Any financial advisor worth their salt will tell you that the smartest way to invest is to diversify across many asset classes.
It’s important to own a collection of bonds and stocks, and gain exposure to sectors the vary from real estate to emerging markets.
So, why then does the richest investor in the world, Warren Buffett, keep all his eggs in one basket, Berkshire Hathaway (NYSE:BRK.A) and should you follow his lead?
What Is The One and Only Stock To Invest In?
While most companies have a specific focus, whether that is cybersecurity like Crowdstrike or entertainment like Netflix, Berkshire Hathaway has a wide range of businesses that span numerous industries.
By encompassing a wide gamut of economic areas, Berkshire is cushioned from the wild swings of fortune that can affect any given company.
When growth stocks are no longer in vogue, Cathie Wood’s stocks featured in her ARK Invest flagship fund, ARKK, can suffer huge drawdowns as they did in 2022. But Berkshire Hathaway shareholders managed to enjoy a 20% relative outperformance compared to the market the same year, even when it tumbled by that same amount. And this year with the S&P 500 up 14.4%, Berkshire has largely been trading in lockstep with it.
The reason Berkshire has historically outperformed during market scares is manifold but a primary cause is it has many businesses under its corporate umbrella whose revenues don’t undulate much during turbulent times.
For example, Berkshire’s golden goose is its insurance business that is a massive money-making enterprise in good times and bad. Only the most egregious of natural disasters tends to hurt the insurance aspect of Berkshire’s financials.
Another primary reason for the firm’s outperformance is Buffett’s discipline to only put money to work when certain key metrics are met. One that is widely reported as a hard line in the sand for Buffett is a price-to-earnings ratio of 15x. If one of America’s largest 500 companies is trading below that threshold, Buffett’s lieutenants are charged with letting him know according to a recent interview on CNBC.
Buffett’s discipline to invest only when certain key metrics are met is easy to see in retrospect but the present environment is a good example of seeing it play out in real time. Sitting now on $157.2 billion in cash on the balance sheet, the pressure from media outlets and shareholders alike on Buffett and his right-hand man Munger to deploy cash is significant. But Buffett is holding firm, refusing to allocate it until the opportunity to invest is compelling.
It’s his discipline to sit on cash that allowed him to scoop up bargains during the Great Recession that have sustained Berkshire’s long-term outperformance, beating the market by a full ten percentage points annually, on average.
How Buffett Generates Superior Returns
If there was one factor that separates professional investors from retail traders it’s conviction in the stocks they own. That can seem like a vague term but it boils down to understanding the numbers well. For example, if you know that a company will produce, over the course of its estimated life, $100 million in cash flows yet it’s trading at a market capitalization of just $50 million, it’s likely undervalued.
So, how do you find these hidden gems?
One primary factor that will signal a company can generate above-average returns over the long-term is a wide economic moat.
That’s a barrier which, in spite of capital resources, few if any companies can compete with. A classic example is Coca Cola’s brand advantage, which even Richard Branson couldn’t beat when he famously launched Virgin Cola. Consumers simply were not willing to switch to a different taste because they had grown accustomed and were loyal to Coke.
Other factors that signal a company will deliver better-than-average returns are high profitability, measured most prominently by a high return on invested capital. Coca Cola still has a ROIC of 15.6%, approximately 50% higher than the average S&P 500 firm. It’s no wonder why Buffett keeps it as a core holding.
After more than half a century of performance, Berkshire Hathaway’s ROIC sits at 12.3%, also well above the market average.
Other measures of profitability include a firm’s return on equity (ROE) and return on assets (ROA). Typically you want to see these numbers north of 10-15% over a 5-10 year period to suggest that a company has a barrier that few competitors can encroach upon.
Another key characteristic Buffett looks for is pricing power. Again that can seem like a nebulous term but it’s been very clearly articulated by the Oracle of Omaha when discussing Apple.
Buffett believes Apple enjoys enormous pricing power, meaning it can raise prices without harming demand much.
His question to exemplify the fact is, if an Apple iPhone owner were to be offered $5,000 in exchange for their phone would they accept it?
He doesn’t believe most consumers would agree to the trade and that, in turn, translates to Apple having the ability to raise prices over time without hurting unit volume sales, thereby leading to higher margins and profits.
Over the long haul, it’s become clear that another item Buffett likes when investing is passive income in the form of sustainable dividends.
In order for a dividend to be paid year after year, the company must either possess an economic moat that ensures it can produce predictable cash flows or it must grow revenues so as not to deplete cash reserves to pay shareholders, and ideally it has both.
A company like Coca Cola is the perfect example of ticking both boxes. Indeed, Berkshire Hathaway now enjoys a dividend yield on its original purchase of KO shares that exceeds 50%. By simply holding Coca Cola shares over the long-term and seeing both its top line and dividend yield increase, Buffett made one of Berkshire’s most lucrative bets ever.
Finally, Buffett is keenly aware of market structure and dynamics. He learned the hard way when taking over Berkshire Hathaway, which was originally a textile mill, that a great manager cannot beat a poor industry.
If market size is contracting, such as in the newspaper industry over the past few decades, a great CEO won’t be able to offset the forces of change disrupting the industry.
Berkshire Is A Stock That Has ETF Hallmarks
Looping back to the advice of financial advisors to diversify capital across multiple stocks, bonds, real estate, and other sectors and asset classes, it’s clear that Berkshire, despite being a single equity, actually ticks a lot of these boxes.
It has wide exposure to sectors from candies to real estate and from late-stage, mature technology companies like Apple to early stage high-growth firms like Snowflake.
Even though it seems like an oxymoron to equate a single stock with a diversified holding base, Berkshire is the rare company that achieves it.
So, if you had to pick a single equity, the one and only stock to invest in for the long-term would be Berkshire Hathaway.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.