FX168 Financial News Agency (North America) News Warren Buffett is one of the most famous figures on Wall Street. Part of the reason is his net worth of approximately $140 billion, and part of the reason is that he has built Berkshire Hathaway Inc. (NYSE: BRK.A) (NYSE: BRK.B) into one of the largest companies in the world through careful acquisitions and stock purchases.
In fact, since Buffett took control of the company in the mid-1960s, Berkshire Hathaway's stock has averaged an annual return of about 20%, while the S&P 500 Index (SNPINDEX: ^GSPC) has averaged slightly above 10% annually. This outstanding performance adds importance to some capital allocation decisions made by Buffett and his team this year:
As of September 30th, Berkshire's balance sheet shows a record $325 billion in cash and short-term US Treasury investments. The company has never had such a large amount of liquid funds available for investment.
The amount of stocks sold by Berkshire this year has hit a historic high. As of September 30th, net equity securities sales exceeded $127 billion. In absolute terms, this is the most aggressive selling behavior in the company's history.
Overall, Berkshire's record cash position and record stock sales are a historic warning to Wall Street. Buffett and his investment management colleagues are clearly looking for reasonably priced stocks.
However, individual investors should not misinterpret this warning as a reason to avoid the stock market. The reasons are as follows.
History shows that despite Warren Buffett's $127 billion warning, the S&P 500 Index may still rise next year.
Since 2010, Warren Buffett's Berkshire Hathaway Inc. has been a net buyer of stocks for seven years, meaning that its purchases of stock securities have exceeded its sales. In many cases, these events have occurred before a strong rise in the S&P 500 Index in the following year.
Since 2010, in the 12 months following Berkshire becoming a net buyer of stocks, the average return of the S&P 500 index is 14%. In contrast, the average return of the S&P 500 index for all years during this period is 12%. This means that Buffett and his team typically tend to buy stocks before years with above-average returns.
Since 2010, Berkshire has been a net seller of stocks for seven years (excluding the current year), meaning its stock securities sales exceeded its stock securities purchases.
Since 2010, in the 12 months following Berkshire's net sale of stocks, the average return of the S&P 500 index is 11%. Since 2010, the average return of the S&P 500 index is 12%. This means that Buffett and his team typically tend to steer clear of stocks before years with below-average returns.
Investors should interpret this information as follows: history indicates that after Berkshire's net buying of stocks in a year, it is wise to invest more actively, while after net selling of stocks in a year, investment should be less active. However, completely avoiding the stock market in either case is a mistake.
For example, historical data indicates that the expected return rate of the S&P 500 index next year will be 11%. Although this is lower than the 12% annual average return rate since 2010, missing out on these gains would still be an issue and the problem would worsen over time.
Since 2010, in the 12 months following Berkshire's net sales, the cumulative return rate of the S&P 500 index is 141%. However, over the same period, considering all years, the cumulative return rate of the S&P 500 index is 427%. Therefore, investors who selectively hold SP&500 after Berkshire's net buying will perform worse than those holding SP&500 index funds, regardless of whether Berkshire is buying or selling stocks. index fundsSince 2010, in the 12 months following Berkshire's net sales, the cumulative return of the S&P 500 index is 141%. However, over the same period, considering all years, the cumulative return of the S&P 500 index is 427%. Therefore, investors who selectively hold SP&500 after Berkshire's net buying will perform worse than those holding SP&500 index funds, regardless of whether Berkshire is buying or selling stocks.
Berkshire's record cash position is not necessarily a dire warning on the surface.
Investors should not overinterpret Berkshire's record $325 billion cash position for another reason. While it certainly indicates that Buffett and his investment managers are working hard to find reasonably priced stocks, Berkshire's investment choices are limited by the size of the company.
Specifically, as of September 30th, Berkshire's stock investment portfolio is valued at $272 billion, meaning it represents over 40% of the company's $629 billion book value (which is a good representation of intrinsic value). Few stocks are large enough to have a significant impact on the company's book value. Buffett himself mentioned this issue in the latest shareholder letter:
Only a few companies in the USA can truly drive Berkshire's growth, and investors have been endlessly picking them. Outside the USA, Berkshire's capital allocation is essentially without meaningful options. In short, investors cannot expect jaw-dropping performance.
It needs to be clear that stock prices are historically expensive. The current expected P/E ratio of the S&P 500 index is 21.3 times, higher than the five-year average expected P/E ratio of 19.6 times. However, investors should not interpret Berkshire's record cash position as a sign that there are no stocks worth investing in. On the contrary, they should see it as a warning to carefully consider valuation before buying stocks.
