Buffet’s investment ethos is based on value and dividend growth compounding. It’s fair to say that the approach, when considered in print form at least, fails to generate the same amount of mystery as strategies based on ‘high-gamma Dax puts’ or ‘relative value fixed-income arbitrage.’ When presented in chart form, the returns of Buffet’s approach demand a second look.
The comparison with the S&P500 is fair and valid; the portfolio of Berkshire Hathaway Inc (NYSE: BRK.A) mainly draws on stocks that make up that index. While the orange line looks to be flat-lining, it’s showing a +100% return to capital. It’s just that Buffet’s approach has outperformed, by some margin.
Dubbed ‘the sage of Omaha,’ Buffet has a legion of followers. While his buy-and-hold approach might not be for everyone, his fund and its ethos are a significant element within the investment space. The statistics point to the investment approach having been incredibly successful over the past decades. The $707bn of assets managed by Berkshire Hathaway need to move into the market somehow. This buying action can generate shorter-term moves which create opportunities for traders with a near-term horizon. Knowing where Buffet and his almost trillion dollars of capital are heading is no bad thing.
The returns generated by his approach vouch for the fact that there are few more powerful long-term investment strategies. His investment vehicle, Berkshire Hathaway (BH) invests in companies with sustainable profits, which can pay and grow their dividends and generate exponential growth.
Industry site Gurufocus provides a tracker for those keen to get a feel on the changing structure of the BH portfolio.
The collapse in the share price of airlines might encourage some to try and pick the bottom of the market. Those tempted by low prices may want to consider Buffet’s move out of the sector. Entering 2020, BH owned significant stakes in the four largest US airlines. At the weekend he announced that in the wake of the COVID-19 crisis he had sold them all.
The weekend saw more pressure on airlines as the operators introduced health and safety policies. Delta and American Airlines will require passengers to wear a mask or other face-covering in the check-in area, premium lounges, boarding gate areas and aboard the planes for the whole flight. The move is intended to try to restore some confidence in the sector, but it’s not a good look to have.
Both measures can be expected to put more pressure on airline stocks. At the open on Monday, LSE listed International Consolidated Airlines Group SA (LON: IAG) was down -2.05% in early trading compared to the broader UK100 index which was down -0.60%.
The extra volatility in airline stocks will provide opportunities for those who scalp short-term retracements but stop losses will be crucial to avoid the losses on bad trades outweighing good. If Buffet’s comments and positioning are anything to go by the sector is in for a bumpy landing. Explaining his move out of the sector, he said:
“We made that decision in terms of the airline business. We took money out of the business basically even at a substantial loss.”
“We will not fund a company … where we think that it is going to chew up money in the future.”
Source: The Global Mill
The Berkshire Hathaway AGM usually attracts a crowd. There is something of a jamboree feeling to proceedings as participants discuss dividend yields and price/earnings ratios. Devotees of the strategy have typically done well and can afford the time and money to meet up and back-slap each other. This year due to the COVID-19 pandemic the conference hall was occupied by a handful of attendees, all observing social distancing. Something else that was different was the amount of cash Buffet has sitting on the side-lines.
Berkshire’s cash pile is currently $137bn in size and represents a massive opportunity cost. At 2% annual inflation, it’s a yearly loss of $2.68 billion in purchasing power. The suggestion is that the refusal to snatch up shares in the Q1 meltdown leaves Buffet bracing himself for a prolonged bear market? Of course, it could be that he just missed the boat.
It appears Buffet was waiting for the panic to reach extreme levels so that one of the firm’s more lucrative strategies could be put into effect. BH has historically made considerable returns by waiting for major corporations to reach a point of distress so that they require a bailout. Investing in good companies with cash flow problems is where BH finds the widest margins. One example of the scale of the potential gains dates back to the financial crash and BH taking a stake in Bank of America. Cashing out stock options six years later BH made a quick $12 billion and became the financial institution’s largest shareholder.
Buffet explained that this time the approach had been undone by the US Fed. He said:
“We did not see anything attractive. A lot of companies got the chance to refinance because of the actions of the Federal Reserve.”
Source: Warren Buffet
Bank of America stock has not rebounded as fast as the broader market and still sits below its 50% retracement. If Berkshire Hathaway is looking to build a position, then there is a groundswell of support for bulls of the stock.
Bank of America – Daily candles – Aug 2019 – 4th May 2020
Such deals may be out of the reach of smaller investors, but the salient lesson is that the COVID-19 crash has not created the same opportunities. Those with smaller cash piles will also be wondering if the March low was a missed opportunity.
While Buffet and his team might not see too much value in the market at the moment, they appear to be reducing the odds on an apocalyptical scenario panning out:
“The range of possibilities has narrowed now vs when this started. It is not as bad as it could have been nor is it as good as it could have been.”
Source: Warren Buffet
Berkshire appears to be still strongly weighted towards financials. For those looking for the next trend, it seems likely that some of the $137bn sitting idly by is put to use in long bank positions. The depressed prices of bank stocks are a reflection of the underlying fear running through the economy. Buffet has seen situations like this before and offered some advice borne from his time in the markets. He said:
“Nothing can basically stop America, the American miracle, the American magic has always prevailed and it will do so again … In World War II, I was convinced of this.”
“I was convinced of this during the Cuban Missile Crisis, 9/11, the financial crisis.”
The mega-deals Berkshire Hathaway conducts during market meltdowns are a considerable ‘kicker’ to their returns. These are out of scope for smaller investors, but the core of the investment philosophy can still drive market prices. Buffet has himself said that the days of Berkshire Hathaway wildly outperforming the S&P500 are over. Picking individual stocks, he says, comes with additional risk and he suggested at the AGM that a perfectly good way for investors to participate now is to buy into the S&P 500 index.
The uninvested cash indicates that the value may not be there for Buffet to wade into the markets. He does appear to be indicating a green light for investing in equities. Trade entry at the right price will be essential, but for Buffet, the downside is becoming less of a concern.
It was Buffet who in 2008 famously bet Protege Partners, the hedge fund manager, that a portfolio of hedge funds would not beat the S&P 500 over ten years. He won the bet and donated his $1 million prize to charity.