When it comes to the world's greatest investors, Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) CEO Warren Buffett is, arguably, in a class of his own. Since taking over the CEO role in 1965, the Oracle of Omaha (as he's now known) has overseen an aggregate gain in his company's Class A shares (BRK.A) of better than 4,100,000%, as of June 14, 2023. Further, on an annualized basis, Berkshire Hathaway has doubled up the total return, including dividends paid, of the S&P 500.
Buffett's more than half-century of outperformance is why new and tenured investors look to him for guidance on what's to come for the U.S. economy, and even what stocks they should be buying. But therein lies the Oracle of Omaha's greatest dilemma at the moment.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
Buffett and his team have been active sellers for months
Buffett isn't shy about his investment "formula" and has willingly shared the ingredients that have made him and his investment team wildly successful over nearly six decades. To summarize this recipe as concisely as possible, Buffett is a long-term-minded investor who would never bet against America, and he wants to buy wonderful companies at a fair price.
Berkshire Hathaway has two pathways for growth and profits. There are the roughly five dozen businesses Buffett and his team have acquired over the years, such as railroad BNSF and insurer GEICO, which generate sales and, collectively, profits each quarter.
The other path is investments. Berkshire Hathaway held stakes in approximately four dozen securities, as of June 14, 2023, with the total value of these investments topping $352 billion. It's this investment portfolio that investors and Wall Street eye like a hawk.
At the moment, Buffett and his investing lieutenants (Todd Combs and Ted Weschler) have a smorgasbord of capital at their disposal. Berkshire ended the March quarter with a whopping $130.6 billion in cash and cash equivalents. But to the dismay of Buffett enthusiasts, it's not being put to work.
During the fourth quarter of 2022, Berkshire Hathaway's operating results showed $14.6 billion in net-equity sales. It was a similar story in the first quarter of 2023, where Buffett's company sold a net of $10.4 billion in equity securities. The cherry on top is that the Oracle of Omaha commented during Berkshire Hathaway's annual shareholder meeting in early May that his company had raised $4 billion in added cash from net-equity sales in April. In a seven-month stretch, Buffett and his team sold $29 billion more in stocks than they purchased.
The answer as to why Buffett isn't deploying Berkshire Hathaway's cash may well be the "fair price" aspect of his investment recipe.
The Oracle of Omaha's $130 billion conundrum
Every so often, Buffett will break one of his own investment rules. For instance, purchasing shares of gaming company Activision Blizzard (ATVI) was done to take advantage of a short-term arbitrage opportunity. In January 2022, Microsoft offered to buy Activision in an all-cash deal valued at $95 per share. If regulators allow the deal to complete, shares of Activision would appreciate meaningfully from where they are now. This differs from Buffett's typical buy-and-hold ethos.
But one "rule" you'll pretty much never see the Oracle of Omaha veer from is his desire to buy wonderful companies at a fair price. While there's no line-in-the-sand, concrete definition of what "value" means to Buffett, a quick glance at a number of broad-market valuation metrics shows that stocks are anything but cheap.
For instance, the S&P 500's (^GSPC 1.02%) forward-year price-to-earnings (P/E) ratio of 18.8 is more or less a valuation midpoint over the past quarter of a century. However, no bear market over the same span has bottomed with a forward P/E ratio of higher than 14. At no point during the 2022 bear market did the benchmark S&P 500 dip below a forward P/E of roughly 15.5.
S&P 500 Shiller CAPE Ratio data by YCharts.
It's the same story with the S&P 500's Shiller P/E ratio, which is also known as the cyclically adjusted P/E ratio, or CAPE ratio. Instead of dividing a company's share price into trailing-12-month or forward-year earnings, the Shiller P/E is based on average inflation-adjusted earnings over the past 10 years. The current S&P 500 Shiller P/E of 30.5 is quite rich, and any figure above 30 has, historically, boded poorly for the stock market as a whole.
Buffett's dilemma is that he knows Berkshire Hathaway's cash is sitting on the sidelines and losing purchasing power. But he's also keenly aware that a "wonderful company at a fair price" is virtually impossible to find right now, based on traditional fundamental metrics. It's a $130 billion conundrum that's coercing the Oracle of Omaha to sit on his hands as the major indexes march higher.
Trust the process
Some investors will, undoubtedly, question Buffett's tactics of sitting on the sidelines with a veritable treasure chest at his disposal while a possible new bull market takes shape. But if those same investors pan out a bit, they'd see that the Oracle of Omaha has been through Wall Street's ups and downs a time or 20.
The fact of the matter is that some of Buffett's best investments have been the result of patience. Take tech stock Apple (AAPL -0.35%), Berkshire Hathaway's largest holding by a significant amount, as an ideal example.
Though Berkshire Hathaway has scooped up shares of tech stock Apple from time to time in recent quarters, the bulk of Buffett's purchases in the largest public company by market cap in the U.S. occurred when Apple was regularly trading for between 10 and 15 times its forward-year earnings. Given its industry-leading innovation, top market share in U.S. smartphones, and amazing capital-return program, this was a phenomenal deal.
Image source: Getty Images.
Buffett also waited to strike with Bank of America (BAC -0.21%), which is Berkshire Hathaway's second-largest holding by market value. The Oracle of Omaha put $5 billion to work in BofA preferred stock following the financial crisis in August 2011, and eventually converted the warrants attached to the preferred-stock purchase into a sizable common stock position in 2017. Apple and Bank of America are perfect examples of Buffett's willingness to wait for wonderful companies to fall into his preferred valuation range.
In addition, Buffett and right-hand man Charlie Munger are fully taking advantage of Berkshire Hathaway's outsized cash position to buy back Berkshire stock. Since the criteria for share repurchases was altered by the Berkshire board of directors on July 17, 2018, Buffett and Munger have overseen more than $70 billion in share buybacks. Share repurchases of this magnitude should be positive for Berkshire Hathaway's earnings per share and make the company even more attractive to fundamentally focused investors.
Although it can be frustrating to see one of Wall Street's greatest investors sit on cash, nearly six decades of outperformance suggests you should trust the process.
