Warren Buffett’s Berkshire Hathaway Loses More Than $2 Billion On Derivative Bets

“Derivatives are financial weapons of mass destruction.”
– Warren Buffett

How many of you know safe weapons of mass destruction?

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Berkshire Hathaway Q3 profit falls on derivatives (Reuters, Nov. 4, 2011):

Warren Buffett’s conglomerate Berkshire Hathaway Inc reported a smaller third-quarter profit on Friday after losing more than $2 billion on derivatives related to stock market performance.

That was nearly three times what Berkshire lost on the same instruments a year ago. Buffett has sharply criticized derivatives in general, but has said these particular contracts were safe and would ultimately be lucrative.

But Berkshire was hurt, like many other insurance companies in particular, by sharp declines in a broad range of market values. In a quarterly report to the U.S. Securities and Exchange Commission, Berkshire said the indexes covered by the contracts fell anywhere from 11 percent to 23 percent in the quarter.

“It’s a noneconomic event,” said David Rolfe, chief investment officer of Wedgewood Partners, which has about $900 million under management and has held Berkshire shares for about 13 years. “Operating (was) in-line to terrific, the derivatives always need explaining.”

Berkshire reported a net profit of $2.28 billion, or $1,380 per Class A share, compared with a year-earlier profit of $2.99 billion, or $1,814 per share.

Cash at the end of the quarter was $34.78 billion, down from $47.89 billion at the end of June. During the third quarter Berkshire funded the purchase of chemical maker Lubrizol and a $5 billion investment in Bank of America Corp, which accounted for the decline.


Operating income rose across segments, except for the company’s finance business, where it fell slightly.

Profits in the insurance business rose as a rebound in reinsurance results offset sharp declines at auto insurer Geico. The reinsurance unit benefited from a reduction in liabilities related to a contract with one unnamed company, while Geico’s profits fell on higher catastrophe losses.

Earnings were also nearly 10 percent higher at Berkshire’s next-biggest unit, the Burlington Northern railroad, as revenue per car rose by double digits.

Berkshire’s MidAmerican Energy utility business saw earnings rise more than 10 percent as well. Profits rose sharply in the manufacturing, service and retailing group due to growth at the industrial businesses of the mini-conglomerate Marmon, offsetting ongoing weakness in housing-related units.

Last month, Buffett said he expected record profits this year for Burlington Northern, MidAmerican, manufacturer Iscar and for the Marmon companies.

But at the same time he said Berkshire’s housing-related businesses were doing as poorly as at any point during the financial crisis.

Book value rose to $96,876 per Class A share. Berkshire recently launched a share buyback program, its first ever, with an upper price limit set at 110 percent of book value.

That would suggest a ceiling of roughly $106,560, whereas Class A shares closed at $115,806 on Friday. Berkshire indicated it bought back about $18 million in stock during the third quarter.

“I think Buffett could have spent more on Cherry Coke than he did on shares,” said Wedgewood’s Rolfe, in a nod to the 81-year-old investor’s favorite beverage.

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