Thoughts on Buffett Selling Apple

His investment decisions are not economic or market predictions, but just a byproduct of the huge size of his portfolio and how few stocks he can buy. Below is an estimate of his investment universe.

In the next post, I’ll have an update on some of the companies we’ve discussed recently. Today’s post has some thoughts on Buffett selling Apple.

We found out in May that Buffett is selling some Apple shares. At the time, it seemed like a sizable amount, and since Buffett doesn’t typically trim, it likely meant further sales were coming. Last week, the Berkshire quarterly report indicated a much larger sale.

The sheer size of the dollar amount of the sale is eye-popping (over $100 billion and perhaps climbing), but using Buffett’s history as a guide, I don’t believe this is surprising. While Buffett is known for being a long-term investor, very few of his stock investments are actually permanent holdings. He views stocks of quality companies as safe when they are cheap, but those same quality businesses are risky stocks when they are expensive. And the rare occasions where he didn’t sell a stock that reached fair value, he has occasionally regretted it (more on this below).

One thing his Apple sale is not: a market prediction. I’ve seen all kinds of commentary that references the Apple sale in the context that Buffett is bearish or is predicting a market decline. He has always said he doesn’t have any idea what the market is going to do near term (nor does anyone else). He is not predicting anything bad happening to Apple or to stocks in general. I think his Apple sale is simply a product of his investment process. The stock has become more expensive, offering less value, and therefore he views cash as a better alternative. It says much about Apple’s valuation, but little about where the stock is headed next.

Berkshire’s Cash Hoard

What is stunning is the amount of cash that Berkshire now has, likely approaching or even exceeding $300 billion at the current moment assuming some additional cash inflows from operating companies and perhaps even some further Apple sales post-quarter end.

Similar to erroneously concluding (in my humble opinion) that Apple sales are a harbinger of trouble, people are also attributing the massive cash pile as a bearish indicator on the economy or the stock market. It’s possible that Buffett has some views on the economy near term given his perch atop one of America’s most diversified conglomerate, but he’s never tried to “time the market”. Even in 1969 when he wound down his stock fund, he wasn’t timing the market but simply using valuation as his guidepost. He couldn’t find any ideas so cash was building up and he decided to close. He viewed stocks as risky, but it was 4-5 years before any of that risk manifested itself in the form of falling prices. He is clear that he’s not timing, he’s simply evaluating risk and using value as his North Star.

The same is true now. Buffett’s $300 billion in cash is not because he expects a crash. It’s because it’s extremely difficult for him to find any investments to make.

How difficult? Let’s review some simplified math:

There are probably only 30-40 stocks in the US and perhaps 100 or so worldwide that Berkshire can buy that will make a difference to the portfolio:

• $600b portfolio including stocks and cash; 5% position = $30b

• This limits his universe to $300b market caps at 10% ownership

• There are only 27 stocks in the US this size

• If we go to 20% ownership, that opens it up to an additional 50 or so; but it's difficult to buy that much, and this is only for a 5% portfolio position!

• I estimate there are likely only 30-40 stocks in the US he can buy to build a 5% position, and a much smaller handful to get a 10% position (his preferred level of size)

• So his universe is 30-40 stocks in the US, and maybe 100 worldwide that he would look at

• But how many of these stocks would he even want to own? Probably only a small minority

• Of those, how many offer current valuations that make sense to him? A fraction of that small minority, if any...

The incredible size of the portfolio, plus the high valuations in large cap stocks, makes it almost impossible to put cash to work at the rates of return he'd like (double digits). It's not market timing, it's just a product of valuation levels and a very tiny opportunity set that shrinks each year.

I do think large cap stocks are relatively expensive, but as I discussed in the last post on Walter Schloss, there are a number of opportunities for the rest of us mere mortals in smaller stocks, some of which have been left behind and offer a nice combination of low prices and quality capital allocation (a few example among many others can be found here, here and here.

Buffett’s own investments in Japan also are worth reviewing (see this post for some thoughts on opportunities he is finding even at his current size).

Lesson Learned on Coke

One reason could be a big lesson he learned a quarter century ago when he did not sell Coke at 50 P/E:

“Coca Cola is a fabulous company that was selling at a silly price… You can definitely fault me for not selling the stock. I always thought it was a wonderful business, but clearly at 50 times earnings it was a silly price.” - Buffett, 2006 annual meeting

He also didn’t sell Coke in 1998 when it got to very expensive levels and has said that not selling at those valuations was a mistake. I think many of our largest and highest quality stocks are reaching levels that approach the Coke of 1998 type valuations (see last post for more comments on some of today’s Nifty Fifty-esque valuations).

Buffett is known for a buy and hold forever investor, but I think there have been some broad misinterpretations of his investment approach that have seemed to gain traction over the past decade. I am going to share some notes on this blog from the BPL partnership letters and also some notes on his investments from the Berkshire letters, with an emphasis on some of the actual transactions as opposed to the description of his philosophy. Buffett is, and always been, a value investor first and foremost. He rarely if ever pays more than 15 P/E for a stock, often less than 10 P/E. And he also has more portfolio turnover than many might realize (just examine his holdings from each decade and notice how different they are). He often sells stocks (especially in the earlier years) when they reached an expensive price, and has occasionally regretted not selling (e.g. Coke in 1998).

He is first and foremost sensitive to risk. He demands a margin of safety and when stocks get too expensive, they naturally become risker. Even in recent years with no need for additional cash, he’s shown a willingness to sell stocks that are fairly valued (BYD, AAPL, CVX, BAC) or when he changes his mind about the business (WFC, PARA, TSMC among others).

He has always behaved in this way since he started investing in the 1950’s: buying undervalued securities and selling them when they reach fair value, when he finds something better, or when he changes his mind. He owns stocks for a long time, but rarely forever, simply because securities prices fluctuate a lot more than business values.

Given enough time, Mr. Market eventually will offer compelling enough prices to entice you to swap money for future earnings or vice versa.

Will Berkshire Pay a Dividend?

A lot of people have asked me whether the huge cash is finally going to lead to a dividend at Berkshire. In short, I don’t think so, at least not while Buffett is in charge. I might be wrong on this view, but I think he still views cash inside Berkshire as safer than in the hands of the majority of his shareholders (many of whom are his family members and original partners).

Some thoughts:

• It makes sense to pay a dividend if shareholders have a better place to put the cash. However, I really think Buffett views the market as expensive, and thus he doesn’t necessarily want his owners to suffer the fate of incurring a tax on the dividend and then putting it into an inferior investment (S&P 500).

• It’s possible he still views Berkshire as a better compounding vehicle than what his owners could achieve on their own (especially after factoring in the 23% capital gains tax on the dividends).

• Also, paying a dividend forces this tax upon all shareholders, whether they want it or not. He has long said that owners who want a dividend can simply sell off 4% or their shares (or whatever amount they want), which would function very similar to a dividend

• I think he views keeping the money invested in T-bills (for the time being) as a better place than giving it to owners (with the government taking nearly 1/4th cut of that), only to have the owners turn around and put it into T-bills themselves (or worse, invest in overvalued stocks)

I’m not suggesting this is the best decision, and it certainly doesn’t mean that some owners have a much better use of the money somewhere else, but those owners could simply sell their BRK shares if they had a better place for the money.

Inflation, Deficit Spending, Tax Rates

Longtime readers of Buffett will know that he’s always been wary about inflation. He bought gold stocks in the 1970’s as an inflation hedge (with varying degrees of success). He has written in years past about the perils of too much government debt, fiscal spending, trade deficits and the risk to the value of the dollar.

He mentioned the likelihood of tax rates going higher at the last annual meeting. He’s clearly concerned about the deficit: no politician wants to cut spending so the only way to keep the deficit under control is to raise taxes. That might lead to lower values: if tax rate goes from 21% back to 35%, that results in an instant 18% decline in domestic earnings, making stocks more expensive than they currently are — a stock valued at 25 P/E suddenly becomes a 30 P/E if the “E” drops by 18%. I think the probability of Democrats winning the White House and gaining seats in Congress is still quite low for this election cycle, but given the desire of both parties to continuing spending far more than we’re earning as a country, I think the prospect for higher taxes is almost a certainty over time. For politicians, raising revenues is always more expedient than cutting spending.

Of course, many companies in the S&P have earnings overseas that wouldn’t be affected by tax changes here, but in general, tax increases means lower earnings and thus lower corporate values. I think Buffett expects higher taxes due to the budget issues we have in the US, and therefore stock prices might be more expensive at current levels than they appear.

But he wouldn’t be selling Apple if he thought the shares were still undervalued. He’s selling because he thinks cash is more attractive than the Apple shares he was willing to part with.

To sum it up, I think what Mr. Buffett is doing (or not doing) with his cash is almost irrelevant to most of us. His portfolio is simply too big to invest in all but probably 100 or so stocks around the world that fit his criteria, and very few of those large cap stocks are priced attractively.

Thankfully, most of us have thousands of stocks to choose from, many of which offer great value, especially compared to the largest stocks in the S&P 500.

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John Huber is the founder of Saber Capital Management, LLC. Saber manages separate accounts for clients and also is the general partner and manager of an investment fund modeled after the original Buffett partnerships.

John can be reached at john@sabercapitalmgt.com.