If you've ever wondered why Wall Street pays so much heed to Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett's investment activity and words of wisdom, simply take a look at his company's latest annual report. Although Buffett and his investment team have been more or less par for the course with the benchmark S&P 500 over the past decade, Berkshire Hathaway's per-share market value has outperformed the S&P 500, inclusive of dividends, by more than 2,700,000% over the past 55 years. That's why investors' ears perk up when Buffett speaks.
However, what you might not realize about the Oracle of Omaha is that diversification isn't his thing. Buffett has spent much of his investing career focusing on a small number of sectors, such as consumer staples and financials, with the latter being his absolute favorite.
This means Buffett tends to avoid investing in a number of widely popular sectors. Let's take a closer look at three of those sectors and dive into Buffett's likely reasoning for avoiding them.
On the surface, healthcare stocks look as if they'd be the perfect addition to a Buffett-run portfolio. The healthcare sector is relatively defensive considering that we don't get to choose when we get sick or what ailment(s) we develop. This means that healthcare companies up and down the product and service chain should see relatively steady demand regardless of how well or poorly the economy is performing.
So, why not invest into healthcare stocks? One simple reason is that Buffett simply doesn't have the time to devote to following clinical studies for experimental medicines and devices.
Another reason is that Buffett really prefers to buy into businesses that he believes have economic moats. This is to say that Buffett buys companies that have sustainable competitive advantages. Because pharmaceuticals and devices approved by the U.S. Food and Drug Administration have a finite period of exclusivity, the vast majority of healthcare stocks don't offer the moat that Buffett would be looking for.
Admittedly, there are exceptions to Buffett's avoidance of the healthcare sector. For instance, Johnson & Johnson (NYSE:JNJ) was once one of Berkshire Hathaway's top holdings back in the late 2000s. However, over the past decade Johnson & Johnson has emphasized growth in its higher-margin pharmaceutical segment, with more than half of its $82.1 billion in sales derived from pharmaceuticals in 2019. Buffett has little desire to chase clinical data, which is probably one of the biggest reasons Johnson & Johnson is now relegated to a token 327,100-share holding in Berkshire's portfolio after once being a top-five holding.
Another extremely popular sector that Warren Buffett has long steered clear of is technology.
Now, I know what you're probably thinking, and you're correct -- Apple (NASDAQ:AAPL) is a tech stock, and it makes up 40% of Berkshire Hathaway's invested assets at the moment. How can I possibly make a case that Buffett is avoiding tech stocks when it's the single largest holding in his company's portfolio? The answer to that question comes in two parts.
First, understand that over the past 15 years, pretty much the only tech stocks that Berkshire Hathaway has owned are Apple, IBM, and Red Hat, which was acquired by IBM last year. Although IBM and Apple were sizable purchases by Buffett, it's certainly not as if Buffett is purposefully adding cutting-edge tech stocks to Berkshire Hathaway's investment portfolio.
Second, Buffett doesn't even view Apple as a tech stock. As the Oracle of Omaha described in his 2018 annual shareholder meeting, "I didn't go into Apple because it was a tech stock in the last. I went into Apple because... of the value of their ecosystem and how permanent that ecosystem could be."
Arguably the biggest reason Buffett avoids tech stocks is because they often don't have economic moats. You have to remember that Buffett will always be somewhat of an old-school investor who's used to analyzing companies with hard assets. The thing is, technology companies are asset-light, and they rely on patents and innovation to drive growth and value. It's a lot harder for Buffett to decipher whether an economic moat can be achieved with asset-light businesses.
As one last point, Buffett has always been a big fan of easy-to-understand businesses. Apple certainly achieves this by selling tangible products such a smartphones and providing a variety of services, such as Apple TV and iCloud. However, not all tech stocks are easy to understand. Chances are that if it takes more than a sentence to explain what a business does, Buffett will want no part of it.
Finally, don't expect to find much in the way of basic materials in a Buffett-run portfolio. Basic materials includes companies that produce precious metals, base metals, building materials, and specialty chemicals.
Typically, when most folks think of "basic materials" they're thinking of investing in gold or companies that produce a precious metal. Buffett is no fan of gold, and thusly no fan of mining stocks.
Why no love for the lustrous yellow metal? As my Foolish colleague Matt Frankel noted, there are two main objections. First off, gold isn't procreative, meaning it's not going to produce anything else of value. When Buffett buys into a bank, he knows that the financial services offered by that bank will continue to generate profits. Or when he purchases an electric utility, he knows the electricity produced will continue to generate income for the utility. But gold does none of this. It just sits there, waiting for someone else to pay a higher price for it than you did.
Secondly, Buffett doesn't believe gold has many practical uses. Although it's used in the production of some tech hardware, has dental crown applications, and is used in jewelry-making, Buffett doesn't view gold as a core industrial need. It's reasons like this that have kept the Oracle of Omaha from ever taking large stakes in basic material companies.
The only basic material stock currently in Berkshire Hathaway's portfolio is Axalta Coating Systems (NYSE:AXTA), which comprises less than 0.3% of Buffett's invested assets. Axalta primary provides coating systems used on automotive and commercial vehicles. Given Buffett's ownership of nearly 75 million shares of General Motors, and Axalta's role within GM's supply chain, this investment makes a bit more sense. Nevertheless, it's crystal clear from Buffett's investment activity that basic materials aren't on the buy list.