Berkshire Hathaway 2001 Annual Report Download - page 16

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We made few changes in our portfolio during 2001. As a group, our larger holdings have performed
poorly in the last few years, some because of disappointing operating results. Charlie and I still like the basic
businesses of all the companies we own. But we do not believe Berkshires equity holdings as a group are
undervalued.
Our restrained enthusiasm for these securities is matched by decidedly lukewarm feelings about the
prospects for stocks in general over the next decade or so. I expressed my views about equity returns in a speech I
gave at an Allen and Company meeting in July (which was a follow-up to a similar presentation I had made two
years earlier) and an edited version of my comments appeared in a December 10th Fortune article. Im enclosing a
copy of that article. You can also view the Fortune version of my 1999 talk at our website
www.berkshirehathaway.com.
Charlie and I believe that American business will do fine over time but think that todays equity prices
presage only moderate returns for investors. The market outperformed business for a very long period, and that
phenomenon had to end. A market that no more than parallels business progress, however, is likely to leave many
investors disappointed, particularly those relatively new to the game.
Heres one for those who enjoy an odd coincidence: The Great Bubble ended on March 10, 2000 (though
we didnt realize that fact until some months later). On that day, the NASDAQ (recently 1,731) hit its all-time high
of 5,132. That same day, Berkshire shares traded at $40,800, their lowest price since mid-1997.
* * * * * * * * * * * *
During 2001, we were somewhat more active than usual in junk bonds. These are not, we should
emphasize, suitable investments for the general public, because too often these securities live up to their name. We
have never purchased a newly-issued junk bond, which is the only kind most investors are urged to buy. When
losses occur in this field, furthermore, they are often disastrous: Many issues end up at a small fraction of their
original offering price and some become entirely worthless.
Despite these dangers, we periodically find a few  a very few  junk securities that are interesting to us.
And, so far, our 50-year experience in distressed debt has proven rewarding. In our 1984 annual report, we
described our purchases of Washington Public Power System bonds when that issuer fell into disrepute. Weve
also, over the years, stepped into other apparent calamities such as Chrysler Financial, Texaco and RJR Nabisco 
all of which returned to grace. Still, if we stay active in junk bonds, you can expect us to have losses from time to
time.
Occasionally, a purchase of distressed bonds leads us into something bigger. Early in the Fruit of the
Loom bankruptcy, we purchased the companys public and bank debt at about 50% of face value. This was an
unusual bankruptcy in that interest payments on senior debt were continued without interruption, which meant we
earned about a 15% current return. Our holdings grew to 10% of Fruits senior debt, which will probably end up
returning us about 70% of face value. Through this investment, we indirectly reduced our purchase price for the
whole company by a small amount.
In late 2000, we began purchasing the obligations of FINOVA Group, a troubled finance company, and
that, too, led to our making a major transaction. FINOVA then had about $11 billion of debt outstanding, of which
we purchased 13% at about two-thirds of face value. We expected the company to go into bankruptcy, but believed
that liquidation of its assets would produce a payoff for creditors that would be well above our cost. As default
loomed in early 2001, we joined forces with Leucadia National Corporation to present the company with a
prepackaged plan for bankruptcy.
The plan as subsequently modified (and Im simplifying here) provided that creditors would be paid 70%
of face value (along with full interest) and that they would receive a newly-issued 7½% note for the 30% of their
claims not satisfied by cash. To fund FINOVAs 70% distribution, Leucadia and Berkshire formed a jointly-owned
entity  mellifluently christened Berkadia  that borrowed $5.6 billion through FleetBoston and, in turn, re-lent this
sum to FINOVA, concurrently obtaining a priority claim on its assets. Berkshire guaranteed 90% of the Berkadia
borrowing and also has a secondary guarantee on the 10% for which Leucadia has primary responsibility. (Did I
mention that I am simplifying?).