Saturday, November 23

Warren Buffett is unwinding his most profitable trade in history, filling Berkshire Hathaway’s coffers with cash. But it is unclear if the Oracle of Omaha is ready to go elephant-hunting with his recent bounty.

Buffett last Saturday revealed that he had continued to slash his position in iPhone maker Apple and other stocks in the third quarter, generating $97bn in gains for Berkshire Hathaway, the sprawling industrial-to-insurance conglomerate he has controlled since 1965.

By crystallising a gain, Buffett has raised Berkshire’s cash levels to unprecedented heights. At $325bn, cash now accounts for 28 per cent of Berkshire’s asset value — the highest level since at least 1990. And it has left his followers attempting to pinpoint the motivation for the sale.

Some investors and analysts believe Buffett, who trained under legendary value investor Benjamin Graham — first at Columbia University and then at Graham’s investment firm — is sticking to his principles. They point to Apple’s relatively high price-to-earnings ratio compared with its potential earnings growth.

Apple warned investors this week that its future products may never be as profitable as the iPhone, as it ploughs capital into artificial intelligence to try to catch up with rivals including Google owner Alphabet.

Others believe something else is afoot, given Buffett’s praise for Apple over the years and a dearth of other investment opportunities, which the 94-year-old has repeatedly lamented. They have been left asking if Buffett is creating a runway for his successor, or if he sees a crisis on the horizon, giving him reason to raise cash.

“It is such a strange thing to see . . . [and it] begs the question, ‘Why is so much cash being built up?’” asked Morningstar analyst Greggory Warren.

Warren said he did not believe Buffett was poised to clinch one of the mega acquisitions that came to epitomise his investment playbook, given his trouble competing with other buyers. Nor is Berkshire stepping in to provide capital to giant US businesses like Intel that have sought out tens of billions of dollars of capital to fund their operations.

Buffett has also limited his buying of other stocks this year, purchasing equities worth just $5.8bn through the end of September. That sum is dwarfed by the $133.2bn of stock sales Berkshire has executed.

The sales have reduced the equity risk Berkshire is taking and gives it ample liquidity to invest, which it has put to work in past times of stress. But some investors sense other reasons for the shift.

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Jeff Muscatello, a research analyst at Berkshire investor Douglass Winthrop, said that valuation was unlikely to be “the entire reason” Buffett had been cashing out.

“The nearing inevitable management transition makes it an opportune time to clear the decks for the next generation,” he said.

Warren of Morningstar agreed, saying it was cash that Greg Abel, Buffett’s heir apparent, would be likely to put to work.

“[Buffett] has been a bit more cognisant about how he talks about Berkshire and the future,” Warren said. “He knows he won’t be there that much longer. He doesn’t necessarily want to saddle the guys with situations they have to deal with.

“He wants Greg to have as large of a cash pile to work with,” he added.

Line chart of Cash and cash equivalents as a percentage of Berkshire’s assets (%) showing Berkshire’s cash position surges to new heights

Berkshire has always run a large cash position, in part to satisfy regulations that it has enough liquidity in its investment portfolio to pay out future claims from its mammoth insurance operation.

The investment in Apple dates back to 2016 when the company bought just under 10mn shares worth $1.1bn. The purchases were a shock, given Berkshire had long avoided fast-growing technology companies. As recently as 2012, Buffett had told shareholders that even with its growing profitability, he “wouldn’t want to buy” Apple.

The initial investment was made by Buffett’s deputy Ted Weschler, according to a person with knowledge of the matter. In the months that followed, Buffett himself came to appreciate the company’s business model, won over by the amount of time customers spent using their iPhones and that few were willing to switch to a competitor once they had bought one.

Buffett soon followed Weschler with his own buying spree, and alongside a small fund run by a subsidiary, Berkshire amassed a 5.9 per cent stake in Apple. At its peak last year, the position was worth nearly $178bn. Quarterly disclosures analysed by the Financial Times suggest that Berkshire spent about $39bn.

Acolytes of the investor say there are good reasons to take Buffett at his word: that he finds the return on short-term Treasury bills more attractive than the “alternative of what’s available in the equity markets”, as he said in May.

“Stocks, including Apple and Bank of America, haven’t become cheaper since then,” said Bill Stone, chief investment officer of Glenview Trust. “It seems like it might be just that simple.”

The iPhone maker’s shares trade at more than 30 times its projected earnings over the next year, according to FactSet. Darren Pollock, a fund manager at investment group Cheviot and a Berkshire shareholder, notes that when Buffett was buying, that multiple was closer to 12 or 13 times and that “Apple was growing at a significantly faster rate”.

“When stocks are overvalued, Berkshire’s cash piles up because Buffett is finding less and less to buy,” Pollock added. “He’s not a market timer. Selling down Apple and having this much cash in a richly valued market is classic Buffett.”

Investors will have to wait another three months before they know for sure. The company told the FT that Buffett was waiting to share any thoughts on the matter for his annual letter due in February.

https://www.ft.com/content/4ebb68c0-b568-414e-9c70-89b7cd1508c9

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