By James K. Glassman

Sunday, March 22, 1998; Page H01

One week ago, Warren Buffett, the world's greatest investor, released his annual chairman's letter for Berkshire Hathaway Inc. Most of the reaction focused on his comment that the market was not overvalued. Whew! What a relief, thought America's investors, who promptly bid up the the Dow Jones industrial average every day last week -- for a total of more than 300 points.

Actually, if you read the letter www.berkshirehathaway.com, you find that Buffett is at least as ambiguous as Fed Chairman Alan Greenspan about the market's prospects. A year ago, Buffett writes, he and Charlie Munger (his mordant and cerebral sidekick) "stated that we did not consider the market overvalued if 1) interest rates remained where they were or fell, and 2) American business continued to earn the remarkable returns on equity that it had recorded." If these two conditions hold, he repeats, "there is no reason to think of stocks as generally overvalued."

But what are the chances that high returns on equity -- those sparkling profits of the past three years -- will continue? I myself am not too sanguine, and Buffett is not making a guess.

Also, if he does think the market is overvalued, why does he make this comment, earlier in the letter: "We are not pleased with our prospects for committing incoming funds. Prices are high for both businesses and stocks. That does not mean that the prices of either will fall -- we have absolutely no view on that matter."

"No view": This is the Buffett we know and love speaking. In his 1992 chairman's letter, he wrote that he has "long felt that the only value of stock forecasters is to make fortune tellers look good." According to this excellent philosophy, investors should ignore the market. ("As far as I am concerned," he once said, "the stock market doesn't exist. It is there only as a reference to see if anybody is offering to do anything foolish.") Yet he can't resist commenting on it.

But what Buffett does in the market is far more important than what he says about it. The diligent reader learns from the chairman's letter that "we made net sales during the year that amounted to about 5 percent of our beginning portfolio." So, even though Buffett doesn't think the market is overvalued, he's been a seller of stocks.

Instead, Buffett has been buying silver -- 111.2 million ounces of it, now worth about $600 million -- and zero-coupon U.S. Treasury bonds. His zeroes, at year-end, were worth $4.6 billion, for a pretax gain of $599 million. Buffett also noted another, smaller "nontraditional position" in derivative contracts for 14 million barrels of oil, worth about $200 million.

These don't seem typical investments for a man with a comfortable view of the stock market. Is he trying to make the rest of us optimistic so that he'll have more gullible buyers for stocks he wants to unload? He couldn't possibly be so sly. Or could he?

Buffett did make some purchases last year. But, before we get to them, it's important to understand the structure of Berkshire. It is a holding company that owns, rather than operates. Its portfolio includes both entire businesses and big chunks of stock in major corporations.

In the latter category, Berkshire owns 11 percent of American Express Co. (worth $4.8 billion at current prices), 8 percent of Coca-Cola Co. (worth $15 billion, his largest holding), 3 percent of Walt Disney Co. ($2.3 billion), 9 percent of mortgage-maker Freddie Mac ($2.9 billion), 9 percent of Gillette Co. ($5.6 billion), 17 percent of The Washington Post Co. ($800 million) and 8 percent of Wells Fargo & Co., the California-based bank ($2.2 billion).

Conspicuously absent from this year's list is McDonald's Corp. According to last year's letter, Berkshire owned 4.3 percent of the company, worth about $1.3 billion. Buffett also indicated that he sold shares of Freddie Mac, Disney and Wells Fargo.

The 1997 acquisitions came in the first category: wholly owned businesses, which include such wonderful firms as Geico Corp., See's Candy Shops Inc. (great chocolate lollipops!), the Buffalo News and Flight Safety International Inc., which trains pilots.

First, last year, Buffett bought Star Furniture Co., a family-owned Texas chain that's similar to two others in Berkshire's portfolio -- Nebraska Furniture Mart and R.C. Wiley. Next, he bought International Dairy Queen Inc., with more than 6,000 stores, mostly run by franchisees. "Charlie and I bring a modicum of product expertise to this transaction: He has been patronizing the Dairy Queens in Cass Lake and Bemidji, Minnesota, for decades, and I have been a regular in Omaha. We have put our money where our mouth is."

It is writing like this that makes Buffett's annual letter the best literature in investing. Ten years ago, for example, he wrote, "Gypsy Rose Lee announced on one of her later birthdays, 'I have everything that I had last year. It's just that it's all two inches lower.' As the table above shows, in 1987 almost all of our businesses aged in a more upbeat way." In 1991: "We continually search for large businesses with understandable, enduring and mouth-watering economics." In 1983, he quoted Lord Keynes: "The difficulty lies not in the new ideas but in escaping from the old ones."

In 1994: "We continue to ignore political and economic forecasts, which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508, or Treasury-bill yields fluctuating between 2.8 percent and 17.4 percent.

"But, surprise -- none of these blockbuster events made the slightest dent in Ben Graham's investment principles. Nor did they render unsound the . . . purchases of fine businesses at sensible prices."

As usual, this year's letter also teaches through metaphor. One of Buffett's best, which I first heard 15 years ago when he was a guest at a luncheon at -- of all places -- the New Republic magazine, concerns baseball. At the time, Buffett said that an investor is like a batter who can wait for his favorite pitch.

This year, he elaborates:

"We try to exert a Ted Williams kind of discipline. In his book, 'The Science of Hitting,' Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his 'best' cell, he knew, would allow him to bat .400; reaching for balls in his 'worst' spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors."

Buffett then writes, "If they are in the strike zone at all, the business 'pitches' we now see are just catching the lower outside corner. If we swing, we will be locked into low returns."

So Berkshire does not swing. "Unlike Ted, we can't be called out if we resist three pitches that are barely in the strike zone; nevertheless, just standing there, day after day, with my bat on my shoulder is not my idea of fun."

True. We all get impatient. But the key to investing is discipline. As Buffett's mentor, Benjamin Graham, wrote, "The investor's chief problem -- and even his worst enemy -- is likely to be himself." Or herself.

Insights like that make the Berkshire chairman's letter as valuable as the stock itself. A full set, going back to 1977, is on the Web site.

The price of Berkshire Hathaway continues to soar. It was trading Friday at $68,800 per share for the "A" version (up from $1,850 in 1985), or $2,304 in the more plebeian "B" class. Since the start of this year, it's up a whopping 51 percent, and it's up 91 percent since last March.

A lower-priced alternative to Berkshire is the Oak Value Fund (1-800-622-2474), whose philosophy, writes Dan Sullivan, editor of the Chartist newsletter and a big fan, "is based on the teachings of Benjamin Graham which were further developed by Warren Buffett."

With risk levels that are one-fourth below the market as a whole, Oak Value has returned an annual average of 35 percent over the past three years, compared with 25 percent for the Standard & Poor's 500-stock index (and 38 percent for Berkshire).

Berkshire itself is the seventh-largest holding in Oak Value's small ($140 million) portfolio; Disney is fifth and The Washington Post Co. fourth. Managers David Carr and George Brumley also own such Buffett-like stocks as RLI Corp., an insurer; R.P. Scherer Corp., time-release systems for drugs; Nike Inc.; publishers E.W. Scripps Co. and Pulitzer Publishing Co.; and ad firms Interpublic Group of Companies Inc. and True North Communications Inc.

A Berkshire-style holding company that I have cited favorably in the past is Leucadia National Corp., with interests ranging from auto insurance to Siberian oil. It may be a bit pricey, however, after rising 49 percent since the start of the year.

Perhaps the best Berkshire proxy is one you can't buy: the Sequoia Fund (1-800-686-6884), which has been closed to new investors for the past 16 years. Since 1993, it's whipped the S&P by 9 percentage points annually. Sequoia's top holding -- 26 percent of the fund -- is Berkshire, with Freddie Mac, at 16 percent, second.

The intriguing third-largest holding (14 percent of the portfolio) is Progressive Corp., an insurance company. Other Sequoia stocks include First Third Bancorp, U.S. Bancorp, Johnson & Johnson, Wallace Computer Services Inc. and Harley-Davidson Inc.

Whether the market is overvalued or not, these are some good stocks to ponder.