From the Chairman's Letter,

"In 2004 our float cost us less than nothing, and I told you that we had a chance—absent a mega-catastrophe—of no-cost float in 2005. But we had the mega-cat, and as a specialist in that coverage, Berkshire suffered hurricane losses of $3.4 billion. Nevertheless, our float was costless in 2005 because of the superb results we had in our other insurance activities, particularly at GEICO."

In other words they just went thought the worst hurricane season in history and still had an underwriting profit. How can that be bad?

"So guided, we've concluded that we should now write mega-cat policies only at prices far higher than prevailed last year - and then only with an aggregate exposure that would not cause us distress if shifts in some important variable produce far more costly storms in the near future."

Notice particularly the "far higher" in the above paragraph and dream a little about what will appear on Berkshire's bottom line if we have another year like 2002 and 2003 that were mega-cat free.

As far as the intellectual content of the chairman's letter, I found it to be one of the best, if not the best, of the 29 or so that I have read. Four things that I liked best are:

Few people on Wall Street, and apparently some of the resident heretics on this board, understand what a truly conservative animal Warren Buffett is. When he presents an annual report, he tells us all the bad news and lets us will figure out the good news for ourselves.

In order to demonstrate this point I would like to present Berkshire's 2005 earnings as they would have been presented if Fred Futile (the guy who hires Ratchet, Ratchet and Bingo to set up his option agreement) was the CEO.

First of all we have all of these one time charges, like hurricane losses and currency losses. Sure they are loses, but they do not happen every year so Fred would want to do a pro forma to show Wall Street what the numbers would have looked like if all those bad things had not happened.

(Earnings example: bad things)

Bad Things

Total one time Bad Things = $4.684 billion or 3.045 billion after tax

So with a little accounting magic we have transformed Berkshires Reported Earnings of $8,528 billion into a pro forma of $11.573 billion or $7,519.81 per share.

Berkshire's 2005 look-though earnings; this is the company's operating earnings plus their share of the undistributed earning of the companies whose common stock Berkshire owns.

I have added Diageo to the list even though the only support I have for this position is an article from the US News – a source which is not necessarily that reliable. They claim Berkshire filed a report with an insurance board showing a 15 million share holding of Diageo as of September 30, 2006. The problem is the article did not say what kind of shares. I am showing data for the ADR but after reading Buffett's letter, I would guess that if they own Diageo, they are holding the local (foreign) shares. From the letter:

"We reduced our direct position in currencies somewhat during 2005. We partially offset this change, however, by purchasing equities whose prices are denominated in a variety of foreign currencies and that earn a large part of their profits internationally. Charlie and I prefer this method of acquiring non-dollar exposure."

The annual report lists equity positions of $46.721 billion, whereas the total listed on the last 13f was $42.664 billion. The difference has to be stuff from the confidential list or securities that are not listed with SEC and are therefore not listed on the 13f. About $2 billion of this is Petrochina H shares which are foreign securities. But if we assume that WESCO, which is listed on the 13F, is not included in the equity total in the annual report because it 80% owned and is therefore consolidated into Berkshire's assets and liabilities, then we still have $4+ billion in equities that are missing and unaccounted for. My guess it that most of this is the foreign equities that Warren is talking about above.

Some of these may have been around for a while but Berkshire purchased $1.7 billion of equities in the fourth quarter. About $500 of that appeared on the latest 13f (mostly Wells Fargo) but the remaining $1.2 billion could be part of Warren's "nondollar exposure." Maybe this is more Diageo. Maybe it is some Korean steel. Who knows? This is something we are likely to find out only when Buffett decides to tell us.

Investment wise, last year was a good year, as Buffett managed to outspend his cash flow for the first time since 2002. Net equity investments totaled $6.4 billion, and acquisitions totaled $7.5 billion if you include PacifiCorp which will not close until this year.