In less than 48 hours, we'll turn the page on what's been a difficult year for Wall Street. Following the S&P 500's gain of 27% last year, this year's decline of 20% has been sobering.
Despite the S&P 500 firmly hitting bear market territory, billionaire investor Warren Buffett has overseen a positive 2% return in shares of his company, Berkshire Hathaway (BRK.A 0.36%)(BRK.B 0.13%), in 2022. His secret? Buy high-quality businesses -- many of which pay a dividend -- and allow his investment thesis to play out over years, if not decades.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
Additionally, the Oracle of Omaha has benefited from portfolio concentration. In Buffett's view, diversification is only necessary if you don't know what you're doing. With a greater than 3,600,000% return on Berkshire Hathaway's Class A shares (BRK.A) since the beginning of 1965, it's pretty clear he knows what he's doing.
As of Dec. 26, 73% of Berkshire's $320 billion investment portfolio was invested in just five stocks.
Apple: 37.7% of invested assets
If there was any question about the Oracle of Omaha's love of portfolio concentration, it's been answered by Berkshire Hathaway's stake in Apple (AAPL +2.30%). Dubbed one of Berkshire's "four giants" in Buffett's annual letter to shareholders, Apple accounts for roughly $120.7 billion of Berkshire's investment portfolio.
What makes Apple so special is its innovation. The iPhone jump-started the smartphone revolution more than a decade ago. Yet in spite of increased competition, Apple's already dominant share of the U.S. smartphone market has increased since the debut of 5G-capable iPhones two years ago. The iPhone, along with iPad and Mac, are products that continue to draw consumers to its brand.
In addition to the success of its physical products, Apple Chief Executive Officer Tim Cook is overseeing the evolution of his company to emphasize subscription services. Apple's services segment offers sustained double-digit growth, juicy operating margins, and can most importantly help alleviate the revenue ebbs-and-flows that occur during physical product replacement cycles.
But perhaps the biggest lure for Buffett is Apple's program to return capital to investors. It offers one of the largest dividends among public companies (more than $14 billion per year) and has repurchased $554 billion worth of its common stock since the beginning of 2013.
NYSE: BAC
Key Data Points
Bank of America: 10.5% of invested assets
Financial stocks are Buffett's favorite sector to invest in, so it really shouldn't come as a surprise that Bank of America (BAC 0.13%) is Berkshire Hathaway's second-largest holding. With more than 1 billion shares held, including those owned by Buffett's secret portfolio, this BofA stake was worth $33.5 billion, as of last weekend.
One reason Buffett loves bank stocks is because they're tried-and-true moneymakers. As the U.S. economy expands over time, banks are able to take advantage by increasing their loans and deposits (i.e., the bread-and-butter of banking). This typically leads to a healthy returns of capital to shareholders involving dividends and share repurchases.
Bank of America's claim to fame is that it's more interest-sensitive than any other U.S. money-center bank. With the Federal Reserve increasing interest rates at the fastest pace in decades, it means BofA is enjoying a sizable uptick in net interest income -- an extra $2.7 billion in the third quarter from the prior-year period. The nation's central bank isn't done raising rates, either, which bodes well for Bank of America's bottom line.
BofA has also done an excellent job of improving its operating efficiency by promoting digital banking as well. As of the end of September, 72% of its 56 million verified digital users were actively banking online or via mobile app. Because digital transactions are considerably cheaper for banks than other types of interactions, this digitization shift should slowly but steadily lift BofA's earnings.
Image source: Getty Images.
Chevron: 9.4% of invested assets
The third stock that makes up an exceptionally large percentage of Berkshire Hathaway's invested assets is energy stock Chevron (CVX +0.60%). In roughly two years, Buffett and his team have acquired an 8.8% stake in Chevron (including assets held by Buffett's secret portfolio) that equates to 9.4% of Berkshire's portfolio value.
Buffett's sizable investment in Chevron looks to be a bet on the continued outperformance of crude oil and natural gas. Russia's invasion of Ukraine has put the energy supply needs of Europe into question. Meanwhile, the COVID-19 pandemic led oil and gas companies to pare their capital expenditures. Between this lack of investment and Europe's energy commodity supply uncertainty, it's quite possible the spot price for crude oil and natural gas will remain lofty for some time.
Chevron's balance sheet is another reason for Buffett to smile. Although most major energy companies are mired in debt, Chevron has just $8.2 billion in net debt as of the third quarter -- that's down from $25.7 billion in net debt at the end of 2021 -- and a debt ratio of a mere 13%. In other words, Chevron has superior financial flexibility among oil and gas stocks, which is why it's been able to repurchase as much as $15 billion of its common stock this year.
I'd be remiss if I didn't also note that Chevron is an integrated energy company. This is a fancy way of saying that it has more going on than just drilling and exploration. Chevron operates pipelines, chemical plants, and refineries that help provide predictable cash flow and a hedge against crude oil price weakness.
NYSE: KO
Key Data Points
Coca-Cola: 8% of invested assets
Beverage giant Coca-Cola (KO +0.44%) is Buffett's fourth-largest holding, and also the longest-held stock in Berkshire's portfolio (34 years and counting). The 400 million shares of Coca-Cola held by Buffett's company have a market value of about $25.5 billion.
The beauty of the Coca-Cola operating model is that its highly predictable. No matter how poorly the U.S. economy or stock market perform, consumers don't change their beverage consumption habits all that much. If they were buying Coke products during an economic expansion, they're likely to continue buying Coke products during a recession or economic downturn. This is what leads to the company's rock-solid operating cash flow.
It also doesn't hurt that Coke is about as geographically diverse as a company can get. With the exception of North Korea, Cuba, and Russia, it's operating in every other country around the world. This means taking advantage of predictable cash flow in developed markets and benefiting from higher organic growth opportunities in emerging markets.
Coca-Cola's impressive dividend, which nets Berkshire Hathaway more than $700 million each year, is yet another bright spot in Buffett's portfolio during a poor year for Wall Street. Coke is riding a 60-year streak of increasing its base annual payout. Among publicly traded companies, only a handful can boast of a longer continuous streak.
NYSE: AXP
Key Data Points
American Express: 7% of invested assets
The fifth and final stock that makes up an inordinately large percentage of Berkshire's portfolio is credit-services company American Express (AXP +0.97%). AmEx is Berkshire Hathaway's second longest-held stock (since 1993).
American Express is benefiting from many of the same tailwinds as Bank of America. Even though loan losses are liable to increase as the Fed lifts interest rates, AmEx has the ability to more than offset these loan losses with an increase in net interest income on the balances outstanding of its cardholders. Whereas a weakening economy usually bodes poorly for financial stocks, the Fed's forced hawkish stance in the face of high inflation is the wind in its sails.
Another reason American Express regularly outperforms its competition is its willingness to play both sides of the aisle. It's both a payment processor and a lender. While the latter can be less desirable during inevitable economic downturns, this combination can really pump-up profitability during periods of expansion. The thing is, periods of expansion last considerably longer than downturns.
Lastly, don't overlook the importance of AmEx's focus on affluent clientele. High earners are less likely to change their spending habits or become delinquent on their payments during minor economic downturns.
