Buffett has profitable year, faults housing excess

NEW YORK (Reuters) - Warren Buffett concluded a highly profitable year for his Berkshire Hathaway Inc (BRKa.N) (BRKb.N) with an admonition for lenders who fueled the housing crisis and words of caution that Berkshire's own results might be less stellar than in 2007.

Despite an 18 percent fall in fourth-quarter profit, net income for all of 2007 rose 20 percent to $13.21 billion.

The late-year weakness stemmed from weaker results in insurance, Berkshire's main business, and in units linked to housing, including businesses that make bricks and carpet, and that offer real estate brokerage services.

Despite spending $32.51 billion on stocks and bonds in 2007, Buffett went another year without the big acquisition he said he wants, leaving Berkshire sitting on $44.33 billion of cash. Some investors say the current environment of beaten-down stocks and sluggish capital markets offers the 77-year-old Buffett plenty of opportunities.

"He's kept this war chest of cash, rather painfully, for a decade, waiting for the opportunity he has now," said Glenn Tongue, who oversees $140 million of hedge fund capital at T2 Partners LLC in New York, including a stake in Berkshire.

"History demonstrates that his patience results in extraordinarily attractive opportunities for Berkshire."

In his widely read, 20-page annual letter to shareholders, Buffett said "the party is over" in insurance, where margins are tightening after Berkshire was for a time able to boost premiums after Hurricane Katrina in 2005.

He said insurance earnings will likely be lower for a few years. Insurance often generates about half of Berkshire's profits.

Buffett said he is looking to invest more outside the United States, after paying $4 billion for a controlling stake in Israel's Iscar Metalworking Cos and buying stock of South Korean steelmaker Posco (005490.KS), French drugmaker Sanofi-Aventis SA (SASY.PA) and British retailer Tesco Plc

(TSCO.L).

He also invests in such multinational companies as Coca-Cola Co (KO.N) and Procter & Gamble Co (PG.N).

CRITICISM OF INFLATED EARNINGS

Buffett plans to still focus mainly on U.S. investments, despite the country's "many imperfections and unrelenting problems." That includes housing, where Buffett ladled blame on lenders who weakened their underwriting standards in the false belief that housing prices would go up and keep going up.

"Today, our country is experiencing widespread pain because of that erroneous belief," Buffett wrote. "As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out -- and what we are witnessing at some of our largest financial institutions is an ugly sight."

Buffett has transformed Berkshire since 1965 into a $216 billion conglomerate by acquiring out-of-favor companies with strong earnings and management, and investing in stocks. The company has 76 operating businesses that make such things as ice cream, paint and underwear.

In December, Buffett moved to diversify further by creating his own insurer to guarantee municipal bonds, at a time other bond insurers are suffering from exposure to risky debt. He did not discuss that venture in his shareholder letter.

"Few Berkshire companies can look forward to dramatic earnings growth in this environment," said Frank Betz, a principal at Carret/Zane Capital Management LLP in Warren, New Jersey, which owns Berkshire stock. "These can be overcome as the subprime crisis fades and insurance rates start to rise."

"Even if he doesn't keep earning $13 billion a year," Betz added, "it's reasonable he might earn $11 billion."

In his letter, Buffett reserved other criticism for companies that assume their pension funds can return 8 percent a year, even in an era of low interest rates. That return, he said, was the average assumption of 363 companies in the Standard & Poor's 500 .SPX that have pension plans.

"What is no puzzle, however, is why CEOs opt for a high investment assumption: It lets them report higher earnings," Buffett wrote. "And if they are wrong, as I believe they are, the chickens won't come home to roost until long after they retire."

Buffett also confirmed Berkshire still has three internal candidates to eventually succeed him as chief executive, and four candidates to replace him as chief investment officer.

(Edited by Eric Beech and Philip Barbara)