CHICAGO (MarketWatch) -- Following Berkshire Hathaway Inc.'s worst year on record, Chairman Warren Buffett told shareholders Saturday that the economy would remain in "shambles" during 2009 and beyond, offering no prediction about the future may hold for U.S. stocks.

In his annual letter to shareholders -- eagerly anticipated by investors for the insights it may hold into his thinking -- Buffett said neither he nor Charlie Munger, his long-time partner in running Omaha-based Berkshire BRK.B, -1.45% BRK.A, -1.30% , can predict winning and losing years in advance -- and no one else can either.

"We're certain, for example, that the economy will be in shambles throughout 2009 -- and, for that matter, probably well beyond -- but that conclusion does not tell us whether the stock market will rise or fall," Buffett wrote.

Buffett, known as the "Oracle of Omaha," admitted to mistakes last year. "During 2008 I did some dumb things in investments," he said. One such error, he said, was the purchase of a large amount of Conoco Phillips Inc. COP, -3.70% stock when oil and gas prices were nearing peak levels.

"I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year," he said. "I still believe the odds are good that oil sells far higher in the future than the current $40-to-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars."

Buffett also said his acquisition of shares in two Irish banks have turned out badly -- with losses of more than 89%.

On the positive side, the investor is pleased with buys totaling $14.5 million in fixed-income securities issued by General Electric Co. GE, -1.29% , Goldman Sachs Group GS, -1.14% and William Wrigley Co. "We very much like these commitments, which carry high current yields that, in themselves, make the investments more than satisfactory. But in each of these three purchases, we also acquired a substantial equity participation as a bonus."

The per-share book value of both Class A and Class B shares of Berkshire fell 9.6%, Buffett said.

The company's net income fell to $4.99 billion from $13.21 billion in 2007.

The 78-year-old billionaire said that although the market value of bonds and stocks the company still holds have dropped dramatically along with the broader market, Berkshire is not bothered by those decreases. "Indeed, we enjoy such price declines if we have funds available to increase our positions. ... Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."

On the lookout for inflation

“ 'Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown. Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.' ” — Warren Buffett

Commenting on the federal government's actions to resolve the economic crisis, Buffett said: "Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects."

Inflation is likely to be one such effect, Buffett said.

"Moreover, major industries have become dependent on federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won't leave willingly."

However, said Buffett, the U.S. government did need to take "strong and immediate action" to avoid a "total breakdown" of the economy.

With regard to the subprime mortgage crisis, Buffett said lenders and buyers have to get back to a basic equation. "The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower's income. That income should be carefully verified."

He pointed out that the U.S. has overcome much worse obstacles in the past. "Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America's best days lie ahead."

With sizable interests in many of the largest publicly held U.S. corporations, Berkshire's book value was likely hit by the falling price of investments in banks and other financial-services companies including Well Fargo & Co. WFC, -2.35% , American Express Co. AXP, -1.08% , U.S. Bancorp USB, -1.06% and M&T Bank Corp. MTB, -3.28%

Those stocks dropped 34% on average during the fourth quarter. Such losses aren't realized, so they won't affect Berkshire's quarterly earnings.

However, Buffett prefers to be judged on Berkshire's book value, which measures the company's assets minus liabilities. Gary Ransom, an analyst at Fox-Pitt Kelton, expected the company's book value to decline by 8% in the fourth quarter.

"He's really getting hit because he has a lot of credit-sensitive businesses," said Jeff Auxier, manager of the Auxier Focus Fund, who owns Berkshire shares.

Berkshire's Class A shares have dropped 44% in the past year and hit a 5 1/2-year low of $73,500 earlier this week. The Class B shares carry 1/30th the economic value of the Class A shares.

The last time Berkshire stock slumped to multiyear lows was about nine yeard ago, when Buffett was famously scorned for missing out on the dot-com boom. He shunned technology stocks in the late 1990s, missing out on huge gains, but when the sector crashed from 2000 through 2002, Berkshire shares almost doubled, vindicating the investor.

However, as the housing and credit markets boomed later on in the decade, Berkshire's stakes in financial-services companies like American Express and Wells Fargo remained large, even as he warned that the bubble might burst. See full story.

"He's the best out there, but it's amazing to see how Berkshire was so concentrated in financials," Auxier said.

'Too fast'

Berkshire waded further into the financial sector during the fourth quarter ,when Buffett bought $5 billion in the preferred stock of investment bank Goldman Sachs.

He also invested $3 billion in preferred shares issued by GE, which has a large, struggling financial-services unit called GE Capital. Blue chip GE announced a sizable dividend cut on its common shares on Friday. See full story.

The deals came with warrants that give Berkshire the right to buy 43.5 million Goldman shares at $115 each and 134.8 million shares of GE at $22.25 each. These contracts expire in October 2013.

Both Goldman and GE shares currently trade below these levels, battered by the financial crisis. Specifically, Goldman dropped 27% since Buffett's investment in the firm was announced Sept. 23, while GE plunged fully 65% since Berkshire unveiled its investment in the industrial conglomerate on Oct. 1.

“ 'He dove in too fast and probably wishes he had waited a few months. ... No one, not even Buffett, can call the bottom.' ” — Mark Sellers, Sellers Capital

Soon after, Buffett wrote in a New York Times editorial that he'd been buying U.S. stocks for his personal account and recommended that other long-term investors do so too.

Since that Oct. 17 article, the S&P 500 Index SPX, -0.48% has slumped 22%.

"He dove in too fast and probably wishes he had waited a few months," said Mark Sellers, managing partner of hedge fund Sellers Capital LLC. "He hoarded cash for years, waiting, waiting, and then used a lot of it very quickly. No one, not even Buffett, can call the bottom."

Indeed, Buffett was clear in his Oct. 17 editorial that he can't predict the short-term movements of the stock market and has no idea whether stocks will be higher a year from now. However, he stressed that "major" U.S. companies will be generating record profits in five to 20 years' time.

Buying some protection

Many of Buffett's recent investments also have been made further up the capital structure of companies, giving him more protection, commented Sellers.

Preferred shares are senior to common stock and also pay large dividends. Goldman and GE are paying Berkshire 10% a year in dividends for five years.

Berkshire also recently invested in bonds issued by companies including Tiffany & Co. TIF, -0.22% and Harley-Davidson Inc. HOG, -1.25% These securities pay 10% to 15% a year, according to Justin Fuller, editor of Web site Buffettologist.com and a partner at Midway Capital Research & Management LLC.

"These investments offer equity-like returns but are higher up the capital structure,"

he said. "It's a no brainer."