a fast crowd and managed a hedge fund, they called me a gunslinger.

My partner put down on his passport application that he was a professional speculator, which pegged him perfectly. He emerged from the bean pit in the Chicago Board of Trade with his shirt on. 

The Sage of Omaha, complimentary as it sounds, doesn't fully describe Warren Buffett.

Yes, in the '50s and '60s, he devoured financial manuals and annual reports, searching for undervalued properties, sometimes going for control with a coterie of friendly operators.

Buffett was and is a value investor in the purest sense. His properties had to be well-managed with position on the board.

The franchise!

The franchise!

Whether it was newspapers, broadcasting, soft drinks, manufactured homes, even credit cards, banks, toothpaste or razor blades, his investments rarely disappointed. 

Many of these decades-ago successes have grown long in the tooth. This list embraces Coca-Cola ( KO - news - people ), Procter and Gamble ( PG - news - people ), Kraft Foods ( KFT - news - people ), Johnson & Johnson ( JNJ - news - people ), even American Express ( AXP - news - people ).

Buffett can't afford to sell much of his inventory because the capital gains taxes at the corporate level are prohibitive. Only recent multibillion-dollar mistakes like ConocoPhillips can be banged out and charged off. Berkshire's $36 billion portfolio carried $15.5 billion in unrealized gains at midyear. 

You don't want to own Berkshire Hathaway for its equity portfolio or even for its portfolio of operating companies.

Buffett goes to great lengths to extol them, all puffed up like the Wizard of Oz, working his levers and generating smoke.

Beneath the surface, Buffett has become a macro investor, and that's where he is moving around big blocks of capital.

I'm sure there's more to come.

Berkshire Hathaway's insurance float grows by billions per annum as Geico is an aggressive marketer, annually adding new policy holders.

Additionally, there's still $21.4 billion in cash on the balance sheet and borrowings approaching $15 billion. Berkshire may have lost its Triple A credit rating, which puzzles me as a subjective call by the credit rating agencies.

But even AA gets you gobs of low-cost capital in our yield-starved bond market. 

Unless you're in the trenches managing money, few investors or observers comprehend how much courage it takes to stand alone when there's panic in the streets.

This is what I give Buffett full credit for.

Decades ago, he waded into Geico and American Express, understanding that their basic franchise was intact when they were floundering in red ink.

During the fourth quarter of last year, Buffett took major positions in the preferred stock of GE and Goldman Sachs when you easily could configure a scenario where they might crumble into dust like Lehman Brothers ( LEHMQ - news - people ).

Berkshire's total investment came to $8 billion for this then bedraggled pair.

Later came a near $3 billion investment in a Swiss Re 12% convertible issue and a $3 billion preferred stock commitment in Dow Chemical ( DOW - news - people ) struggling to fulfill its contract to buy Rohm and Haas ( ROH - news - people ). 

Another $6.6 billion was put into Wrigley ( WWY - news - people ) in the form of 11.45% subordinated paper. Six billion here, $3 billion there, all of a sudden we're talking over $20 billion moving around the board, over half the value of the entire equity portfolio. 

Berkshire also has sold long maturity equity put options for a sizable premium to insurance companies involved with annuities. Seldom remarked, there's a major bond portfolio of $35 billion which unlike MetLife ( MET - news - people ) and Allstate ( ALL - news - people ) wasn't caught up in shaky commercial real estate or sustained portfolio bond defaults and credit downgrades.

Fair value rests above amortized cost, including $11 billion in foreign government paper.

The updated résumé depicts Buffett as a major player in macro investing, making big decisions on currencies, world financial markets and the viability of major corporations under maximum stress.

This ain't day-to-day stock picking or overweighting or underweighting sectors of the market like energy or technology, which is what I'm confined to.

We should love Buffett not for NetJets, Geico and his Buffalo newspaper or even for his equity portfolio of Coca-Cola and Wells Fargo ( WFC - news - people ), but for his capacity to move around multibillion-dollar blocks of money that carry inherent high rates of return with prudent risk tolerance.

Without turning to necrolatry, this is Buffett's subconscious legacy to his shareholders. 

I leave open the issue of Berkshire Hathaway as a stock.

Book value at midyear, according to the company, was $73,806, while the market price ticks near $100,000. Shareholders during the past five years are holding even, but the stock peaked near $150,000 late in 2007 along with everything else, inclusive of collectibles and real estate. 

When Warren goes to the great chocolate factory in the sky, take something off whatever you think Berkshire is worth. I see it at book value. 

I don't care how many sealed envelopes rest in his corporate safe. Buffett ain't replaceable.