For Warren Buffett, 2003 was business as usual: new acquisitions, steady growth and an increase in low-cost float that looks to fuel Berkshire Hathaway's (BRKa:NYSE) growth well into the next decade.

In one of the most awaited investment treatises of the year, Buffett's annual letter to shareholders -- released on his Web site Saturday morning -- the Oracle of Omaha touted the power, and limits, of his cash position. At the same time, he detailed Berkshire's performance in 2003.

According to Buffett, Berkshire's net worth grew by $13.6 billion, increasing the per-share value of Berkshire stock by 21%. While that performance is impressive, Buffett notes the results failed to eclipse those of the S&P 500, which posted a total return of 28.7% in the same period. However, he does note that over the last 39 years, Berkshire's book value has posted a compounded annual return of 22.2%, which more than doubles the closely followed equity benchmark's 10.4% annualized total return.

He notes how significant the benchmark is in measuring his value to Berkshire shareholders. "Berkshire's long-term performance versus the S&P remains all-important," Buffett writes in the early paragraphs of this year's missives. "Our shareholders can buy the S&P through an index fund at very low cost. Unless we achieve gains in per-share intrinsic value in the future that outdo the S&Ps performance, Charlie and I will be adding nothing to what you can accomplish on your own."

Yes, but investors are flocking to the Berkshire Hathaway site today not to determine Buffett's relative financial value, but rather his value as the Oracle of Omaha, the chief executive that large and small investors turn to the first Saturday in March for his views on the markets, corporate ethics and even kernels of wisdom about life.

For many, the first Saturday in March is their chance to get an MBA from Professor Buffett.

Quietly Agnostic

While Buffett is typically concise and calculated in his comment about the value of the broad equity markets, this year's letter was absent of all but brief references to common stocks, and most of those came during his discussion of the Berkshire public equity portfolio.

Buffett notes that not only valuation, but also Berkshire's size, has dampened his enthusiasm for stocks as an outlet for Berkshire's burgeoning capital.

"In recent years, however, we've found it hard to find significantly undervalued stocks, a difficulty greatly accentuated by the mushrooming of funds we must deploy," Buffett writes. "Today, the number of stocks that can be purchased in large enough quantities to move the performance needle at Berkshire is a small fraction of the number that existed a decade ago."

However, that didn't stop him from reporting two new positions, HCA Inc. and PetroChina. Earlier disclosures suggest Buffett has been acquiring stakes in both companies for some time, but the positions appear in the annual letter for the first time this year because they have reached the $500 million market value cut-off that Buffett sets in disclosing individual equity positions.

The annual report also suggests that Berkshire modestly trimmed its stake in H&R Block and added to its already sizeable position in Wells Fargo. Overall, however, Berkshire's equity portfolio remained fairly stagnant, a hallmark of Buffett investing.

"We bought some Wells Fargo shares last year," Buffett notes. "Otherwise, among our six largest holdings, we last changed our position in Coca-Cola in 1994, American Express in 1998, Gillette in 1989, Washington Post in 1973 and Moody's in 2000. Brokers don't love us."

In his only clue about the equity markets, Buffett appears agnostic, at least with respect to the stocks he owns.

"We are neither enthusiastic nor negative about the portfolio we hold," the Oracle writes. "We own pieces of excellent businesses -- all of which had good gains in intrinsic value last year -- but their current prices reflect their excellence."

And, in retrospect, Buffett suggests his negative view of the late-1990s bubble euphoria should have translated into action in his own portfolio.

"The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble," he notes, sounding almost like a market-timing sage. "If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I."

The value of Berkshire's investment portfolio increased by more than $4.1 billion in 2003, including a gain of $448 million in its common equity book. However, that pales in comparison to the nearly $1.5 billion in growth in the U.S. government portfolio, over $1.1 billion appreciation in his junk bond portfolio and $825 million from foreign exchange, a relatively new investment for Buffett.

"During 2002 we entered the foreign currency market for the first time in my life, and in 2003 we enlarged our position as I became increasingly bearish on the dollar," Buffett writes. Buffett argues that the U.S. trade deficit and foreign claims to U.S. commerce are troublesome. And, with Berkshire's escalating cash position , he feels compelled to hedge at least a portion of the company's exposure to the U.S. dollar.

"As an American, I hope there is a benign ending to this problem," Buffett said. "But, Berkshire holds many billions of cash-equivalents denominated in dollars. So I feel more comfortable owning foreign-exchange contracts that are at least a partial offset to that position."

Buffett's huge gains in the junk market began with nearly $8 billion in high-yield purchases in 2002. However, Buffett notes the junk market is now "decidedly unattractive" to Berkshire. "Yesterday's weeds are today being priced as flowers," he opines.

To round out the Berkshire portfolio, Buffett notes the company continues to significantly utilize the U.S. Treasury market, both Treasury Bills and repurchase agreements. While he acknowledges rates are unattractive, Berkshire seems content to "reach" for additional income by extending the portfolio maturity.

That strategy, as the Oracle notes, is illustrative of Berkshire's risk tolerance.

"Charlie and I detest taking even small risks unless we feel we are being adequately compensated for doing so," Buffett quips. "About as far as we will go down that path is to occasionally eat cottage cheese a day after the expiration date on the carton."

Building Businesses

If the tone and content of this year's letter from Buffett to his faithful represents one tenet above others, it is the ongoing transition of Berkshire Hathaway from "Warren Buffett's mutual fund" to a holding company overseeing the allocation of capital to scores of businesses, from insurance and energy to bricks and carpet. Compared to letters of recent years, Buffett spends a disproportionate amount of time talking about the operations of Berkshire's various operating companies, including insurers General Re and GEICO, power and pipeline company Mid American Energy and Acme Brick, Shaw Carpets and Clayton Homes in a full range of consumer businesses.

And while Buffett may still love to play the public markets, he is well aware of his need to focus on large acquisitions that will make a difference to a much larger Berkshire's bottom line.

"We will continue the capital allocation process we have used in the past," Buffett writes. "If stocks become significantly cheaper than entire businesses, we will buy them aggressively. If selected bonds become attractive, as they did in 2002, we will again load up on these securities. Under any market or economic conditions, we will be happy to buy businesses that meet our standards. And, for those that do, the bigger the better. Our capital is underutilized now, but that will happen periodically. It's a painful condition to be in -- but not as painful as doing something stupid. I speak from experience."

In the operating highlights, Buffett seems most proud that the troubles at General Re, the re-insurance business Buffett called Berkshire's "400-pound child."

"General Re had been Berkshire's problem child in the years following our acquisition of it in 1998," Buffett admits. "That's behind us: General Re is fixed."

General Re's reinvention combined with solid performance of the other insurance subsidiaries led Berkshire's float from its insurance subsidiaries -- in simple terms, the amount of premiums not paid out in claims and available for investment -- to increase 7% to over $44 billion. Moreover, Berkshire's underwriting profits of $1.7 billion meant Berkshire was "paid" to hold the float.

Mid-American Energy continues to grow, largely through opportunistic pipeline investments from distressed energy merchants in the past two years. In addition, Buffett expects the Public Utilities Holding Company Act, or PUHCA, to be repealed in the coming years, potentially making other energy investments more attractive for Berkshire.

While Buffett continues to talk up Berkshire's purchase of manufactured housing firm Clayton Homes he admits the industry is "awash in problems." Ironically, Clayton Homes is acquiring the assets of bankrupt Oakwood Homes, a company in which Berkshire was a debt holder. Completion of the purchase should make Berkshire's debt holdings whole.

Fund Follies

Continuing a thread from his 2002 letter, Buffett assailed the lack of independence on mutual fund governing boards. Many believe Buffett's comments and subsequent conversations with those in the business gave rise to the plethora of investigations in the past year. Buffet believes it is a problem of colossal size.

"I am on my soapbox now only because the blatant wrongdoing that has occurred has betrayed the trust of so many millions of shareholders," he opines. "Hundreds of industry insiders had to know what was going on. Yet none publicly said a word."

He poses a rather simple solution for fund companies to ponder.

"Let me make a small suggestion to 'independent' mutual fund directors," Buffett writes. "Why not simply affirm in each annual report that (1) We have looked at other management companies and believe the one we have retained for the upcoming year is among the better operations in the field; and (2) we have negotiated a fee with our managers comparable to what other clients with equivalent funds would negotiate."

Buffett argues that would be very simple and go a long way in restoring confidence for the individual investor. Conversely, those who refuse provide fair warning to investors.

"If directors are unwilling to make these two declarations, shareholders should heed the maxim, 'If your don't know whose side someone is one, he's probably not on yours."


Buffett always has his share of quips and quotes on wide ranging topics. Here's a sampling:

On Berkshire governance: "True independence -- meaning the willingness to challenge a forceful CEO when something is wrong or foolish -- is an enormously valuable trait in a director. It is also rare. The place to look for it is among high-grade people whose interests are in line with those of rank-and-file shareholders -- and are in line in a very big way. We've made that search at Berkshire. We now have eleven directors and each of them, combined with members of their families, owns more than $4 million of Berkshire stock. Moreover, all have held major stakes in Berkshire for many years. In the case of six of the eleven, family ownership amounts to at least hundreds of millions and dates back at least three decades. All eleven directors purchased their holdings in the market just as you did; we've never passed out options or restricted shares. Charlie and I love such honest-to-God ownership. After all, who ever washes a rental car?"

On the tradition boardroom: "Despite the lapdog behavior of independent fund directors, we did not conclude that they are bad people. They're not. But sadly, 'boardroom atmosphere' almost invariably sedates their fiduciary genes."

On Berkshire and taxes: After a U.S. Treasury official suggested Buffett and Berkshire "has played the tax code like a fiddle," Buffett felt compelled to use this year's letter to respond.

"Alas, my 'fiddle playing' will not get me to Carnegie Hall -- or even to a high school recital. Berkshire, on your behalf and mine, will send the Treasury $3.3 billion for tax on its 2003 income, a sum equaling 2.5% of the total income tax paid by all U.S. corporations in fiscal 2003. Our payment will almost certainly place us among our country's top ten taxpayers. Indeed, if only 540 taxpayers paid the amount Berkshire will pay, no other individual or corporation would have to pay anything to Uncle Sam."

And, finally, he made it clear he has been a long-time customer of the Internal Revenue Service.

"I do wish, however, that Ms. Olson the U.S. Treasury staff member would give me some credit for the progress I've already made. In 1944, I filed my first 1040, reporting my income as a thirteen-year-old newspaper carrier. The return covered three pages. After I claimed the appropriate business deductions, such as $35 for a bicycle, my tax bill was $7. I sent my check to the Treasury and it -- without comment -- promptly cashed it. We lived in peace."

At time of publication, Edmonds had no positions in any stocks mentioned, although holdings can change at any time.

Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

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