What Warren Buffett Is Buying and One Proposed Corporate Rule Change You Need to Know

Berkshire Hathaway (BRK.A -0.34%) (BRK.B -0.01%) saw quite a bit of buying and selling activity in the second quarter. Plus, President Donald Trump is looking into ending the quarterly reporting requirement for publicly traded companies.

In this episode of Industry Focus: Financials, host Shannon Jones and Motley Fool contributor Matt Frankel give listeners a rundown of these two news items.

A full transcript follows the video.

This video was recorded on Aug. 20, 2018.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. It's Monday, August the 20th. On today's Financials show, we're tracking what Warren Buffett's Berkshire Hathaway is buying and selling. Also, we'll dive into President Trump's ask of the SEC to study the possibility of moving away from quarterly company earnings reports to twice a year reporting. We'll dive into all of that and what it could mean for investors in this week's episode of Industry Focus: Financials.

Before we do, I'm your host, Shannon Jones, I'm joined in the studio via Skype with financials guru and certified financial planner, Matt Frankel. Matt, how's it going? 

Matt Frankel: Great! I'm trying out new headset for the first time. It's an exciting day over here.

Jones: That is very exciting! We are moving on up the chain here with this exciting technology, Matt. Glad to have you!

As promised, when we covered Berkshire's earnings a couple of weeks ago, we said we would come back to our listeners to talk about what exactly Berkshire and friends were buying and selling in the second quarter of this year. It's obviously something that investors always look forward to. This quarter, no exception. 

What we see, high-level, is, despite the aging bull market that's going on, Berkshire was definitely a net buyer and even went on a bank-buying bonanza. Matt, what can you tell us about what Berkshire is buying? 

Frankel: There were a few notable buys this quarter. Apple (NASDAQ: AAPL) is the big one, as has it has been for the past few quarters. Berkshire added about 5% to its Apple stake this quarter, which doesn't sound like a lot, but we're still talking about billions of dollars. The Apple stake is actually worth about $55 billion right now. This is by far their biggest stock investment. It keeps getting bigger. 

If comments from Warren Buffett and Charlie Munger are any indicator, it could continue to get bigger. They've both made comments that they would love to own more of Apple. Munger actually said they would love to own the whole thing if they could. Obviously, they can't. Berkshire still has over $100 billion of cash sitting on the sidelines. It's entirely possible that, if they still perceive Apple as a good value, the stake could continue to get bigger. 

Beyond that, there are two other big categories of investments Buffett made. He invested in three different bank stocks that they already owned. Buffett didn't buy anything new this quarter. He bought more US Bancorp and Bank of New York Mellon, both of which are considered some of the best-run, best-quality banks in the sector, and both of which have under-performed the market significantly over this year so far. Buffett also loaded up on Goldman Sachs, which is interesting, particularly, because he sold Goldman Sachs a few years ago, a little bit of his stake. Now it looks like he's seeing it as a good value again, since it's been one of the laggards of the sector. That was a Buffett stock that originated in the financial crisis, did really well in the few years after he acquired it, and now has come down a little bit. It looks like Buffett might be starting to build a position in that again.

And, airlines were the other big category that Buffett bought this quarter. Buffett made big headlines, a couple of years ago, about two years ago, when he bought stakes in all four of the major U.S. airlines -- Delta, American Airlines, United and Southwest. This quarter, Buffett added significantly to his Delta and Southwest stakes, over $500 million into each one. This is almost a 20% increase on each stake. There's been widespread speculation that Buffett's going to eventually buy and hold airlines, particularly Southwest. 

His method of investing in the airlines has a lot of parallels to when he invested in railroads a few years ago, and eventually acquired BNSF Railroad, which Berkshire still owns. There's been a lot of speculation. This is likely to only add fuel to that fire, especially since one of the two he added to was Southwest. Berkshire could easily afford to buy the portion of Southwest that they don't already own just with the cash they have in the bank. That's a very significant investment. 

In addition, Berkshire made a couple of smaller purchases. "Smaller," I mean in the $50 billion ballpark each. That's still small to Berkshire. General Motors is one that had a pretty bad second quarter. He could have just added to that as a value play. Teva Pharmaceuticals is another big one, the generic drug maker that he bought into a little while ago. It's still a relatively small position for Buffett. And, Liberty Global, he added a little bit to his investment.

The airlines, Apple, and the banks were the three big attention-grabbers of the quarter.

Jones: From an industry perspective, when we're thinking about it from a read through to everyday investors, you mentioned he loaded up quite a bit on a couple of airline stocks and on banks. Do you think, for average investors like us, now is a really good time to actually be buying into these industries? If so, why?

Frankel: Banks, I particularly like, not just because they're my specialty. They've been one of the worst performers of 2018, after really, really good performance over the past few years. If you pick and choose, in the way Buffett's doing, picking the ones who have underperformed even the poorly performing banking sector ... US Bancorp is, in my opinion, the best-run of the big banks, period. Goldman Sachs, I've written several times, I think, is one of the best values in the banking space, just because of their vast potential when it comes to commercial banking that they're just starting to scratch the surface of. I like that.

Apple's always a winner. I own it in my own portfolio. It's really, really tough to make a case against Apple as an investment, unless you might think it has gotten a little bit too expensive. And, airlines, I don't know if it's a great time to get into the sector, unless you're speculating on which one Buffett might take out. To be perfectly honest, airlines are a little bit outside of my wheelhouse, so I don't really want to give anyone definitive advice one way or the other on them.

Jones: Yeah, agreed. I think definitely, from the financials sector, you've got it underperforming the market so far in 2018. And then, too, we did an episode, maybe about three or four weeks ago, talking about big bank earnings. You've got really strong fundamentals with many of these major banks. So, to see them underperforming the market actually opens up a really awesome buying opportunity to get in on either new positions into some of these stocks, or really to load up on some of your current positions. I agree with you 100% on following into bank stocks and into that particular industry. 

Shifting gears a bit, had some notable opportunities to buy. Buffett also had some notable sells this quarter, as well. He closed out of a position and trimmed a few back. What exactly did he scale back on? 

Frankel: Well, first of all, it's important to note that Buffett was a net buyer of stocks. His buys totaled about $3 billion more than his sells. It still looks like he's positive on the market in general. The sell that stuck out the most to me was Phillips 66. This is a position that Buffett sold several billion dollars' worth of a couple of quarters ago. He made a point to say that the only reason he was getting rid of it was to keep his stake below 10% to avoid regulatory issues. And he made a point to say that he planned on holding the stock for the long-term. Well, fast forward to now. It looks like that might not be the case anymore, because Buffett unloaded $1.3 billion worth of Phillips 66, after he just recently said he planned to hold it for the long-term. I found that one particularly interesting. I wonder what changed there.

In addition to that, he sold about $200 million worth of Charter Communications. Still has a pretty substantial position. He sold some United Airlines and American Airlines, possibly to offset the increased stakes in Southwest and Delta. So, he's bought two airlines and sold the other two. 

He sold about $260 million worth of Wells Fargo (WFC -0.26%). Don't make the mistake of reading into that too much. Buffett did not sell Wells Fargo because he has any issue with a business. This is another issue where he wants to maintain a stake under 10% to be regulatory compliant. Berkshire owns about 9.3% of Wells Fargo right now. Buffett also owns some shares in his personal portfolio. To remain under the 10% threshold as Wells Fargo buys back some of its own stock, Buffett needs to sell some of Berkshire's shares to keep his stake proportionally low. This is a very small amount. Even though it says it's $260 million, it's less than 1% of Berkshire's Wells Fargo holdings. 

It's not because of the scandals or anything to do with the bank's business itself. Buffett has said time and time again that he believes in Wells Fargo. He recently said he thinks it's going to be the best of the big four banks over the next decade or so. This is not Buffett losing faith in Wells Fargo. It's simply a housekeeping matter to keep his stake under 10%. 

He did close out one position, Verisk. But that was a very small investment. I really don't see that as significant, in terms of what Buffett's buying and selling. It was less than $30 million, I believe, which in Berkshire terms is nothing.

Those are the big sales, just to run past them. Phillips 66, ticker symbol PSX, if you don't know. Charter Communications, CHTR. The two airlines, United and American Airlines, to offset the ones he bought, UIL and AAL. And Wells Fargo, but I don't really count that as a sale, it's just a technicality. Those are the big sales, that's a rundown of his big sales. 

Jones: I think you highlighted a big point, particularly when investors start following 13-F filings. Love to track Berkshire Hathaway. There are many other fund managers and portfolios, but when it comes to 13-F filings, it's important that an investor understands the why someone is trimming back a position. To your point, Matt, it may not necessarily be because of something happening with the business, per se. It may be really because they want to keep the position under a certain amount for regulatory reasons. And there may be a whole host of other reasons. It's really important to dig into the numbers and not just go after the headlines. 

Main takeaway this quarter for Berkshire Hathaway: despite an aging bull market, he is still a net buyer. We get questions all the time, "Is it still safe to buy with the market hitting new highs and continuing to go up?" For us here at The Motley Fool, again, we're long-term buy-and-hold investors. We look for opportunities to buy companies, especially when they're at a discount to dive in. We don't try to time the market. We don't try to say, "Don't buy stocks when the market is high." Look for good companies to invest in over the long term. That's exactly what you see Warren Buffett and Berkshire Hathaway doing. 

Alright, last Friday, President Trump tweeted, and I'll read it for our listeners who are catching up. Specifically, he said, "In speaking with some of the world's top business leaders, I asked what it is that would make business and jobs even better in the U.S. Stop quarterly reporting and go to a six-month system, said one. That would allow greater flexibility and save money. I have asked the SEC to study."

Alright, Matt, let's unpack this particular tweet. Just for our listeners catching up, currently, public companies are required to report earnings on a quarterly basis. But according to President Trump and others, this schedule may be less than ideal, some even calling it quarterly capitalism. Matt, tell us what this all really means, and what's really driving the desire for this change, too. 

Frankel: Quarterly reports came about in the Security Exchange Act of 1934, a response to the Great Depression. Everyone was concerned that investors weren't being well informed about what's going on in public companies. As an investor protection, companies are required to report every three months, just to kind of inform their potential investors, let them know what they're doing, to make better decisions.

The problem with that is, it's evolved to where it really encourages short-term thinking on the part of management teams. In other words, managers are often incentivized to perform to this quarter's numbers, especially when they're issuing quarterly guidance projections, which is a whole other issue. Managers are often incentivized compensation-wise, where the stock price is going to be at the end of this year, at the end of this quarter. They want to make the analysts' projections, so the stock doesn't plunge as a result of missing estimates. 

So, they make decisions based on what's best for the company over the next few months, rather than what's best for investors over the long-term. They might choose to cut down on their capital spending to make their earnings look better, whereas instead, they could spend more money if it's going to have a better long-term effect. The concern is that managers are making trade-offs that are good in the short-term but bad in the long-term, and that the long-term potential of American business would be so much better if they didn't have the requirement. That's the main idea behind this. 

President Trump's not alone. In addition to the business leaders he was talking to, we've heard from Warren Buffett, who says that quarterly projections are generally a bad thing because they encourage short-term thinking. Jamie Dimon, CEO of JPMorgan Chase. There have been several others. There have been studies done about this. I read one right before we recorded, a study from The Accounting Review, that said, outside of the U.S., a lot of places don't have these quarterly requirements. Companies that have annual reporting requirements instead of quarterly have, on average, 10% greater sales as a percentage of their assets, 3.5% higher sales growth a year, and 1.5% greater return on assets. There have been studies done that say that getting rid of quarterly reporting does incentivize companies to make better long-term decisions that pay off in the form of better sales, better returns. He's got a point there.

In addition, when he says it's costly and time consuming, he also has a point there. Quarterly reports are complex accounting documents. A lot of investors and a lot of analysts only read the earnings press release, which is usually a short form. But if you look at what's called the 10-Q, which is actually the quarterly report, these can be pretty lengthy documents. I just checked, Apple's recent quarterly report was 56 pages long, of a bunch of calculations and descriptions of their business. These are time consuming, lengthy processes that cost companies money, encourage short-term thinking, and just generally may not be in the best interest of long-term shareholders. That's where this debate came from. 

Now, whether a six-month calendar would be any better is anybody's guess. I don't know if it would make that big of a difference if reporting requirements were stretched out by three months. But there's definitely an argument to be made that quarterly reports are not in the best interest of long-term investors. 

Jones: Absolutely. The key here, and what's really driving it, just to reiterate, is that basically, many executives and business leaders think that the U.S. markets definitely have a very myopic view when it comes to company performance. I think it's hard to argue against that. When you have the short-term earnings targets that you're trying to meet, ultimately, and you really can't blame many of these executive teams for having to cut back on capital expenditures and really investing in the business. I think there's definitely a valid point there. Also, with the cost of compliance, like you mentioned. 

Another really interesting point is that, you do see increased volatility in the markets, especially around that first quarter of the year when people are gearing up for earnings season in Q1. There was actually another report out not too long ago that pointed out that the VIX, the volatility index that measures investor fear, actually tends to rise an average of about 5% right around that Q1 earnings timeframe. I think there's definitely a lot more volatility that comes into the mix when you are reporting on a more frequent basis. 

To your point, Matt, I think, whether that is every three months or every six months is kind of debatable. I think you're going to see increased volatility the more you actually push that out, especially if you're not giving more frequent updates in between. But we'll get to the disadvantages of the system in a second. 

As you pointed out, overseas, we do have other countries that have gone to this every six months schedule. You've got U.K., Australia, New Zealand, the European Union, even, with the six-month semi-annual schedule. There's also, too, an advantage to harmonize across the board and across the globe. 

With that being said, valid points on the desire to move toward this six-month schedule. But let's really unpack what this means for investors. There are some obvious disadvantages to going to the six-month system. Matt, let's start with the first one that everybody should probably already know or have guessed by this point, it really comes down to transparency.

Frankel: Yeah. Like I mentioned, the quarterly reports came out of the Security Exchange Act of 1934. The whole point of quarterly reports is to protect investors. So, it becomes a question, at what point are investors not getting enough information? And is there a way to go to a six month or even annual reporting schedule while keeping investors sufficiently informed?

There are several possible avenues this could take. We could go to annual reporting, but companies are required to disclose certain material events throughout the year that they're not required to disclose ordinarily. There are a couple of different ways they could take this. 

But the big drawback is, having access to all this information is what makes the markets fair and efficient, to some degree. It levels the playing field between Wall Street experts and the public by making this same information available to everybody. You don't need to be a detective, you don't need to analyze all the numbers yourself. The companies put out quarterly reports, you see all the numbers in black and white, and you can make your decisions just like everyone else on Wall Street can. 

It's definitely going to be an interesting debate, to see how they would deal with that issue. But it definitely is an issue of transparency, getting away from quarterly reports.

Jones: Exactly. You hit the nail on the head, it really comes down to investor protections at the end of the day. At least with a quarterly system in place, investors have more opportunities to not only just detect fraud or accounting irregularities, but really, too, if you think about it from an investor perspective, every quarter, you get a better sense of whether or not this company is staying the course. Are they growing favorably or, are they responding to changing market dynamics in the way that they should? Having that increased frequency of reporting really gives more information so that an investor can make an informed decision. 

Like I mentioned, too, I think when you begin to report less, obviously, there's a chance that companies could try to cook the books a little bit more in between those every-six-month reporting schedules. That's not to say that on a quarterly basis, companies don't do that already. But at least there's a little bit more of a safety net to be able to detect those things early. And then, too, I think you have to consider, right now with U.S. and our reporting standards and our regulatory framework, U.S. stocks actually are more attractive when it comes to investment opportunities, especially from international investors. That's because of the framework that we've built over the years. Because of fallout from time periods where we didn't have the regulatory scrutiny that we do now, I think for most, you can usually very easily look back and see time periods in our history as a country when regulatory standards began to back off or become laxer. It didn't necessarily incentivize the companies to actually give more reporting and be more transparent. I think that's one important consideration here.

I'm all about giving the average retail investors more transparency and more power at the end of the day. That really comes down to good corporate governance, too. To cap it all off, Matt, would you be in favor of moving from this quarterly earnings system to a semiannual or even maybe just an annual system?

Frankel: It definitely has its pros and cons. You mentioned earlier that earnings season right now, the VIX tends to spike, stocks tend to move up and down pretty big, if you went after quarterly earnings. Could you imagine if earnings were only released once a year, how big those moves would be? The volatility could be solved and not solved at the same time.

But just to sum it up, I'm all for it, if they can figure out a way to do it without sacrificing transparency. Maybe you don't have to disclose all of your earnings. Then we'd get away from whether or not you made the numbers every quarter. But, there are still some things that should need to be disclosed, maybe a quarterly brief or update. But generally speaking, we are long term investors all around here, we like giving the public as much information as possible. So, I'm for it with the caveat that, as long as it doesn't sacrifice transparency too much, I'm in favor.

Jones: I'd have to say, for me, just in attempting to solve the problem of short-termism, I totally agree that it is a problem in our markets. That's really what The Motley Fool is all about, is trying to get away from short-termism and looking through that long-term lens, I would even say this debate should really open up and really bring in more scrutiny, in terms of aligning executive compensation with driving long-term shareholder value. Really, what it comes down to is not necessarily, did the company hit X earnings target for this quarter, but, is the management team, and really even so the Board of Directors, are they really driving for results that will impact an investor or shareholder's portfolio over the long-term? I mean, we could do an entire episode just on good corporate governance structure. I think, when you look at things like executive compensation, is that aligned with that long-term view that the company wants you to have, that we want to have. And, too, aligning the overall incentives for anyone involved on the company side, I think is key.

I would say I am for change. I would say changing from three to six months, I don't think it will have that big of an impact on the problem of short-termism as something like really going after executive compensation would. But I am open to change. To your point, Matt, to cap it all off, at the end of the day, it's about balancing the regulatory and compliance requirements for these corporations with the need to keep our markets fair, transparent, and efficient; and all while doing that with that long-term view in mind. Definitely not an easy task to undertake. I am glad that there will be a study to hopefully determine whether or not we should do it. But I think it's important for us to really take the time to get it right, just to make sure every stakeholder involved is ultimately treated fairly and compensated well, too.

Frankel: Yeah, definitely. You hit it right on the head there. It's all about balance. As long as they can do it in a balanced way -- we'll have to see what this study comes up with -- I don't think anybody would argue against companies acting in favor of long-term investors.

Jones: That's it for this week's Financials show. Thanks so much for tuning in! As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Shannon Jones. Thanks for listening and Fool on!