Is It Safe? Berkshire Gets Maligned

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Berkshire Hathaway(BRK/A Quote) has long been a stock market anomaly.

Berkshire's A-shares gained 2,021% from 1991 through 2007, outperforming the S&P 500 index by a remarkable 1,507%. This year, Berkshire's stock has fallen 2.7%, about the same as the U.S. benchmark. Investors and analysts are questioning once-infallible Chief Executive Warren Buffett.

Accusations of hypocrisy may be valid, considering Buffett's admonishment of derivatives while Berkshire has its own derivatives book of more than 250 contracts, in addition to the holding company's curious investments in Goldman Sachs(GS Quote), American Express(AXP Quote) and US Bancorp(USB Quote) during a meltdown that originated in the financial industry, in part, because of derivatives.

These appear to be significant contradictions in Berkshire's investing style and errors in Buffett's judgment. But further consideration reveals a rationale, and the long-term benefits will most likely outweigh short-term dips.

Berkshire's derivative contracts aren't nearly as complex or convoluted as those that have been destroying once-impressive financial organizations from the inside.

Most of Berkshire's contracts are so-called equity put options on world equity indexes that the firm sold. The shortest contract won't expire for another 10 years. Berkshire would only lose money if the markets are lower at expiration than at origination. If that was the case and 10-plus years from now equity markets are lower than at origination, there would be bigger problems to worry about than a potential loss for Berkshire Hathaway.