Last Saturday marked the official release of one of 2008's best business courses - Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) annual shareholder letter. The education is free, as the shareholder letter became available on the company's website, but the year proved costly for shareholders as class A shares fell some 30% to end the year at $96,600. However, Berkshire Hathaway's shares did exceed the market's return, which fell 37% during the calendar year.
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As followers of Buffett know, he doesn't judge success or failure by short-term share price fluctuations; this is a good thing seeing as Berkshire shares are already down another 20% in 2009, roughly matching the market's year-to-date fall. Berkshire's yardsticks, which Buffett laid out on page five of this year's letter, include its sizable investment portfolio, which ended the year at a value of $122 billion. Nearly half of this amount, $58.5 billion, is funded by an insurance float that Buffett characterizes as "money that doesn't belong to us but that we hold and invest for our own benefit" - meaning it's invested until it is paid out as an insurance claim. In 2008, the investment portfolio reported a full-year 14% drop in value, from $90,343 per Berkshire share to $77,793. (For further reading, see Think Like Warren Buffett.)
The second yardstick consists of Berkshire's 67 non-insurance companies, which don't include investing or insurance. This portfolio of companies reported a modest 4% drop in pretax earnings from $4,093 per Berkshire share to $3,921, because its retailing and residential construction businesses were hit particularly hard. Still, this level of performance is enviable, as was the 9.6% drop in Berkshire's overall book value per share. Remarkably, this drop in book value is the worst performance in Berkshire's history, followed by 2001's book value drop of 6.2%.
Still Defined by Its Insurance Operations.
In terms of relative performance, 2008 represented one of Berkshire's top 10 performance years, as they outperformed the S&P500 by 27.4% with results going back to 1965. The company is still primarily an insurance operation, which Buffett characterized as "an economic powerhouse," that delivered yet another annual underwriting gain. The insurance operations contain two reinsurance businesses - General Re and BH Reinsurance, which provide insurance to other insurers and compete with the likes of Ace Limited (NYSE:ACE) and XL Capital (NYSE:XL). The other primary operation is auto insurer GEICO, which now counts itself as the third largest auto insurer behind State Farm and Allstate (NYSE:ALL), and has grown market share nearly four-fold to 7.7% since 1993.
Much to Learn from the Other Units
Berkshire's manufacturing, service and retailing operations posted a slight 3% decrease in net income to $2.3 billion. However, like many firms, conditions deteriorated significantly in the fourth quarter and Buffett predicts pretty grim prospects for 2009. Still, the group earned 17.9% on average tangible net worth, which is a clear indication of the quality companies that Buffett owns. This is an enviable return and demonstrates that earnings capacity has hardly been impaired, though growth in earnings will take some time to recover.
Berkshire's non-insurance group is still representative of Berkshire overall - it's a group that Buffet claims "retains strong earning power even under today's conditions and will continue to deliver significant cash to the parent company." This group will use this cash to acquire and invest in other firms with appealing business models, which is in contrast to how "many competitors were trading water (or sinking) as 2008 came to a close."
In other words, Berkshire's book value growth was a far cry from the 20.3% annual growth it has experienced over more than four decades of operations, but it still bested most of the competition during a period of freefall in business activity that is among the worst Buffett has ever seen. However you measure it, there is much for investing students to learn in each installment of Berkshire's shareholder letters regarding how to manage businesses through thick and thin. (For more, see Warren Buffett: The Road To Riches and Warren Buffett: How He Does It .)