If you're a fan and follower of legendary investor Warren Buffett, then you're certainly aware of Berkshire Hathaway (BRK.A 0.63%) (BRK.B 0.52%). When people talk about mirroring Buffett's buys and sells, they're actually talking about Berkshire's trades. The holdings of the company's portfolio are publicly disclosed every quarter, too, which makes riding the Oracle of Omaha's coattails a relatively easy task. Easier still is simply owning shares of the highly diversified multinational conglomerate!
Whatever your style, a handful of things are likely to happen with Berkshire Hathaway's portfolio in what will hopefully be a more normal 2021. Three stand out above the rest. Buffett and his acolytes have already tipped their hands, so to speak, as to two of them.
1. Rekindled operating earnings, cash flow
It's an often overlooked nuance of the Berkshire Hathaway portfolio, but it's not just a collection of stocks. Around half of Berkshire's $500 billion valuation reflects the value of privately held companies, like See's Candies, Dairy Queen, Helzberg Diamonds, GEICO, Pampered Chef, and Benjamin Moore, just to name a few.
These owned companies are tracked differently than Berkshire's stocks. Berkshire's publicly traded investments are called "investments in equity securities" on the company's books, and changes to their value are booked as "investment gains (or losses)" on its quarterly statements. Businesses that are outright owned by Berkshire Hathaway, however, don't have an ever-changing market value. They're the companies that drive revenue that's eventually turned into net income and cash flow, as any stand-alone business reports.
The arrangement can make it tough to ferret out just how Buffett's non-stock holdings are performing in any given quarter. And like most other companies, this year has been a tough one for Berkshire. Its third-quarter operating profits fell 32% year over year, worsening from Q2's 10% dip in operating income to $5.5 billion. You may have seen much different numbers due to gains in the value of the stocks also held by Berkshire during that time, though no amount of unrealized stock gains can fully offset the record-breaking net loss of $50 billion booked during the first quarter of the year, when the pandemic first took hold. As it stands right now, Berkshire's actual operating income this year should be on the order of about half of last year's total.
Buffett cares little about these wild swings in reported quarterly income, as the stock market's volatility exaggerates how well or how poorly the portfolio is actually doing. But you should care, since the cash these privately held companies produce ultimately funds things like new acquisitions and stock buybacks. The good news is, there's every reason to believe operating income and cash flow will look more like 2019's levels in a more normal 2021.
2. A scaleback of Apple
Much of this year's non-operating (and unrealized) gains logged by Berkshire can be attributed to the fund's surprisingly big stake in Apple (AAPL 0.42%).
It's no secret Buffett's never been a huge fan of tech stocks, explaining he doesn't understand them well enough to judge them. Nevertheless -- and presumably with some nudging from other Berkshire team members -- the company began building a stake in the tech giant back in 2016. In the meantime, it's ballooned into Berkshire's biggest single stock position. With nearly 1 billion shares worth more than $100 billion, Apple accounts for nearly half of the total value of Berkshire's overall stock holdings.
That may be enough, though, if not more than enough. Berkshire shed around 36 million shares of the iPhone maker during Q3, or roughly $4 billion worth.
The move could simply be chalked up to a little profit-taking. Apple shares have nearly doubled in value this year, and it's not like Buffett hasn't occasionally sold some Apple stock since Berkshire first opened its position in 2016. But Buffett and his stock-picking team rarely do one-offs. They generally want in or out. The fact that we've now seen multiple partial exits may well indicate Berkshire is looking for a more substantial exit of the trade.
3. Added pharmaceutical exposure
Finally, while Berkshire may be on the way out of its Apple trade, it's clearly looking to add stakes in pharmaceutical stocks. During the third quarter, the company added brand new positions in Bristol-Myers Squibb (BMY 2.11%), Merck (MRK 0.59%), and AbbVie (ABBV -0.35%). Berkshire also bought a small stake in Pfizer (PFE 0.29%).
None of these positions were particularly big by Berkshire standards. The company didn't commit more than $2 billion to any of them, and "only" owns a little more than $100 million worth of Pfizer despite its successful (and now approved) COVID-19 vaccine. It's not clear exactly what Buffett or his managers may see for the industry that they didn't see as of the second quarter.
As is the case with the modest repeated sales of Apple shares, though, this new interest in pharma companies is likely to be a prelude to much bigger positions that are gradually expanded rather than established with one big trade.