When the Oracle of Omaha, Warren Buffett, buys or sells stocks, Wall Street wisely pays close attention. That's because Buffett has a history of vastly outperforming the benchmark stock indexes since becoming CEO of Berkshire Hathaway (BRK.A -0.49%) (BRK.B -0.46%) nearly six decades ago. Since taking the reins, he's overseen an aggregate gain of 3,787,464%, through Dec. 31, 2022, for his company's Class A shares (BRK.A).
Mirroring the Oracle of Omaha's trading activity is often pretty simple. Since all companies with at least $100 million in assets under management are required to file Form 13F with the Securities and Exchange Commission each quarter, investors will always have a snapshot of what Buffett and his investing lieutenants, Ted Weschler and Todd Combs, have been buying and selling.
However, Berkshire Hathaway's quarterly earnings reports tell an important tale, too.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
Berkshire Hathaway's fourth-quarter cash flow statement tells a cautionary tale
It's not uncommon for investors to become fixated on a company's headline performance metrics, such as revenue, net profit/loss, operating margin, and cash on hand/available. But Berkshire Hathaway's annual report is more than 140 pages long, and sometimes you have to do some digging to find the nuggets of wisdom hidden within.
For instance, there was a standout figure more than halfway through Berkshire Hathaway's annual report in the company's consolidated cash flow statements.
For more than a half-century, it's Buffett's investment activity that's gained notoriety. In particular, investors are most-interested in the stock(s) he's buying. But the company's fourth-quarter operating results painted a different picture for Wall Street. Although the Oracle of Omaha and his team put close to $1.7 billion in capital to work in equity securities during the fourth quarter, the company's cash-flow statement shows that over $16 billion in equity securities were sold. All told, Berkshire Hathaway sold a net of $14.6 billion in equity securities during the fourth quarter.
While the Oracle of Omaha and his investing lieutenants are very clear long-term optimists, this cash-flow statement provides over 14 billion reasons for Wall Street and the investment community to be cautious moving forward.
"Wonderful companies at a fair price" are hard to come by right now
What might investing extraordinaire Warren Buffett be concerned about that caused him to be a net-seller of equities during the fourth quarter? Though I can't read the Oracle of Omaha's mind, I'd venture a guess that stock valuations are playing a key role in his (and his lieutenants') tepid buying activity.
To quote Buffett, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." The problem is that it's slim pickings when it comes to wonderful companies at a fair price, especially following more than a decade of historically low interest rates that served as rocket fuel for growth stocks.
For example, historic data provided by sell-side consultancy company Yardeni Research shows that most double-digit percentage pullbacks in the S&P 500 (^GSPC -1.00%) over the past 24 years have found their bottom when the forward-year price-to-earnings (P/E) ratio settled between 13 and 14. Put another way, no major market pullback since the beginning of 1999 has found its bottom with a forward P/E north of 14. The current forward P/E ratio for the S&P 500 is above 17, and it never fell below approximately 15.5 last year.
S&P 500 Shiller CAPE Ratio data by YCharts.
It's a fairly similar story with the S&P Shiller price-to-earnings ratio, which is also referred to as the cyclically adjusted price-to-earnings ratio, or CAPE ratio. The Shiller P/E is based on average inflation-adjusted earnings from the previous 10 years.
With the exception of the financial crisis, the Shiller P/E ratio is known to find its support around 22 during bear markets and other notable declines over the past quarter of a century. As of this writing on March 16, it's sitting above 28.
The key takeaway being that, even though the S&P 500 and other major indexes are well off their all-time highs set in early 2022 or late 2021, most stocks still aren't cheap, or even at a "fair price," by historic standards.
Image source: Getty Images.
Warren Buffett's treasure chest could soon be open for business
However -- and this is a big "however" -- there is a chance that at least some of Berkshire Hathaway's more than $128 billion war chest of cash, cash equivalents, and Treasuries (as of Dec. 31, 2022), could be put to work sooner than later, even with the broader market still somewhat pricey.
For much of the past two weeks, all eyes have been on the U.S. and global banking industry. U.S. regional banks SVB Financial (SIVB.Q 20.00%) and Signature Bank (SBNY) were seized by regulators after their long-term Treasury bond positions had built up large mark-to-market losses. Meanwhile, First Republic Bank (FRCB) was given a capital injection from nearly a dozen of the nation's largest banks, and Credit Suisse (CS) agreed to borrow more than $53 billion from the Swiss central bank to shore up its balance sheet. This short-term worry is potentially creating an opportunity for the long-term-minded Buffett to pounce in an industry he knows well and absolutely loves investing in.
For instance, Bank of America (BAC -1.53%) is Berkshire Hathaway's second-largest holding by market value, and has been hit pretty hard by the recent turmoil in the banking industry. But at 5% below book value, BofA could very well catch the Oracle of Omaha's attention.
In addition to having a more-diversified balance sheet and revenue stream than regional banks like SVB, Signature, and First Republic, Bank of America is the most interest-sensitive of the U.S. money-center banks. Hypothetically, if the U.S. were to enter a recession, the benefit of generating more interest income from higher rates on variable-rate loans should more than outweigh any negatives from an increase in loan losses. This makes Bank of America particularly attractive with its shares trading below book value.
With roughly a quarter of Berkshire Hathaway's investment portfolio tied to financial stocks/exchange-traded funds, the current malaise surrounding banks could be the perfect excuse for Buffett to find wonderful companies at fair prices.
