Billionaire Warren Buffett, in his annual letter to shareholders, sternly urged companies to develop harsh penalties for executives who get into trouble with risky investments.
Buffett's Berkshire Hathaway Inc. delivered a 61 percent jump in net income because the value of its investments and derivatives rose sharply in 2009 after taking a beating the year before. But its businesses' exposure to housing construction helped keep it from outperforming the S&P 500 for the first time since 2004.
Buffett used most of his letter, released Saturday, to reiterate the business basics that have made his company a juggernaut. But it did include a section about how corporations should manage risk. Buffett said CEOs and the boards that hired them should pay a steep price if their companies get into trouble with risky investments.
Buffett lamented that shareholders, not CEOs and directors, have borne most of the burden of company failures during the economic crisis.
"In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control," Buffett wrote. "If he's incapable of handling that job, he should look for other employment. And if he fails at it — with the government thereupon required to step in with funds or guarantees — the financial consequences for him and his board should be severe."
Buffett told his shareholders he takes responsibility for the risks Berkshire takes. He also has 98 percent of his net worth tied up in Berkshire stock, so he takes a personal hit if the company has trouble.
Berkshire's derivative contracts helped deliver a largely unrealized $787 million gain in investments in 2009 after a $7.5 billion loss recorded in 2008.
Most of Berkshire's derivatives operate similar to insurance policies. Some of them cover whether certain stock market indexes will be lower 15 or 20 years in the future. Others cover credit losses at groups of 100 companies, and some cover credit risks of individual companies.
That investment gain helped Berkshire post net income of $8.055 billion, or $5,193 per Class A share, for 2009. That's up 61 percent from last year's $4.994 billion, or $3,224 per share, and better than analysts expected.
Revenue rose 4.4 percent to $112.5 billion in 2009.
But Buffett also acknowledged mistakes in the past year, including letting debt and losses at fractional jet ownership unit NetJets grow for too long, and suggesting a credit card through the Geico insurance unit that turned into a fiasco that had to be sold for a $50 million pretax loss.
Buffett devoted much of his letter to educating new shareholders about the company. Berkshire added about 65,000 shareholders in February as part of its $26.7 billion acquisition of railroad operator Burlington Northern Santa Fe Corp. So those new investors may not be familiar with Buffett's hands-off approach to managing its roughly 80 subsidiaries.
Berkshire's holdings include clothing, furniture and jewelry businesses, but its insurance and utility businesses typically account for more than half of the company's revenue. It also has major investments in companies such as Coca-Cola Co. and Wells Fargo & Co.
Analyst Justin Fuller said over the last two years Buffett appears to be using his annual letter to talk mostly about Berkshire while using interviews and media commentaries to weigh in on other issues.
"They've really transitioned away from using the letter to pontificate on things," said Fuller, who writes online at www.buffettologist.com.
Much of the reason for the increase in profit in 2009 had to do with the value of Berkshire's investments and derivative contracts, some of which are worth more when certain stock indexes are up. While Berkshire's annual profit exceeded what analysts expected, the company fell short of the growth posted by the Standard & Poor's 500 index, which is Buffett's preferred measure of performance.
Buffett said Berkshire's book value — assets minus liabilities — grew 19.8 percent to $84,487 in 2009. The S&P 500, which Berkshire recently joined, gained 26.5 percent last year when dividends are factored in.
Three analysts surveyed by Thomson Reuters had estimated that Berkshire's book value per share at the end of 2009 would be $83,391.44. They had expected full-year earnings per share of $4,712.47.
Buffett said he would love to add to Berkshire's collection of companies that deliver high returns without much new investment, like See's Candies, but the railroad and utility acquisitions made sense because they offer good uses for Berkshire's cash.
"If our expectations are met — and we believe that they will be — Berkshire's ever-growing collection of good to great businesses should produce above-average, though certainly not spectacular, returns in the decades ahead," Buffett said.
Berkshire's utility division, which includes MidAmerican and PacifiCorp, added $1.07 billion net income during 2009, down from $1.7 billion in 2008 because the recession led to lower demand for electricity. Burlington Northern's results will be added to the utility unit in future quarters.
Berkshire's manufacturing, retail and service businesses suffered because of the recession last year, and many of those businesses, such as Acme Brick and Shaw Carpet, are tied to construction. That business unit contributed $1.1 billion net income to Berkshire in 2009, less than half the $2.3 billion profit it generated the previous year.
That division includes NetJets, which lost $711 million in 2009. Buffett said he failed shareholders by letting the problems at NetJets continue so long, but now he's been bailed out by MidAmerican Chairman David Sokol, who took over NetJets.
Buffett said Sokol has made NetJets solidly profitable, partly by laying off 500 pilots and delaying an expansion of NetJets' Columbus, Ohio, headquarters.
Andy Kilpatrick, the stockbroker-author of "Of Permanent Value, the Story of Warren Buffett," said he thinks Berkshire's businesses are primed to rebound.
"If the economy turns a little bit, he's going to be a huge beneficiary," Kilpatrick said.
Berkshire finished the year with $30.6 billion in cash on hand, although it has since used about $8 billion of that to acquire Burlington Northern. The company's cash is down 31 percent from the $44.3 billion it held at the end of 2008 because it made a number of investments.
"It's been an ideal period for investors: a climate of fear is their best friend," Buffett wrote.