Warren Buffett is perhaps the best-known proponent of buy-and-hold investing. By putting money in the market and leaving it there, the famous investor has been able to build his Berkshire Hathaway conglomerate into a business valued at over $920 billion.
It may seem strange, then, that Berkshire is currently holding about $277 billion in cash and cash equivalents. Just why is Buffett opting to hold this much cash instead of investing it, and will he be able to find a use for this stockpile anytime soon?
Understanding the Berkshire Cash Hoard
Although it has reached new record heights, a large cash reserve has almost always been a feature of Berkshire Hathaway.
About $30 billion is a permanent backstop the company keeps to fund potential payouts from its insurance businesses. The rest of the money has been built up over many years by Berkshire’s wholly-owned businesses, stock sales and dividends from the company’s portfolio.
During Q2, Buffett added significantly to the already impressive reserve of about $189 billion by selling roughly 390 million shares of Apple. The tech stock, by far Berkshire’s biggest holding, is up nearly 20% over the last 12 months.
Even after the selling in Q2, Apple still accounts for about 30% of the Berkshire’s equity portfolio. This move was likely made to limit Berkshire’s risk in Apple, as the stock may have made up too much of the portfolio even for Buffett’s relatively concentrated investment approach.
Another reason Buffett has alluded to is that he’s capturing gains at a time when the tax rate is more favorable than what he expects it to be in the future.
Given that Apple is still by far Berkshire’s largest holding, it doesn’t seem that Buffett has actually soured on the company itself.
Having ample cash on hand to deploy rapidly has also been a prime investing tool for Buffett and Berkshire over the years. In 2008, for instance, Berkshire rescued Goldman Sachs by injecting $5 billion into the bank at a time when few financial businesses had money to lend.
The ability to deploy such large amounts of money during economic downturns or periods of business turmoil has helped create Berkshire as it exists today.
Why Isn’t the Oracle of Omaha Finding Deals Right Now?
In large part, the fact that Buffett is holding so much cash has to do with the fact that the market as a whole looks quite expensive right now.
As a value investor, Buffett’s approach is to buy stocks that are trading significantly below their intrinsic value or buy great companies at fair prices.
Enthusiasm for AI and the perceived achievement of an economic soft landing by the Federal Reserve, among other factors, have driven stocks to unusually high valuation multiples over the past two years. If earnings growth fails to keep pace with expectations, however, many of the market’s leading stocks may ultimately prove to be overvalued.
The high price of the market at large is further shown by the so-called Buffett Indicator, a ratio of the total value of the stock market to total GDP that is favored by Buffett personally.
At the moment, this indicator is running far above its historical average, suggesting that stocks are significantly overvalued.
It’s important to note that this ratio only applies to the total US stock market, meaning that there could still be undervalued stocks even in a market that is, broadly speaking, overvalued.
The problem is that undervalued buys are few and far between among large-cap companies. As Buffett has personally acknowledged many times, the number of companies in which Berkshire can make meaningful investments at this point in its history is quite small.
Berkshire’s size and the scale of its cash stockpile prevent it from being able to effectively deploy significant resources into all but fairly large companies.
The Allure of Cash at Higher Interest Rates
A final factor that is making Buffett comfortable with cash is the fact that interest rates have risen enough to make US treasuries an attractive holding.
While stock prices are too high for Buffett’s liking, treasury bills are yielding about 5 percent. Since this is where Berkshire keeps most of its cash stockpile, the company can receive this rate of return at very low risk levels while waiting for appealing investment opportunities to come along.
The sheer scale of Buffett’s investment in treasury bills was demonstrated by a recent JPMorgan report that found Berkshire controlled about 3% of the total market for these benchmark debt instruments.
Unless Berkshire can find new investments that allow it to deploy large amounts of cash, it’s likely that the company’s treasury holdings will only continue to grow.
Why Is Buffett Holding So Much Cash?
Buffett is holding so much cash so he can pay out claims from insurance operations and have ample capital to buy undervalued assets if the market sells off.
Taking the factors mentioned above into consideration, a fairly clear picture of why Buffett is holding so much cash begins to emerge.
To begin with, Berkshire as a business is naturally cash-heavy. Between a large reserve required for insurance payouts and a number of wholly-owned businesses that continue to generate free cash flow, the company as a whole will generally tend to accumulate enormous amounts of cash over time.
Buffett’s historical use of this cash to make large, dramatic investments when opportunities arise means that it’s generally advantageous for Berkshire to have plenty of extra cash on hand.
Market conditions, meanwhile, explain why Buffett hasn’t been as eager to deploy capital recently. An expensive stock market driven up by expectations of high earnings growth from AI has left little room for the kind of value buying Buffett favors.
At the same time, the relatively high yields of treasury instruments allow Buffett to generate significant gains from Berkshire’s cash reserve without taking on much risk. Under these conditions, Buffett can afford to wait until really attractive investment opportunities come along and has very little pressure on him to act before then.
Buffett himself largely confirmed this view in comments made during Berkshire’s annual shareholders meeting in May. Deploying a variation on a baseball analogy he’s used repeatedly over the decades, Buffett explained to his shareholders that he wasn’t deploying cash because “We only swing at pitches we like.”
During the same meeting, he also explained that his criteria for investing in today’s market would be an opportunity that he believed could make Berkshire a large return at a very low level of risk.
As to whether Buffett will find such an opportunity anytime soon, much will depend on whether the market corrects. Earlier this week, stocks sold off sharply on concerns around higher unemployment in July and the possibility of another recession on the horizon.
While the market has pared its losses since then, the selloff may indicate that investors are beginning to question the high valuations currently associated with US stocks.
If a deeper or more lasting market decline occurs, Buffett may once again have the opportunity to buy large stakes in undervalued companies. Until then, it seems he’s content to stay at the plate and wait for a pitch that appeals to him.
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