It’s remarkable how many insights you can gain from simply observing the real-world activities of famous Wall Street investors.
Indeed, while financial gurus like Warren Buffett often provide valuable analysis and opinion, it’s essential to recognize that their actions speak louder than words in the zero-sum game of investing.
And Buffett is a man worth watching. The Oracle of Omaha has increased the value of Berkshire Hathaway’s shares by almost 3,800,000% since 1965, easily beating the S&P 500’s return of just 24,710% over the same period.
However, according to Berkshire’s last two quarterly reports, all is not well at the Nebraska-headquartered multinational conglomerate.
But why does this matter?
Well, Berkshire Hathaway’s influence in the market extends beyond just its financial power. For instance, when the company makes or abstains from taking a significant position in a venture, it can have notable implications for the market.
One of these is perception. Berkshire’s investing decisions signal to traders that a particular company is worth considering, and this attention increases market confidence in its prospects, attracting other investors and potentially driving up its price.
Moreover, Warren Buffett’s involvement lends credibility and validation to a business, as his reputation as a successful investor comes with a hefty dose of gravitas, thus positively impacting a corporation’s image. This validation may lead to heightened interest from investors and improved market sentiment.
With this in mind, let’s take a closer look at Berkshire’s financial statements – and see what kind of message Buffett and his associate, Charlie Munger, are sending about the market.
Some Solid Numbers Mask A Hidden Danger
On the surface of it, Berkshire Hathaway’s last two quarters haven’t been too bad.
For example, the firm’s operating earnings rose 12.6% from $7.16 billion to $8.07 billion for the first quarter of 2023, while in the fourth quarter of the previous fiscal year, its insurance investment income grew 64.1% to $2.00 billion.
And yet, a very worrying trend has emerged. Rather than using the company’s sizable cash reserves to build its investment portfolio, Buffett has been getting rid of his equity securities.
Thus, during the fourth quarter ended December 2022, Berkshire bought just $1.68 billion of stock while selling a whopping $16.32 billion.
Likewise, it was a similar story at the start of this year, too, with $2.87 billion in equity purchases and $13.28 billion in sales.
In fact, taken together, these transactions add up to a princely $25 billion in net disinvestments over the last six months.
Berkshire Can Move The Market
One of the most important things to think about when emulating the Oracle of Omaha’s stock-picking decisions is to consider the share price impact that Berkshire Hathaway’s investment choices can have on the market.
Indeed, when the conglomerate unveils a substantial investment, it frequently suggests to the market that the company in question merits a second look. Investors may construe this as a vote of confidence in the firm’s ensuing prospects, which can result in buying interest.
Consequently, the escalated demand for the stock can push its price up. The market regards Berkshire Hathaway’s involvement as a favorable development – which other investors will seek to emulate.
On the other hand, if Buffett and his team divest their stake – or choose not to invest in a particular business – it can exert an unfavorable influence on the company’s stock price. Berkshire’s withdrawal can trigger selling momentum since investors may regard it as an indication to scale down or liquidate their holdings in the enterprise.
It’s noteworthy that the impact of Berkshire Hathaway’s various investment commitments is not confined to the immediate term either. The response can have a prolonged effect, particularly if other market players see its actions as indicative of the company’s future fortunes.
But what’s especially disturbing right now is that stocks remain relatively overpriced, notwithstanding the onset of a bear market in 2022.
A good way to demonstrate this is to look at the Shiller price-to-earnings (PE) ratio.
The metric offers a long-term perspective on stock market valuation using average earnings adjusted for inflation. It attempts to measure the relative expensiveness or cheapness of the market compared to historical earnings levels, with a high ratio suggesting it may be overvalued and a low ratio implying the opposite.
In fact, the Shiller PE ratio for April through June 2023 is 29.27. Alarmingly, on the last three occasions that the ratio went above 30, the S&P 500 nosedived, losing more than 20% of its value.
Even individual stocks are performing poorly, with some of Berkshire Hathaway’s biggest holdings looking overvalued. Take Apple, for instance, whose price-to-cash flow multiple has skyrocketed from 16.4 at the end of last year to 24.7 today.
Could Berkshire Have Gotten It Wrong?
Although one of the most prosperous investors in history, Warren Buffett is still susceptible to committing errors.
For example, the Wall Street wizard famously got it wrong when he bought IBM in 2011, which, at that time, was viewed as a dependable and profitable operation with robust earnings and an excellent reputation.
Nonetheless, even with his outstanding business acumen, the firm failed to match expectations. Instead of flourishing under Buffett’s guidance, IBM faltered with dwindling revenues and an outdated model that couldn’t keep pace with recent technological advancements.
However, Buffett has an extraordinary history of profitable investing over multiple decades.
His strict adherence to the principles of value investing and long-term strategies has continually produced exceptional returns.
By studying his actions, retail investors can obtain valuable information about his decision-making processes, such as the businesses he chooses to invest in, his preferred industries, and the criteria he employs while assessing viable projects.
This data can constitute a valuable educational experience and aid you in creating your own investment philosophy.
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