Some Insights from Berkshire's Latest 13-F Filing
We see opportunity arising from recent weakness in Berkshire's equity portfolio.
Berkshire Hathaway (BRK.B) (BRK.A) recently filed its quarterly 13-F statement with the Securities and Exchange Commission. The filing revealed few significant changes in the composition of the firm's equity portfolio in the fourth quarter of 2008. The overall market value of the portfolio deteriorated sharply (about 25%) from the third quarter to the fourth quarter, which is not a surprise in light of market conditions. Together with estimated losses from Berkshire's equity put option positions (see the Stock Strategist article "Our Take on Berkshire's Equity Put Option Positions"), the firm's equity portfolio performance will likely contribute significant losses in the firm's upcoming report on fourth-quarter earnings. From a longer-term perspective, however, we see the recent and possible near-term future weakness in Berkshire's shares as a compelling investment opportunity.
Warren Buffett penned an op-ed piece in October 2008 in The New York Times titled "Buy American. I Am." One might question why Berkshire didn't pursue greater buying activity in the fourth quarter in light of that article, at least on the face of the 13-F filing. But it's worth noting that the firm has been quite active in taking senior equity positions in long-successful companies that have been hit relatively hard by the financial and economic crises. These large transactions required the application of much of Berkshire's previously massive cash position, and included stakes in preferred shares in Goldman Sachs (GS), General Electric (GE), and Harley Davidson (HOG). These multibillion-dollar purchases fall outside of Berkshire's 13-F filing, and they also fall outside the realm of opportunities available to most ordinary investors. Berkshire managers continue to work for their shareholders as the firm applies valuable capital to attractive investment opportunities.
Some of Berkshire's largest common-stock position changes in the fourth quarter were actually sales, including two of the firm's better-performing holdings. Berkshire sold half of its stake in Johnson & Johnson (JNJ), the best-performing stock in the past few years among its largest seven holdings. Berkshire also shaved about 10% of its position in Proctor & Gamble (PG). Berkshire still has a substantial position in both of these firms, however, and Morningstar analysts currently have each of these wide-moat stocks rated at 5 stars (Consider Buying). On the buying side, Berkshire added to its holdings in Burlington Northern (BNI) and Ingersoll Rand (IR), and established a new position in Nalco (NLC). We currently have Burlington Northern, Ingersoll Rand, and Nalco rated at 5 stars.
Rather than focusing too closely on short-term changes in the composition of Berkshire's common stock portfolio, we are using the latest 13-F filing to briefly review Berkshire's record from a longer-term perspective. It has clearly been a tough external environment recently; in fact, the market downturn has been so severe that it has cut significantly into longer-term performance records for many managers.
From December 1998 to December 2008, a volatile 10-year period whose endpoints generated a 25% decline in the S&P 500 (even in nominal terms, before inflation), Berkshire Hathaway's equity investments rose from $39.8 billion to more than $60 billion. The growth in Berkshire's aggregate portfolio reflects the allocation of cash flow arising from insurance and other businesses, of course, as well as stock performance. But Berkshire's effective stock selection also played a role--one that has continued to display itself recently, on average, among the firm's largest holdings.
Since Jan. 1, 2008, the S&P 500 has fallen almost 45%, with most of those losses arising since midyear 2008. But Berkshire's seven largest holdings at the outset of 2008 (which made up about 75% of the portfolio market capitalization) have outperformed the S&P 500 significantly, on either a simple or weighted-average basis. This despite the fact that Berkshire is relatively heavily weighted in financial stocks, and its Wells Fargo (WFC) and American Express (AXP) holdings have been significant drags. We currently have both of those firms rated at 5 stars as well. For that matter, one doesn't have to look very hard to find stocks in Berkshire's portfolio that we recommend these days, given the market's swoon. (A complete list of Berkshire's latest 13-F holdings and our ratings on those stocks is at the bottom of this article.)
Berkshire's investment record highlights a broader and very interesting investment issue. Last year, we had one of the roughest years for equity ownership since World War II. How have insurance companies whose investment portfolios carry a relatively large allocation to stock holdings (relative to government debt, corporate bonds, and other fixed-maturity investments) stacked up against other insurance companies? One would think those insurers who were invested relatively heavily in equities did worse in the stock market. But that isn't the case, in general or at Berkshire Hathaway.
We've taken a close look at the investment portfolios of 80 insurance companies that we follow here at Morningstar. For that group as a whole, as well as a subset of about 20 larger property & casualty insurance and reinsurance companies, the share of equity in a firm's investment portfolio last year was not significantly associated with the firm's performance in the stock market. The two things that do seem to matter are, first, the share of mortgage and other asset-backed securities in total investments, as well as the amount of capital backing the total investment portfolio. The higher the weighting of investments in mortgage and asset-backed securities, the worse the firm did in the stock market, and the higher the level of capital relative to investments, the better the firm did in the stock market. Berkshire is a relatively heavy investor in equities, but it also has a high level of capital relative to its investment portfolio, and it avoided much of the mess in structured finance that ensnared other insurers.
In some important and underappreciated ways, the equity markets have actually been performing relatively well in the past year or so. At a time when markets for a lot of fancy structured debt vehicles were frozen up, liquidity could easily be had by selling stocks last year. Stock markets performed well from a liquidity standpoint for institutional and mutual fund companies being pressed to raise cash. This can help explain how stock prices have fallen so significantly and pervasively below the fair value estimates we have developed using longer-term assumptions here at Morningstar.
We do not view Berkshire's latest 13-F filing or its equity portfolio with a great deal of alarm. Berkshire's stock has fallen so far as to approximate its book value at the end of the third quarter, a rare thing. Fourth-quarter losses may cut into Berkshire's book value significantly, but getting Buffett et al. anywhere near book seems like a bargain.
|The Berkshire Hathaway Portfolio|
|American Express Co. (AXP)|| |
|Burlington Northern Santa Fe (BNI)|
|CarMax Inc. (KMX)|
|Comcast Corp (CMCSA)|
|Costco Wholesale Corp. (COST)|
|Eaton Corporation (ETN)|
|General Electric Co. (GE)|
|Home Depot (HD)|
|Ingersoll-Rand Company Ltd. (IR)|
|Johnson & Johnson (JNJ)|
|Kraft Foods (KFT)|
|Lowe's Companies (LOW)|
|M & T Bank Corporation (MTB)|
|Nalco Holding Company (NLC)|
|Norfolk Southern Corp. (NSC)|
|Procter & Gamble Co. (PG)|
|Sun Trusts Bank Inc. (STI)|
|Torchmark Corp. (TMK)|
|Union Pacific Corp. (UNP)|
|United Parcel Service (UPS)|
|UnitedHealth Group Inc. (UNH)|
|US Bancorp (USB)|
|USG Corporation (USG)|
|Wellpoint Inc. (WLP)|
|Wells Fargo & Co. Del (WFC)|
|Wesco Finl Corp. (WSC)|
|NRG Energy, Inc. (NRG)|
|Wal-Mart Stores, Inc. (WMT)|
|Bank of America Corp. (BAC)|
|Gannett Inc. (GCI)|
|Iron Mountain Inc. (IRM)|
|Washington Post Co. (WPO)|
|Constellation Energy Group (CEG)||Under Review|
|Comdisco Holding Co. (CDCO)||Not Rated|
|Wabco Holdings Inc. (WBC)||Not Rated|
Berkshire Hathaway holdings as of 12-30-08. Star ratings as of 2-18-08.
Bill Bergman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.