Berkshire May Post ‘Blockbuster’ Results by Buffett’s Measure

By Erik Holm

Aug. 6 (Bloomberg) -- Berkshire Hathaway Inc., with a stock portfolio valued at more than $60 billion, may report its best quarter in at least two years using the metric preferred by the firm’s billionaire chairman, Warren Buffett.

About $11 billion in gains in Berkshire’s stocks and a recovery of derivative bets tied to equity markets caused book value, a measure of assets minus liabilities, to reverse after two quarters of declines, according to analysts and investors including Glenn Tongue at T2 Partners LLC. Berkshire is set to report second-quarter results tomorrow.

“It’s going to be a blockbuster,” said Tongue, whose New York-based firm’s largest holding is Berkshire shares. “It may well be the greatest dollar gain in book value in any quarter in the history of the company. Warren Buffett showed extraordinary discipline in the first quarter when all others were losing their heads.”

Buffett, one of the world’s most celebrated stock pickers, this year confessed to investing mistakes that hurt returns over the prior 12 months. Berkshire’s book value per share, the measure highlighted by Buffett in the first sentence of his annual letter to shareholders, has declined in four of the past five quarters, and 2008 marked only the second time since Buffett took over in 1965 that it dropped for a full year.

In his “owner’s manual” for Berkshire shareholders, Buffett says he considers the figure to be an objective substitute for the best measure of the Omaha, Nebraska-based firm’s success: a metric he calls intrinsic value.

Intrinsic Value

“Intrinsic value is an estimate rather than a precise figure,” Buffett wrote in the manual on Berkshire’s Web site. “The percentage change in book value in any given year is likely to be reasonably close to that year’s change in intrinsic value.”

The value of shares Berkshire reported holding as of March 31 increased 23 percent in the second quarter. Berkshire is the largest shareholder in American Express Co., whose stock rose 71 percent in the three months ending June 30. Buffett’s firm is also the biggest investor in Wells Fargo & Co., which jumped 70 percent, Goldman Sachs Group Inc., which rose 39 percent, and Burlington Northern Santa Fe Corp., up by 22 percent.

Buffett, 78, didn’t respond to a request for comment left with assistant Carrie Kizer. He doesn’t provide a number for intrinsic value in his annual reports or other communications with shareholders.

Berkshire’s book-value decline of 9.6 percent last year beat the 37 percent plunge of the Standard & Poor’s 500 Index, and the firm has outperformed the total return of the index in 38 of the 44 years Buffett has led the company, according to Berkshire’s own calculations. Under Buffett, Berkshire’s book value per share grew 362,319 percent through the end of last year, compared with 4,276 percent for the S&P, the firm said.

Markets Recover

The declines last year and in this year’s first quarter were fueled by drops in Berkshire’s own equity portfolio, and charges on derivatives tied to corporate defaults and stock indexes on three continents.

Since then, markets have reversed, helping both the equity derivatives and Berkshire’s own stock holdings. The gains in the existing stock portfolio, including warrants to buy shares of Goldman Sachs, and the reversal of losses for the equity contracts may have increased book value by 10 percent before results from operating units are factored in, Tongue said.

‘Remarkable Turnaround’

“Some of the stocks had a remarkable turnaround,” said Janet Tavakoli, author of “Dear Mr. Buffett” and founder of Chicago-based advisory firm Tavakoli Structured Finance. “Combine that with the equity puts going up, and this will be a very interesting quarter.”

Berkshire’s own stock rose 3.8 percent in New York Stock Exchange composite trading in the quarter. It reached $100,000 on Aug. 3, the highest since January. Berkshire’s record closing price is $149,200 on Dec. 10, 2007.

Berkshire’s equity puts -- the derivative contracts tied to stock markets -- were sold to undisclosed buyers for $4.9 billion, according to Buffett’s most recent letter to shareholders. Under the agreements, Berkshire must pay out if, on specific dates starting in 2019, four market indexes are below the point where they were when he made the deals. In the meantime, Berkshire can invest the cash and keep any profits.

The four indexes -- the S&P, the U.K.’s FTSE 100 Index, the Dow Jones Euro Stoxx 50 Index and Japan’s Nikkei 225 Stock Average -- would all have to fall to zero for Berkshire to be liable for the entire amount at risk. That figure was $35.5 billion as of March 31 and can move with currency valuations.

Derivative Liabilities

The $10.2 billion in liabilities on the derivatives, which pushed down book value in past quarters, will shrink after the indexes recovered in the second quarter, said Guy Spier, principal at New York-based hedge fund Aquamarine Funds LLC, which owns Berkshire shares. The liabilities are accounting losses, not cash that Berkshire has paid out.

“We’re going to have a huge reversal in the index puts -- just massive,” said Spier. “We can expect to see some substantial non-cash results.”

The S&P rose 15 percent in the quarter, while the Nikkei jumped 23 percent. The FTSE increased by 8.2 percent and the companies in the European Dow rose 16 percent.

Quarter   Book value   Change from
                      prior quarter

1q09      $102.8       -5.9%
4q08      $109.3       -9.1%
3q08      $120.2        1.8%
2q08      $118.0       -1.2%
1q08      $119.4       -1.1%
4q07      $120.7        0.7%
3q07      $119.9        4.0%
2q07      $115.3        4.9%
1q07      $109.9        1.4%

To contact the reporter on this story: Erik Holm in New York at eholm2@bloomberg.net.