Week 125 - Berkshire Hathaway’s Stock Portfolio

Situation: We have called Berkshire Hathaway a “hedge fund for the masses” (see Week 101). It has almost a hundred wholly-owned subsidiaries, but also has a common stock portfolio that currently represents 34% of its market capitalization. With respect to risk vs. reward, that portfolio behaves quite differently than the company as a whole (see Week 101). On November 14, 2013, Berkshire Hathaway filed Form 13F with the US Securities and Exchange Commission (SEC), as required. That 3rd quarter update details Berkshire Hathaway’s common stock portfolio as of 9/30/13. Over 40 companies are on the list but only 15 have a dollar value greater than 1% of the entire list’s value. Our analysis of these companies is in this week’s Table but excludes two on the list  because the stocks were issued too recently for analysis (Phillips 66; General Motors).

We like to follow Berkshire Hathaway closely because “financials” and “information technology” are the riskiest of the 10 S&P industries. Those industries are the growth engine of our economy, and who better to look to for guidance than Warren Buffett. If your portfolio doesn’t include any stocks issued by companies in those two categories of industries, it will underperform the S&P 500 Index by a significant margin. Remember, the oldest rule for investors is the greater the risk, the greater the reward. That doesn’t leave you getting much sleep at night, so we ask you just to remember that the greater the risk, the greater the volatility. Berkshire Hathaway is important because it is mainly an insurance company and that is the only sub-industry among financials that we find to be worthy of your attention as a retirement investor (see Week 101, Week 117, Week 122). The others are Chubb (CB), HCC Insurance Holdings (HCC), and WR Berkley (WRB). You may take the position that those companies have to pay out more for property damage due to weather-related events amplified by global warming. That’s true, but then those property and casualty insurers follow up by raising their premiums a lot higher. 

Berkshire Hathaway sailed through the Lehman Panic (Column D in Table) without losing as much as our benchmark stock/bond index fund (VBINX), while beating Vanguard’s S&P 500 Index fund in every rolling 5-yr period over the past 30+ yrs. However, that record may come to an end on December 31st (see Column F in the Table). This has all been accomplished with low volatility (current 5-yr Beta = 0.25) and below-average valuations (current P/E = 15). What’s not to like? Well, two things. One is that Warren Buffett has total executive control in managing Berkshire Hathaway, and he’s getting on in years. Another is that his style of governance (delegation of authority to subsidiary company CEOs) doesn’t measure up to current standards of “due diligence.” That means investors in Berkshire Hathaway need to know the moving parts of the company, and attend the annual meetings in Omaha (or at least read the annual reports). I’ve been doing that for years and have reached the conclusion that Berkshire Hathaway is in reality two companies. One is composed of the wholly owned subsidiaries; the other is composed of the common stock holdings.  

Looking at the Table, we see that the 13 largest stock holdings represent 87% of the common stock portfolio and 30% of Berkshire Hathaway’s market capitalization. Breaking down the dollar value of those stock holdings, we see that 44.4% is invested in four financial services companies (WFC, MCO, USB, AXP). American Express (AXP) and Wells Fargo (WFC) represent almost 39%! Taken together, those 13 companies performed better than the S&P 500 Index (VFINX) over the past 10 yrs (Column C) and almost as well over the past 5 yrs (Column F), yet with significantly less volatility (5-yr Beta = 0.82 vs. 1.00 for the S&P 500 Index; losses during the Lehman Panic were 35.7% vs. 46.5%). The 4 financial services companies have a 5-yr Beta of 1.02 and the two largest (WFC & AXP) have a 5-yr Beta of 0.94, whereas, a mutual fund that comes close to being an index fund for the financial services sector (PRISX in the Table) has a 5-yr Beta of 1.15. Now, bear in mind that Warren Buffett made these huge bets on AXP and WFC decades ago, apparently to achieve outperformance during bull markets at the expense of underperformance during bear markets. Note: red highlights in the Table denote values that underperform the benchmark stock/bond index fund (VBINX). 

Bottom Line: Over 45% of Berkshire Hathaway’s stock portfolio is invested in financial services companies, yet the portfolio has a 5-yr Beta that is 29% less than for a fund that is close to being a financial services index fund (PRISX). The portfolio differs from the remaining 66% of Berkshire Hathaway in being somewhat more risky in terms of 5-yr Beta and losses during the Lehman Panic. In fact, its stock portfolio has metrics that are similar to those for the S&P 500 Index Fund (VFINX) except better (Table). That outperformance is due to the 44% of the portfolio’s net asset value that is contributed by 4 financial services companies. The surprise is that the portfolio’s volatility is so much less than one would expect. To summarize, Berkshire Hathaway as a whole acts like a hedge fund in that it performs well when the market is down but tends to lag behind when the market is up (see Column F in the Table and our Week 101 blog). The stock portfolio is a crucial factor because it saves Berkshire Hathaway from lagging even more when the market is up, since those stocks tend to track the market whether it is moving up or moving down (see Columns C&F in the Table). That stock portfolio is helping Berkshire Hathaway exactly where it needs help and when it needs it.

Risk Rating: 4

Full Disclosure: I own stock in Berkshire Hathaway and make monthly additions to DRIPs in Wal-Mart Stores, Procter & Gamble, IBM, Exxon Mobil, and Coca-Cola.

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