Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) is a legendary stock in the investing world. Led by the iconic Warren Buffett, the diversified holding company has outperformed the S&P 500 index many times over since 1965.
Buffett's investing philosophy is based on key ideas such as a company's competitive advantage, management quality, and long-term compounding returns. These guiding principles have helped the company avoid major blunders and score several big wins under his leadership.
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However, Berkshire Hathaway is not the same reliable market-beater it used to be in its prime. As a result of its success, the company is now too large to invest heavily in small to medium-sized value stocks, and finding attractive deals in the large-cap space has become increasingly challenging in recent years, as Buffett himself has admitted.
A new era has dawned
This reality is reflected in the fact that Apple, the largest component of the S&P 500 by weight, is also Berkshire Hathaway's biggest stock holding by a wide margin. Although Apple stock has been a great investment since Buffett and his team first started buying the tech giant in 2016, it's unlikely that the iPhone maker will continue to outpace small- and mid-cap growth stocks over the next 10 to 20 years due to its enormous size and moderate growth prospects.
This scarcity of value in Buffett's feasible investing range means that shareholders should probably lower their expectations in terms of capital appreciation in the years ahead. However, that doesn't mean that Berkshire Hathaway doesn't deserve a place in your core portfolio.
Stocks can serve different purposes in a well-diversified portfolio, and beating the broader market regularly doesn't have to be their only reason for being there. So how does Berkshire Hathaway stock fit into a well-diversified portfolio according to the main principles of modern portfolio theory?
A strong correlation to the S&P 500 with an important caveat
Berkshire Hathaway stock is highly correlated with the S&P 500 index, which means that it tends to follow the same trend as the overall market over periods of five to 10 years. This is evident from the fact that Buffett's conglomerate and the S&P 500 have moved in tandem for most of the past five years:
BRK.A Total Return Level data by YCharts
This result is expected, considering that many of Berkshire Hathaway's equity investments are large-cap blue chip companies that also have a big weight in the index. However, Berkshire Hathaway also has some distinctive features that differentiate it from the S&P 500 as an investing vehicle.
One of these features is Berkshire Hathaway's substantial cash position, which gives it the ability to capitalize on market opportunities and withstand economic downturns. At last count, the company had $157 billion in cash and equivalents on its balance sheet.
To illustrate the enormity of its cash reserve, Pfizer, one of the biggest pharmaceutical companies in the world, currently has a market value of only $155 billion.
This Pfizer-sized cash reserve implies that Berkshire Hathaway has a high probability of surviving even severe economic shocks, such as a global war or an economic depression. The S&P 500, on the other hand, would likely tumble if America faced a major global conflict or a second great depression.
Berkshire Hathaway's resilience, by virtue of its enormous cash position, can be seen in its recent yearly performance. When markets plunged in 2022 due to rising interest rates, Buffett's conglomerate moved in the opposite direction, gaining a decent 4% for the year. The S&P 500, on the other hand, lost over 18%, even including dividends.
BRK.A Total Return Level data by YCharts
Conclusion
Berkshire Hathaway can still deliver strong capital gains for long-term investors. However, it probably won't boat race the broader market in the coming decades, either. Instead, Berkshire Hathaway provides an attractive mix of capital appreciation and safety.
So, if you're concerned about the high valuations among the S&P 500's largest constituents or the increasingly tense geopolitical situation, Berkshire Hathaway stock could be a perfect addition to your portfolio right now.
