Whether or not you're a Warren Buffett fan, there's no doubt that he's one of the greatest investors of all time. The CEO of conglomerate Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) has grown his net worth from around $10,000 to $80 billion since the 1950s, and has delivered a compound annual return for Berkshire Hathaway's shareholders of 20.3% since 1965. A $100 investment in Berkshire back in 1965 would be worth more than $2.5 million today.
Buffett's success is primarily attributed to his ability to spot businesses with sustainable competitive advantages, as well as his persistence to stick with his holdings over long periods of time.
But this only tells part of the story. Buffett's outperformance is also a direct reflection of his unwillingness to buy into the idea of traditional investment diversification. The Oracle of Omaha doesn't believe in diversifying if you know what you're doing. By sticking with companies in industries and sectors he knows very well, Buffett has amassed a long history of outperformance.
As of the closing bell on Thursday, Aug. 20, 92% of Buffett's more than $240 billion in invested assets were concentrated in just three sectors.
Information technology: 49.33%
The craziest thing about this figure isn't that information technology made up just 0.43% of Buffett's invested assets exactly 10 years ago and is nearly half of Berkshire's portfolio today. Rather, it's that the entirety of this 49.33% stake is tied up in a single stock: Apple (NASDAQ:AAPL).
In an interview on CNBC's Squawk Box in February, the Oracle of Omaha stated that "I don't think of Apple as a stock. I think of it as our [Berkshire Hathaway's] third business," behind insurance and railroads.
Interestingly, it wasn't Apple's technology ties that initially attracted Buffett to begin building a stake in the company in 2016. Instead, it was Apple's incredible branding power that got him hooked. One need only look at the lines wrapping around Apple stores anytime the company releases a new iPhone to understand what sort of branding power the company has.
Buffett has also been a big fan of Apple's CEO Tim Cook, who's in the process of transforming his company from being product-oriented to service-focused. For multiple quarters, we've watched services and wearables grow at a double-digit pace on a year-over-year basis. Services are an especially higher-margin segment that should lead to less revenue lumpiness for Apple over time.
Additionally, the tech kingpin has done a good job of returning capital to shareholders, which the Oracle of Omaha appreciates. Apple has been borrowing at historically low rates to fund aggressive share repurchases, and currently pays out one of the largest nominal dividends in the U.S. at north of $14 billion a year.
Maybe the biggest surprise here is that Buffett's favorite sector, financials, now represents "only" 29% of Berkshire Hathaway's portfolio. The 32.02% financials tallied at the end of June marked a nine-year low, while the current 29.05% represents the sector's smallest allocation since the market bottom during the first quarter of 2009.
Why the perceived financial sector exodus? I believe there to be two answers.
To begin with, it's not that Buffett suddenly dislikes bank stocks and insurers, so much as they've vastly underperformed the broader market since the March 2020 lows. Top holding Apple has doubled from its March bottom, while money-center bank Wells Fargo (NYSE:WFC) is down 56% year-to-date, and has declined below its March 2020 bottom.
Remember, financials are highly cyclical companies that typically depend on steady economic growth to drive loan activity and higher interest income. During recessions, the Federal Reserve's dovish monetary policy pushes lending rates down, thereby hurting interest income for the likes of Wells Fargo and its peers.
The second factor that explains the decline in financial sector allocation is that Buffett and his team appear to be consolidating their holdings in the sector. Bank of America (NYSE:BAC) has been a particularly popular add for the Oracle of Omaha in recent weeks. Bank of America is arguably the most interest-sensitive of all bank stocks, and should therefore be among the first to benefit when lending rates start rising again. BofA has also done a solid job of controlling its noninterest expenses by focusing on mobile banking solutions and closing some of its physical branches.
Meanwhile, Wells Fargo has been steadily getting chopped down in Berkshire Hathaway's portfolio. In addition to unfavorable near-term growth prospects, the company has struggled to move past a fake account scandal that came to head in 2016-2017.
Consumer staples: 13.56%
Finally, consumer staples stocks (i.e., companies that provide essential products like packaged food and beverages) have shrunk to less than 14% of Berkshire Hathaway's investable assets. This marks at least a two-decade low, and is well below the 45.5% allocation given to consumer staples 10 years ago.
Why no love for consumer staples? One explanation might be the relatively low interest rate environment we've been privy to now for more than a decade. Consumer staples are usually mature, slow-growing businesses that benefit when value stocks are in favor. However, access to cheap loans has allowed growth stocks to vastly outperform mature businesses and value stocks. As a result, most consumer staple stocks have been running in place for years. As Apple has grown in value as a percentage of Berkshire Hathaway's portfolio, the allocation given to consumer staples has shrunk.
Another consideration is that Buffett is still feeling the sting from one of his worst investments in recent decades: Kraft Heinz (NASDAQ:KHC). Although the coronavirus disease 2019 (COVID-19) pandemic has reignited interest in some of Kraft Heinz's packaged foods, it's doesn't negate that the company took a more than $15 billion goodwill writedown in February 2019 on its Kraft and Oscar Mayer brands, or that it's been financially constrained by nearly $29 billion in total debt.
Kraft Heinz was perceived to be a business model that couldn't be disrupted, but that hasn't turned out to be the case. As a result, Buffett's appetite for consumer staples stocks appears to have waned.