Warren Buffett's Berkshire Hathaway Inc posted its best quarter in nearly two years, as recovering stock markets boosted the value of its equity investments and derivatives bets.

Operating earnings for the second quarter nevertheless fell short of forecasts, reflecting lower underwriting gains, including from the Geico Corp auto insurance unit, and the impact of the recession on Berkshire's more economically sensitive manufacturing and service units.

Warren hasn't been able to defy the laws of gravity, said Thomas Russo, a partner at Gardner Russo & Gardner in Lancaster, Pennsylvania, which invests more than $3 billion and owns Berkshire shares. Berkshire's operating companies are not trying to compromise their long-term results. They are taking the hits that come with an economic contraction.

Net income for Omaha, Nebraska-based Berkshire rose 14 percent to $3.3 billion, or $2,123 per Class A share, from $2.88 billion, or $1,859, a year earlier. Earnings had previously fallen for six straight quarters.

Excluding investments, operating profit fell 22 percent to $1.78 billion, or $1,147 per share, from $2.27 billion, or $1,465. On that basis, analysts expected profit of $1,238 per share, according to Reuters Estimates. Revenue fell 2 percent to $29.61 billion.

Berkshire has close to 80 operating units that provide such products as insurance, carpeting, electricity and natural gas, ice cream, paint and underwear.

Results included $1.53 billion of derivatives gains. These were tied mainly to the performance of four market indexes in the United States, Europe and Japan, which rose between 8 percent and 23 percent in the quarter.

The derivatives are a major reason earnings had fallen in recent quarters. Accounting rules require Berkshire to report changes in their value with earnings. Berkshire said the bets will continue to generate extreme volatility in earnings.

Book value increased 11 percent from the first quarter and on a per-share basis rose to $73,806 from $66,248. Net income was the highest since the third quarter of 2007 and came on the heels of a first-quarter loss, Berkshire's first quarterly deficit since 2001, Reuters data show.


Berkshire's common stock holdings increased 22 percent from the first quarter to $45.79 billion, reflecting price changes as well the purchase of $350 million of stock.

The company is the largest shareholder of American Express Co and Wells Fargo & Co, whose shares rose a respective 71 percent and 70 percent in the quarter.

Berkshire also ended June with $30.37 billion of other investments, including in Dow Chemical Co, General Electric Co, Goldman Sachs Group Inc, Swiss Re and Wm Wrigley Jr Co.

Buffett has become something of a white-knight investor in the financial crisis. Berkshire ended June with $24.51 billion in cash, down from $25.55 billion at the end of March.

The magnitude of the investments he has been able to make is because of his past discipline, and his credibility, Russo said. He had to weather a lot of criticism for not making the easy and early bets, but waiting for the big fat pitch.

Berkshire did sell some stock, and said its sales of oil company ConocoPhillips shares continued in July.

While Berkshire on June 30 had $8.23 billion of paper losses on the stock index derivatives, that was down from $10.19 billion at the end of March.

Berkshire said it modified six of the derivative contracts during the quarter, reducing potential losses.

These derivative contracts now mature between 2018 and 2028, and Buffett has said he expects them to be profitable.

Meanwhile, liabilities on contracts tied to the default rates on junk bonds fell to $2.51 billion from $3.67 billion. Buffett has said these contracts may lose money.


While insurance investment income rose 31 percent to $1.16 billion, underwriting profit fell 77 percent to $83 million.

Berkshire said the decline came in part because customers of Geico had higher claims losses, and the weak economy caused them to raise deductibles and reduce coverage to save money.

Though premiums increased, Berkshire now expects underwriting gains at Geico to fall in 2009 from 2008.

Operating profit in noninsurance businesses fell 47 percent to $574 million, despite a 22 percent increase from utilities and energy operations.

Profit fell by two-thirds in manufacturing, servicing and retailing businesses such as industrial conglomerate Marmon Holdings, the carpet maker Shaw, and several jewelry and home furnishings businesses.

Berkshire said each manufacturing business has taken actions to reduce costs, slow production and reduce or delay capital spending until the economy improves.

The NetJets Inc unit, which provides private jet services to executives, lost $253 million before taxes.

Its longtime chief executive Richard Santulli stepped down this week and was replaced by David Sokol, who chairs Berkshire's MidAmerican Energy unit. Many analysts view Sokol a potential successor to Buffett as Berkshire's chief executive.

In Friday trading, Berkshire Class A shares closed up $1,150, or 1.1 percent, at $108,100, while its Class B shares rose $22.69, or 0.65 percent, to $3,540. Both remain more than one-fourth below their record highs set in December 2007.

(Reporting by Jonathan Stempel and Lilla Zuill; editing by Carol Bishopric and Andre Grenon)