Warren Buffett has some explaining to do.

Berkshire Hathaway Inc , his insurance and investment company, is in the midst of one of its worst stretches since Buffett took over the company in 1965.

Berkshire's shares have lost close to half their value since December 2007. Investment losses have piled up as stock markets tumble. And tens of billions of dollars are at risk on derivative contracts that depend on stocks rising. For now, they are not.

All this makes Buffett's annual letter to Berkshire shareholders, to be released on Saturday, one of the most eagerly awaited in the career of the 78-year-old billionaire, the second-richest American according to Forbes magazine.

It will be interesting to see if Buffett himself has learned lessons he might not have learned in his long career, said Bill Bergman, a senior equity analyst at Morningstar Inc and former economist at the Federal Reserve Bank of Chicago.

Buffett is likely to expound on the global economic turmoil and the foibles -- or worse -- of the copiously paid bankers, hedge fund managers and traders who helped create it.

He may also toss in a few loopy asides, such as his 2005 applause for second-in-command Charlie Munger's latent expertise in women's intimate apparel. Munger was 81 at the time; he is 85 now. Berkshire owns Fruit of the Loom.

But investors will also look for signs that Berkshire is primed for a turnaround, whether under Buffett or under his as-yet unnamed successors to become the Omaha, Nebraska company's chief executive and chief investment officer.

I hope to hear him say that financial services has fundamentally changed, and may require him to adjust his belief in holding on to assets from that sector, said Michael Yoshikami, president of YCMNet Advisors in Walnut Creek, California.

When you have an economic meltdown like this, Buffett will be negatively affected, as in the past.

The annual report will also include fourth-quarter results.

Two analysts who follow Berkshire expect, on average, a profit excluding investments of about $2.3 billion, or $1,486.50 per Class A share, down from $1,518 per share a year earlier, according to Reuters Estimates.

Buffett prefers to release the annual report and shareholder letter on Saturdays, when markets are closed and investors can digest his thoughts slowly and in peace.

A change in regulatory reporting deadlines led to midweek releases in 2007 and 2008. Last year's letter ran to 20 pages and more than 11,000 words.

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This year's report will include the fuller description that Buffett promised U.S. regulators he would provide about how Berkshire values its derivatives contracts.

Many involve put options that are tied to where the Standard & Poor's 500 <.SPX> and three other stock indexes are trading starting in 2019. Others assume that defaults on riskier junk bonds will stay in check between now and 2013.

Berkshire had $2.21 billion of pretax losses on the contracts from January to September 2008. It has said it could owe close to $48 billion in the far-fetched case that all stocks go to zero and all junk bonds default.

Buffett has said he intends to hold the contracts until they mature.

On top of this, Berkshire largely held on to its battered financial holdings, such as multi-billion-dollar stakes in American Express Co and Wells Fargo & Co .

Half of Berkshire's results come from insurance companies such as Geico Corp. And many of its roughly 70 other businesses are tied to the health of housing, such as Shaw carpeting and the Home Services of America real estate brokerage, or the overall economy, such as industrial firm Marmon Holdings Inc.

Berkshire got hit in four ways, Bergman said. Falling stock prices, the put options, increased economic sensitivity through subsidiaries such as Marmon, and a tough year for (insurance) catastrophe losses.

Still, Buffett is seeking value. Since September, he has spent $11.6 billion on securities yielding 10 percent or more from General Electric Co , Goldman Sachs Group Inc -- though attached warrants to buy common stock are out of the money -- and companies including Harley-Davidson Inc .

Berkshire teamed up on at least two of the investments with Chris Davis's money management firm Davis Selected Advisers LP.

Buffett looks like he was, at best, early when he announced in October that he was plowing all his personal investments other than Berkshire shares into U.S. stocks.

He has admitted error before. After 1999, a bad year for Berkshire, Buffett gave himself a D for capital allocation.

Buffett is one of the few CEOs who is candid rather than marketing-oriented in his letters, Yoshikami said.

He admits when he is wrong. You don't get that candor from other CEOs. That's why his credibility is so high.

(Editing by Ted Kerr)

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