Warren Buffett's tremendous success as an investor didn't come from trying to time the market, nor from predicting which stocks would go up or down in the near term. Those are impossible tasks, he has noted on multiple occasions. Instead, the primary thing that Buffett and his team at Berkshire Hathaway (BRK.A 0.24%) (BRK.B 0.38%) do is try to determine whether a business, at that particular moment, is worth more or less than its market price.
That strategy has led to some phenomenal results. Berkshire Hathaway stock has grown at a compound annual rate of about 20% since 1965, when Buffett took control of what was then a failing textile business. To put that in perspective, the S&P 500 (^GSPC 0.61%) has produced compound annual returns of just 10.4% over that time.
As impressive as that may sound, it can be hard to grasp just how vast that difference becomes when compounding has decades to work its magic. From 1965 through 2024, an investment in the S&P 500 (with dividends reinvested) would have multiplied in value by about 390 times. The same investment in Berkshire would have risen by more than 55,000 times.
In short, buying stocks that are fundamentally worth more than the market thinks they are works. But in recent times, Buffett has concluded that many of the equities in Berkshire's portfolio might not be worth as much as the market is paying for them. Further, he has found the pickings quite slim in terms of potential new equity holdings to buy. As a result, Berkshire Hathaway has been a net seller of stocks for 10 consecutive quarters. In that period, Buffett and his team have sold $174 billion more in stocks than they bought.
Two of the biggest positions recently getting trimmed at Berkshire Hathaway were Apple (AAPL 2.15%) and Bank of America (BAC 0.87%). The conglomerate cut its stakes in them by 67% and 39%, respectively. With some of the proceeds from those sales and others, Buffett has been piling into a high-yield investment that's paying around 4.3% as of this writing.
Image source: The Motley Fool.
Cutting some of his biggest holdings
At one point, Apple stock accounted for more than half the value of Berkshire's equity portfolio. Buffett first purchased shares of the iPhone maker in 2016 when it traded for around $25 on a split-adjusted basis. Over the next few years, he built a massive stake in the stock, pouring an estimated $36 billion into it by late 2018.
When Buffett made his initial investment in Apple, it was trading at a P/E multiple of around 10. That was an incredible value for the stock, even as the company was experiencing a downturn in net income. Buffett saw the value of the iPhone and the Apple ecosystem, noticing how attached people were to their smartphones. He expected the business to turn around, thanks to Apple's brand strength, its leading position in smartphones, and its strong free cash flow. Sure enough, the stock soared over the next eight years.
NASDAQ: AAPL
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But by late 2023, it had climbed to above 30 times earnings, which is an extremely high multiple for a company growing its earnings per share at a single-digit percentage annual rate. That was enough to convince Buffett to start taking some cash off the table. From October 2023 through September 2024, he sold more than two-thirds of Berkshire's stake in the tech giant.
Apple remains the largest holding in Berkshire's portfolio, accounting for nearly 22% of its value. But given its forward P/E of 29, it's unlikely that Buffett plans to start adding to the position again in the near future, absent any significant developments.
Bank of America was Berkshire's second-largest holding as of last summer. But over the last three quarters, Berkshire has trimmed its stake in the company by 39%. Bank of America remains Berkshire's third-largest holding based on the company's most recent 13F filing with the Securities and Exchange Commission. But Buffett may have continued selling the stock in the second quarter.
NYSE: BAC
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Berkshire's original stake in Bank of America came from stock warrants received in connection with preferred shares Buffett picked up in 2011 through a special deal he made while Bank of America was struggling. Those preferred shares paid nice dividends, but in 2017, it became more lucrative to own the common stock instead. So, Buffett exercised his warrants and converted the preferred shares into common stock, then proceeded to gradually add to the position through 2020.
Again, valuation seems to be the biggest reason for Buffett's decision to book some profits on his Bank of America investment. The stock's run-up in price has been fueled by expectations that interest rates will decline. Bank of America has longer-dated debt on its balance sheet that struggled when the Federal Reserve was hiking interest rates, but that will leave it well positioned relative to its peers when interest rates decline. But as the stock price climbed over the past couple of years, its price to tangible book value did too. That ratio has exceeded 1.6 for much of the past year. It currently trades closer to 1.7, well above its 10-year average of 1.49.
The investment paying Berkshire $13.5 billion per year
Those massive stock sales put a lot of cash in Berkshire Hathaway's coffers. As mentioned, Buffett's stock sales outpaced his purchases by $174 billion over the past two and a half years. While a sizeable chunk of that cash went toward paying Berkshire's massive tax bill from last year, almost all of the rest went toward a single investment holding.
As of the end of the first quarter, Berkshire held $314.1 billion in U.S. Treasury bills on its balance sheet. With those bonds delivering an average yield of around 4.3%, the company is in line to collect $13.5 billion in 2025 just from interest on its government bond holdings. That number could climb higher if Buffett buys more T-bills throughout the year.
A $13.5 billion payout for doing nothing but supporting the U.S. government isn't a bad deal. Berkshire's total income from operations in 2024 was $47.5 billion. But Buffett has made it clear that he would rather invest Berkshire's growing pile of cash (Treasury bills are considered a cash equivalent) in equities instead of bonds.
"Berkshire shareholders can rest assured that we will forever deploy a substantial majority of their money in equities," Buffett wrote in his 2024 letter to shareholders.
NYSE: BRK.B
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The challenge Buffett currently faces is that most stocks on the market are expensive from a valuation standpoint. That's especially true for stocks that he could buy in quantities large enough that they could actually move the needle for a giant like Berkshire Hathaway. With nearly $350 billion to deploy, Berkshire's universe of investable stocks is limited to those with large market caps that can absorb billions of dollars of capital. Unfortunately, large-cap stocks trade at much higher valuations these days. Illustrating that trend, the S&P 500's forward P/E ratio has climbed above 22 to one of its highest levels since the dot-com bubble, save for a few quarters in 2020 and 2021 (ahead of the 2022 bear market).
If Buffett were a smaller investor with just a few million dollars to invest, he'd surely be able to find great opportunities in the market. The small- and mid-cap indices trade for around 16 times expected forward earnings. Even the equal-weight S&P 500 index trades at just 17.6 times earnings, reflecting the fact that smaller members of the index are trading at more attractive values than its largest components.
Investors who take the time to research individual companies outside of the largest and most well-known names in the market can find some great companies worth more than their current market values. And if you consistently buy those stocks, you can generate excellent returns over the long run.
