Warren Buffett's buying again. After sitting on tens of billions of dollars in cash for several years, the Oracle has started to employ that money. Though Berkshire Hathaway has sold or reduced its positions in Mueller Industries (NYSE:MLI), Gap (NYSE:GPS), and ServiceMaster (NYSE:SVM), it's been buying more than selling. Its cash is down and its equity portfolio is up, thanks to a number of large-cap purchases in the past year, including Sanofi-Aventis (NYSE:SNY) and First Data (NYSE:FDC).
And there's a reason he's buying now. Large caps are cheap overall, and some large caps are trading at huge discounts to their fair value.
Go big or go home
"Yeah," you might say, "but what have large caps done lately? Don't you have to be in small caps to make big money?"
That's certainly been true the past few years. Since 2000, there have been a few large caps that have outperformed, but large caps overall, as measured by the S&P 500, have lost roughly 2% annually. Small caps, on the other hand, have done much better -- the Russell 2000 has returned 6% annually over the same time period. So yes, small caps definitely have been the place to be of late.
But do you really want to buy the asset class that's already had a nice multiyear run? Or do you want to buy the companies that have been growing for more than half a decade, but are trading at lower prices now than they were back then? For me, the answer is simple: I don't want to own the outperformers of the recent past. I want to own the stocks that will shoot the lights out in the future.
And that means buying large caps now.
Don't believe the hype
Despite rumors to the contrary, large caps can yield excellent returns if you buy them at the right time. During the 1990s, the compound annual return of the S&P 500 was 15%, easily outperforming the 11% annual return of small caps. It's just a matter of buying these massive companies at great prices.
And if you picked up some of the large caps with the biggest competitive advantages, your returns would have been even better. Even before dividends, Procter & Gamble (NYSE:PG) earned shareholders a 20% compounded annual return during the 1990s. By 1990, Walgreen (NYSE:WAG) had more than a thousand drugstores and sold billions of dollars of goods each year. Yet during that decade, it had an annual compound return of 26%, again, not counting the dividend.
Many large caps got to be large caps because they're relentless growers. If you can find a relentless grower trading at a discount, it can be extremely lucrative.
The Foolish bottom line
Philip Durell, the lead advisor for the Motley Fool Inside Value newsletter, recently summed up the situation: "When I first started Inside Value, I figured that most of the stocks I'd recommend would either be obscure or going through temporary tough times. But certain large caps are so cheap that they're incredibly compelling investments right now."
You can read about all of Philip's picks -- including his favorite large caps -- by clicking here for a free 30-day trial to Inside Value.
This article was originally published on June 1, 2006. It has been updated.
Fool contributor Richard Gibbons has several big ideas and many Foolish ones. He owns shares of First Data, but does not have a position in any other security discussed in this article. Gap and First Data are Inside Value recommendations. Gap is also a Stock Advisor recommendation. ServiceMaster is an Income Investor pick. The Motley Fool has adisclosure policy.
