03/08/2011 11:30 am ET Updated May 25, 2011

Buffett Admits Berkshire's "Bountiful Years Will Never Return"

Somebody should give him a medal.
In his latest annual letter to Berkshire Hathaway shareholders, Warren Buffett concedes, despite a lifetime of achieving superior investment returns, that Berkshire's "bountiful years will never return."

In his commendable straight-forward manner Buffett assertsthat Berkshire's 46 year record against the S&P (was) a performance quite good in the earlier years and now only satisfactory. The bountiful years, we want to emphasize, will never return. The huge sums of capital we currently manage eliminate any chance of exceptional performance. We will strive, however, for better-than-average results and feel it fair for you to hold us to that standard."

"Looking forward," Buffett went on, we hope to average several points better han the S&P-though the result is, of course, far from a sure thing. If we succeed in that aim, we will almost certainly produce better relative results in bad years for the stock market and suffer poorer results in satrong markets."

The challenge to the nation's greatest investment genius has become more difficult; "to increase per-share intrinsic value at a rate greater than the increase (including dividends) of the S&P 500."

The quandry is made clear; Buffett wants to make another major acquisition like Burlington; but he also needs to increase capital expenditures to $8 billion this year, and retain considerable cash in the billions to protect against insurance claims. And he needs to cash in his gains on Goldman Sachs and General Electric. How he re-employs this bounty is crucial.

The record is exemplary; in every 5 year period since 1965, when I was a Goldman Sachs risk arbitrageur, and Buffett a 35 year old client, The Oracle has beaten the living daylights out of the S&P 500. Take the tough times of the past half decade; Berkshire book value rose a compound annual rate of 10%== versus a miserly 2.3% for the S&P 500. Amazing, huh?

Often, Buffett gives his shareholders a guideline to figure out if current market is above or lower than today's opening price of $127,500 a share. A careful reading of the master's shareholder 2011 letter suggests to me that the intrinsic value of Berkshire could possibly be higher. He tells us that the "intrinsic value" of many businesses is far greater than what the assets are carried at on the balance sheet.

Point of order: You could have bought Berkshire A at $97,205 in the 1st quarter of 2010, and be sitting on a handsome 30% gain . Whenever pessimism reigns, Berkshire always surprises on the upside.

The strongest clue to me is the relish with which Buffett goes on about GEICO, which has been steadily increasing its market share of automobile insurance, and is now employing the synergy from offering home insurance. Brilliant!

Buffett tells us that GEICO's premium volume id $14.3 billion and growing." Yet, this goodwill is carried at only $1.4 billion on Berkshire's books- 10 cents on the dollar. The obvious conclusion; the intrinsic value of GEICO, as a going concern, is a great multiple of the amount it is carried on the books- and will continue to climb by said multiple.

Another hint; Don't underestimate the value of Berkshire's float of $66 billion- the secret weapon of free capital, by which Berkshire profits in every year natural disasters do not cost it a fortune. Float makes fortunes.

I was impressed too by his math on the value of dividend paying stocks. Berkshire has received the bounty of $376 million in Coca-Cola dividends since 1995. Buffett expects this $376 to double again over the next 10 years. As Coke is yielding just under 3% today, this would imply that to sell at the same 3% yield means Coke will be double its current market price. As Buffett says; "I wouldn't be surprised to see our share of Coke's annual earnings exceed 10

Berkshire's home construction businesses made only $362 million pre-tax in 2010== about 25% of their peak earnings in 2006. Hmmm! Seemed like a hint of better times to come, eventually. Buffett has been busy adding on lines of business and expanding his operations in housing. Contrary thinking at work. Pay attention.

Another distinction between the Buffett-Munger school of management and the rest of American business. Berkshire's directors are not provided liability insurance by Berkshire to use as a defensive shield in the case of lawsuits. They must purchase it for themselves, if they so wish. Okay, I admit; many of them are bloody wealthy.