Berkshire in-the-money on Goldman Sachs

Goldman Sachs posted better than expected results and the share price closed at $ 130.15. The warrants which Buffett purchased for Berkshire are again in the money and the 10% yield on the preferred stock looks heavenly.

Currently Goldman is clamouring to repay the TARP funds received from the US government in the past. Who wants to work under compensation restrictions after all? $ 500,000 (half a million) is hardly anything after all! However there seems to be a catch. The US government may not accept back the funds under the assumption that banks not paying back would be seen as weak.

Will Goldman pay off Berkshire instead? If it were to, Berkshire would make 15% on the preferred for around 6 month holding (including the 10% redemption premium). This would translate to a 30% annualised return. Plus Berkshire would have a free ride on $ 5 billion worth of Goldman stock at a price of $ 115 per share.

The rating agencies have got to be nuts to downgrade Berkshire.


  1. Hi rajeev, its nice article on waren buffet wisdom which snubs critics! I m great admirer of warren buffet but some times it irks me why legend like warren buffet criticize a lot derivatives and structure products but the balance sheet of his company berkshire had index puts and good amount of cdos . Can u explain this? Rakesh junjunwala again criticizes lot about derivative but he himself plays in nifty and other options. What this means ?

  2. Hi Randeep,

    A lot of people, including many in the media have this confusion as to why there is a difference between what Buffett says and what he does.

    Buffett himself has addressed this issue many a times. A para from his 2006 letter to shareholders is given below.

    “I should mention that all of the direct currency profits we have realized have come from forward
    contracts, which are derivatives, and that we have entered into other types of derivatives contracts as well.
    That may seem odd, since you know of our expensive experience in unwinding the derivatives book at Gen
    Re and also have heard me talk of the systemic problems that could result from the enormous growth in the
    use of derivatives. Why, you may wonder, are we fooling around with such potentially toxic material?
    The answer is that derivatives, just like stocks and bonds, are sometimes wildly mispriced. For
    many years, accordingly, we have selectively written derivative contracts – few in number but sometimes
    for large dollar amounts. We currently have 62 contracts outstanding. I manage them personally, and they
    are free of counterparty credit risk. So far, these derivative contracts have worked out well for us,
    producing pre-tax profits in the hundreds of millions of dollars (above and beyond the gains I’ve itemized
    from forward foreign-exchange contracts). Though we will experience losses from time to time, we are
    likely to continue to earn – overall – significant profits from mispriced derivatives.” End of quote

    His 2008 shareholder letter also talks about the put options that Berkshire has written.

    In general, the principles which Buffett uses for investing are the principles he uses for writing derivative contracts.

    1. He does not take a short term view of any market. The put options he has written are for periods of around 15 to 20 years.

    2. He writes the contracts only when he feels that there is mispricing in his favour.

    3. He knows his worst case scenario. Even if things go against him and he ends up with a loss, he makes sure that the effect on his overall results will be small.

    As for Mr. Rakesh Jhunjhunwala, I admire some of his long term investments like CRISIL. However I am not a great fan of his trading / speculative actitivites. (also applies to his friend and mentor Mr. Radhakrishna Damani).

    In any case not enough information is available on Mr. Jhunjunwala’s trading positions in derivatives, the extent of risk inherent in them and risk containment strategies and measures adopted by him.

    I hope this clarifies some of your doubts.

  3. Thanx mr rajeev thats very well written,now i want ur views on derivatives for retail investor,if some one wants to take long term view on index option say about 2011-12 wuld u recomend it .as said risk reward ratio is in favour of reward for long term investor so taking a long term call on index will it be gud for retail investor? Like nifty call option of 2011.I sincerly congratulate on ur article on ‘pl god one more bubble pls’.its really nice article and its shows ur grip on mkt behaviour

  4. Hi Randeep,

    Whether a long term call option is attractive or not depends on the ‘valuation’ of the call option. This is somewhat technical in nature and may require some reading on the subject. The factor which decide whether a call option is attractive or not is the ‘implied volatility’ of the call option. The inputs which go into calculating the implied volatility are the risk free interest rates prevailing in the market, the dividend yields, call option price, the strike price and the time to expiration of the call option.

    Some time back, long dated call options were trading at ZERO implied volatility. It means that you could get 100% of the market upside and zero downside by a combination of investing in bonds and buying the call option.

    Say you had Rs. 100, you could invest Rs. 75 in bonds and buy a call option with Rs. 25 with a 3 year expiry. In 3 years, Rs. 75 would grow to Rs. 100 and thus protect your principal. The call option would give you the full upside on Rs. 100 worth of equity.

    TODAY however interest rates are low. Hence you would have to keep a bigger proportion of your funds in debt and have little left for call options. Similarly implied volatility is high. Thus the valuations of call options are not attractive to the buyers of call options.

    In general however retail investors would do well to follow BUFFETT’S advice and stay away from derivatives.

  5. Rajeev / Randeep ,

    I think Buffett is an example of value investor + shrew business man (or capital allocator). I do not question his objective focus on total returns for this shareholder. However, individuals like us, including me, should really questioned on when we keeping harping buffett as a value investor or some kind of investing role model. Buffett of last 10 years very different that buffett of last 40 years. In last few years buffett has changed in approach and adapted to new realities. Read this nice piece as a reference.

  6. It is trending towards Japan-like status, but relatively slowly, to the point where we won’t get to where Japan is today for decades. And because Japan isn’t sitting still on this front, by the time we look like the Japan of today, the contemporary Japan will look a lot worse.

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