Situation: In case your reason for buying stocks in your working years is to have a growing income from dividends in your retirement years, this blog has emphasized “value stocks.” The bible of value investing is Benjamin Graham’s book: The Intelligent Investor. His most famous student is Warren Buffett, who graduated from Columbia University in 1951 with a Masters Degree in Economics.
Why value investing, and what is a value stock? The central thought is to discipline yourself not to overpay for earnings and/or assets (“book value”). On page 349 of the Revised Edition (1973) of The Intelligent Investor, Benjamin Graham says “Current price should not be more than 1.5 times the book value last reported. However, a multiplier of earnings below 15 could justify a correspondingly higher multiplier of assets. As a rule of thumb, we suggest that the product of the [earnings] multiplier times the ratio of price to book value should not exceed 22.5.” In other words, 1.5 times 15 equals 22.5.
How do you calculate the “Graham Number” or rational stock price? It is the square root of 22.5 times Earnings Per Share for the Trailing Twelve Months (TTM) times Book Value per share for the most recent quarter (mrq). We suggest that you think of the share price of a value stock as being no greater than: a) twice the Graham Number, b) 25 times the 7-year average for Earnings Per Share (see page 159 of The Intelligent Investor), and c) no more than 4 times Book Value per share. When you purchase a stock meeting those 3 requirements, it is demonstrably worth what you paid for it. The details are shown in Columns AA-AE of Tables accompanying our recent blogs.
Berkshire Hathaway’s stock portfolio contains 46 holdings worth $201,828,368,888 as of the last 13F SEC filing dated 8/14/19. The top 5 holdings (AAPL, BAC, KO, AXP, WFC) are worth $133,600,000,000 (66% of the total). Eight of the 46 companies have issued A-rated value stocks, since the company meets the following 4 criteria: 1) its bonds are rated A- or better by Standard & Poor’s (S&P), 2) its stocks that are rated B+/M or better by S&P, 3) its stocks have the 16+ year trading record that is required for quantitative analysis using the BMW Method, and 4) its stocks are listed in both the iShares Russell 1000 Value Index (IWD) and the Vanguard High Dividend Yield Index (VYM).
The top 10 stocks in Berkshire Hathaway’s portfolio, listed by valuation, are:
Apple AAPL ($51B)
Bank of America BAC ($25B)
Coca-Cola KO ($21B)
American Express AXP ($19B)
Wells Fargo WFC ($18B)
Kraft Heinz KHC ($8B)
U.S. Bancorp USB ($7B)
JPMorgan Chase JPM ($6B)
Moody’s MCO ($5B)
Delta Air Lines DAL ($4B)
Mission: Use our Standard Spreadsheet to analyze value stocks in the portfolio, based on the 4 criteria listed above.
Execution: see Table.
Administration: Six of the top 10 stocks in the portfolio are not value stocks (AAPL, BAC, AXP, KHC, MCO, DAL). Data for those can be found in the BACKGROUND Section of the Table.
Bottom Line: The 8 A-rated value stocks account for $54 Billion (27%) of the portfolio’s value. These show that Warren Buffett’s area of expertise is not only value stocks generally but financial services stocks specifically, since 5 of the 8 companies are from that industry. The take-home points for retail investors are: a) don’t overpay for a stock, b) buy what you know, and c) remember that the best bargains are often in the Financial Services industry. But those stocks also tend to have the greatest volatility, which is a key reason why they are underpriced.
Risk Rating: 7 (where 1 = 10-year U.S. Treasuries, 5 = S&P 500 Index, and 10 = gold bullion)
Full Disclosure: I dollar average into KO, PG, JPM and JNJ, and also own shares of AAPL and TRV.
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