"Risk comes from not knowing what you're doing." -- Warren BuffettSince February, the shares of Berkshire Hathaway ( BRK.A) have consistently fallen. And despite the recent market rally, the company's common shares hit a new 2008 low yesterday.
"You can observe a lot by just watching." -- Yogi BerraI believe the principle reason is Warren Buffet's investment style drift, which was reflected in a large derivative loss in first quarter 2008. Let me explain. As a dedicated short seller I often take a variant view of a company's prospects through logic of argument and analytical dissection, mocking conventional wisdom and the associated popularity surrounding certain investments that, in my view, created an unwarranted degree of optimism in the marketplace. Indeed, some of my best investment shorts -- including Ron Perlman's Marvel Entertainment ( MRVL) in the early 1990s, after which it filed bankruptcy; America Online, coincident with its 2001 acquisition of Time Warner ( TWX); homebuilding companies, a favorite of the momentum crowd in 2004; or private mortgage and credit insurers in 2006 -- initially triggered ridicule by many market participants as my targeted stock market icons (and shorts) were typically seen as Teflon. If one reads some of the great investment books that chronicles legendary traders/investors successes -- such as Jack Schwager's Market Wizards: Interviews with Top Traders -- there is common thread to the successes of Soros Fund Management's George Soros, Duquesne's Stanley Druckenmiller, Fidelity's Peter Lynch, Capital Growth Management's Ken Heebner, Omega Advisors' Leon Cooperman, SAC's Steve Cohen and Steinhardt Partners' Michael Steinhardt: They consistently stick to their knitting and avoid style drift. Not surprisingly, when I initially explained the rationale behind shorting Berkshire Hathaway in March 2008, I received a lot of criticism, particularly from some of my hedge fund heavyweight friends who I respect immensely. Frankly, it was hard for me to write that piece as I have worshipped at the altar of Warren Buffett over the years.
Nevertheless, I stood by my analysis and initiated a short, and I even shorted more Berkshire several weeks later. The night before Buffett's Woodstock of Capitalism, Berkshire Hathaway reported horrible first-quarter 2008 results, weighed down by derivative losses and disappointing results in the company's insurance operations. There was little coverage of Berkshire's weak first-quarter performance, though Citigroup's research analyst downgraded the stock a week or so later, as it occurred on the eve of the company's Annual Meeting (and pilgrimage to Omaha) -- a much ballyhooed event, which was covered widely by most business news networks.
"Even Napoleon had his Watergate." -- Yogi BerraThere was even less coverage of Buffett's recent foray into derivatives. Berkshire's exposure to derivatives increased by $16 billion, to $40 billion, in the last year.
"Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." -- Warren BuffettOver the past five years, Buffett frequently called derivatives "financial weapons of mass destruction", comparing derivates to "hell...easy to enter and almost impossible to exit." Yet, he has, very much out of character, immersed himself in a large and, thus far, unprofitable derivative transaction. His investment successes have not been in speculating in the market (something he has been critical of) but rather by purchasing easily understandable companies with dependable cash flows that sometimes seem imperiled by an exogenous event and are available on the cheap. It immediately occurred to me after gazing at Buffett's style drift (manifested in Berkshire Hathaway's large first quarter derivate losses) that he might be increasingly viewed as the New Millennium's Ben Franklin, a man who wrote "early to bed and early to rise" but spent many of his evenings in France, whoring all night and showing up to work after noon (to the massive frustration of John Adams). I concluded that Warren Buffett was getting a free pass and had drifted away from an investment process that had rewarded both him and Berkshire's shareholders so dramatically over the years.
"He hits from both sides of the plate. He's amphibious." -- Yogi BerraI also recently highlighted why I thought that Buffett was not only a great investor but, in recent years, he had become an even better marketer, with the benefit of his image accruing to Berkshire. For example, he has cultivated an image of someone who started with nothing, even though he was the son of a well-to-do stockbroker who became a U.S. Congressman. Everyone thinks of him as America's Business Grandpa, but remember, he grabbed control of a textile firm and promised not to change anything. He did make changes, though, eventually using the textile company's cash flow for acquisitions, shutting down the factory over time. In essence, Buffett has sold himself as a savior, or investor of last (or often first!) resort. As such, he has positioned himself to prosper in the form of getting beneficial terms in acquisitions, a positive but still a "marketing" technique. As an example, Berkshire contributed over $4 billion of subordinated debt in the recent Mars deal. But what didn't get much press -- and it should have! -- was that on top of the debt, Berkshire invested over $2 billion of equity in the Wrigley ( WWY)/Mars transaction at a "discount" to the price that Mars eventually will pay for Wrigley's common shares. I am staying short Berkshire Hathaway.
"The future isn't what it used to be." -- Yogi BerraEnough said. TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com. Doug Kass is the author of The Edge, a blog on RealMoney Silver that features real-time shorting opportunities on the market.