"It’s often useful in testing a theory to push it to extremes."

[value-is-what-you-get]

From the annual report Warren says "It’s often useful in testing a theory to push it to extremes." 

 

This is under the section describing the Black-Scholes model's shortcomings in valuing long-term expirations.  Inspired by this, I thought it would be a fun exercise to push the Derivative case to the extreme.

 

The general theory in the market is that Warren made a mistake with derivatives - drank the Kool-Aid as it were.

 

From the Income Statement, the stated Derivatives losses were 6.821B.  (mark-to-market - no actual cash paid out, simply a required accounting entry)  Somewhere above that is approx 4.5B in revenue recorded for the premium received.  Net loss for period on derivatives is 2.321B for income tax and reporting purposes.  Actual cash cost is -4.5B ->premium received.  Looks like the short-term voting machine wins that round.

 

Now pushing this to the extreme, suppose Warren had really swung for the fences and sold 47 of these (assuming buyers were available of course). 

 

The Mark-to-Market liability would wipe out stated shareholder equity and our company would be worthless according to the stock market.  The net loss for the period would be in the order of 300B and the headlines would scream and the stock price would plunge!

 

And yet we'd have all the existing operating companies, divisions, talent, stock positions, plus an additional 211.5B in CASH premiums to invest in underpriced stocks.  It's just a question of whether or not the American version of the capitalist system will survive which determines any ACTUAL liability due in 15-20 years time. 

 

The numbers win - Mr. Market is wrong once again!