Over the past half-century, Berkshire Hathaway (BRK.A 0.07%)(BRK.B 0.32%) CEO Warren Buffett has garnered himself quite the audience. In 1973, when the Oracle of Omaha conducted his first annual shareholder meeting for Berkshire Hathaway in the cafeteria of an owned subsidiary, a few dozen people showed up. Attendance for this year's annual shareholder meeting in Omaha, Nebraska, likely neared 40,000.
Investors and shareholders come from near and far to listen to Warren Buffett speak about the economy, the stock market, and his investing philosophy. After all, riding Buffett's coattails has been a portfolio-enriching strategy for close to six decades. Since taking over as CEO in 1965, he's led his company's Class A shares (BRK.A) to an aggregate return of more than 4,300,000%, through the closing bell on Aug. 4, 2023.
But there's one big snafu for investors currently looking for sage investment advice from the Oracle of Omaha: he's not pressing the buy button very much.
Berkshire Hathaway CEO Warren Buffett. Image source: The Motley Fool.
Buffett's $33 billion warning is a potential wake-up call for Wall Street
This past weekend, Berkshire Hathaway released its second-quarter operating results. For the most part, it was business as usual, with the company's operating income -- derived from its myriad of owned assets (e.g., BNSF and GEICO) -- rising nearly 7% to roughly $10 billion from the year-ago period.
But it's not the headline revenue and profit numbers that deserve the attention of professional and everyday investors. Rather, it's Berkshire Hathaway's cash flow statement -- specifically with regard to investing activities.
Cash flow statements allow investors to see where Warren Buffett and his team are putting money to work and/or generating capital. While short-term Treasury bills have been particularly popular as yields rise, it's Berkshire's cash flow from equity securities that provides an ominous warning to Wall Street.
NYSE: BRK.B
Key Data Points
During the second quarter, Buffett's company purchased $4.569 billion worth of equities (i.e., stocks). However, it also sold $12.55 billion in equity securities, which works out to net-equity security sales of $7.981 billion in the June-ended quarter.
The problem is that Berkshire Hathaway was also a net-seller of equities in the fourth quarter (Q4) of 2022 and first quarter (Q1) of 2023.
During Q4 2022, Buffett and his investing lieutenants, Todd Combs and Ted Weschler, purchased just $1.68 billion in equities while selling $16.32 billion, equating to $14.64 billion in net-equity sales. Meanwhile, in Q1 2023, Buffett and his investment team bought $2.873 billion in equity securities and sold $13.283 billion. That's $10.41 billion in net-equity security sales.
On a combined basis, Warren Buffett has overseen $33.03 billion in net-equity security sales in a nine-month stretch. In other words, it's become plainly evident that the Oracle of Omaha, and perhaps his investing lieutenants, see little in the way of value with the major indexes rebounding strongly from their 2022 bear market lows.
News flash: Stocks aren't cheap
Warren Buffett has no shortage of investment quotes and quips he's known for. But the one that tends to stick most with investors is his take on valuation. Said Buffett, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
To be blunt, you'd struggle to find wonderful companies at a fair price right now.
S&P 500 Shiller CAPE Ratio data by YCharts.
For instance, take a closer look at the S&P 500's (^GSPC +0.77%) Shiller price-to-earnings (P/E) ratio, which is also known as the cyclically adjusted P/E ratio, or CAPE ratio. While P/E ratios are normally calculated using trailing-12-month or future-year earnings, the Shiller P/E is based on average inflation-adjusted earnings from the previous 10 years. Using 10 years' worth of earnings data removes abnormal earnings fluctuations in a single year, such as what we witnessed during the COVID-19 pandemic.
As of the closing bell on Aug. 4, the S&P 500's Shiller P/E ratio was 30.89. Not only is this well above its average reading of 17.05, when back-tested to 1870, but it marks only the sixth time in 153 years where the Shiller P/E has surpassed 30 during bull market or significant Wall Street rally. The previous five instances where the S&P 500's Shiller P/E surpassed 30 eventually (key word!) resulted in declines ranging from 20% to 89%.
To be clear, the Shiller P/E ratio isn't a market-timing tool. In other words, valuations can stay extended for weeks, months, or even years before correcting lower. Nevertheless, a reading above 30 has historically been bad news for Wall Street.
The S&P 500 is also exceptionally pricey when examined using the price-to-earnings-growth ratio, or PEG ratio. For this calculation, the S&P 500's forward P/E ratio is divided by its five-year forward consensus expected annual earnings growth.
Whereas the S&P 500 has spent virtually all of its time between a PEG ratio of 1 and 1.5 since the start of 1995, it ended at a PEG ratio of 1.9 on July 27, 2023. With the exception of the COVID-19 pandemic, it's the priciest the benchmark index has been, relative to its future growth prospects, in at least 28 years.
Image source: Getty Images.
Patience has been a virtue for Warren Buffett
On the surface, Warren Buffett's $33 billion ominous warning to Wall Street signals that either stock valuations need to come down, or growth rates needs to pick up, before equities become attractive again.
But don't overlook the fact that Berkshire's CEO has been through quite a few volatile periods in the equity markets before, and that his patience has paid off immensely for his company's shareholders.
Even though the Oracle of Omaha isn't putting a sizable amount of Berkshire Hathaway's capital to work at the moment, he's loaded his company's investment portfolio (and owned assets) with cyclical businesses. Companies that are cyclical tend to ebb and flow with the health of the U.S. economy.
Warren Buffett is a big fan of American businesses. While he understands that recessions are a normal part of the economic cycle, he's well aware that periods of economic expansion last substantially longer. Rather than trying to guess when these downturns will occur, he prefers to focus on cyclical stocks that can benefit from disproportionately long expansions. Though valuations can move outside of their historic norms from time to time, having a long-term mindset and betting on the American economy to grow over time has been a winning formula.
Berkshire's CEO also realizes that the stock market spends a disproportionate amount of time rising than falling. Data from Bespoke Investment Group recently found that the average length of a bull market (1,011 calendar days) is roughly 3.5 times longer than the average length of a bear market (286 calendar days), dating back to September 1929.
Although it may be disappointing to see Warren Buffett and his investing lieutenants effectively sit on their hands as Berkshire Hathaway's cash pile grows, you can rest assured that any notable declines in the broader market will likely encourage the Oracle of Omaha and his team to act.
