5 Stock Picks For A Buffett-Style Portfolio
Warren Buffett’s Berkshire Hathaway (BRK.B) makes money three ways. It has 60 or so operating companies that generate sales and profit, explains John Reese, a contributor to MoneyShow.com and the editor of Validea, which analyzes the strategies of many of the stock markets great investors.
It also has an enormous pile of cash — over $100 billion — that earns interest while waiting to be invested in a business or other productive asset. And it has its famous stock portfolio loaded up with shares of big American banks and iconic companies like Coca-Cola (KO) and Apple (AAPL).
Each of these three segments plays an important role in the company’s long-term performance, but the stocks Berkshire buys and sells get the most attention.
Investors naturally like to look at the stock portfolio for clues to Buffett’s thinking on the markets, and to see how Berkshire is positioned. Buffett made his name as a value investor, and the portfolio presumably reflects his views on companies that are undervalued or that have unbeatable competitive positions.
Mostly, people want to know how the portfolio compares to the market in general. From 1965 through the end of 2018, Berkshire’s A shares have a compounded return of 20.6% versus 9.7% for the S&P 500.
The Financial Analysts Journal ran an analysis of the portfolio originally conducted by principals at AQR Capital Management that set out to identify what the authors called “Buffett Alpha.” What they found was that Berkshire has the highest Sharpe ratio (a measure of risk adjusted performance) out of any stock that has traded for 40 years going back to 1926.
That would make Berkshire the top rated mutual fund out of any mutual fund since 1976. Morningstar’s John Rekenthaler recently weighed in on the findings.
An undeniable feature of Berkshire’s portfolio is its concentration around a small number of stocks. Apple makes up 22% of its holdings, and the top five positions are 62% of the portfolio. The S&P 500 is far less concentrated. The top holding is just 3.7% of the index, and the top five stocks make up 13.5%.
Another distinguishing feature is his high concentration of financial stocks. Berkshire holds about $60 billion worth of large and regional banks, or about 31% of Berkshire’s public stock exposure.
Financial stocks have struggled recently, but as the five-year performance shows, financials, as represented by the Financial Select Sector SPDR ETF (XLF), have kept pace with the overall market.
To have the potential to beat the market over time, you have to look different than the market. This can be done by holding stocks that aren’t in the index or by holding stocks that have a different weighting than the index. The term “active share” describes how different a portfolio is versus its comparable benchmark.
Active share is a characteristic of those who can generate outperformance over time, and portfolio managers above 80% are said to have “high” active share. The disparity in Berkshire’s weighting of Apple (22%) and the S&P 500 (3.7%) contributes to an increase in Berkshire’s active share.
The larger a firm gets in terms of assets under management, the more difficult it may be to achieve high active share because of limitations in the stocks that can be bought.
As a standalone fund, the $200 billion Berkshire portfolio would be the third largest mutual fund and second to the S&P 500 ETF Trust (SPY) in the exchange-traded fund realm.
Buffett has said the portfolio won’t see the same returns it has in the past, but its high active share (Validea calculated it at 86%) means the holdings are very different from the overall market.
It’s not realistic for most investors to try to copy Buffett’s approach to building a stock portfolio — i.e. making concentrated bets that are sometimes contrarian and looking very different from the market — but it can be for some.
Certainly, investors can learn a tremendous amount by looking at his holdings and thinking about Buffett’s investing process, discipline, long term investing approach and paying attention to value. Getting those things right increases the chances of generating satisfactory returns over time.
Berkshire has a 20.6% compounded return. But look at it in dollar terms. A $10,000 investment in Berkshire in 1965 would have been worth a little over $1 million in 1983, $13 million in 1993 and $143 million in 2013. As of the end of 2018, it would be $247 million, equivalent to a 2,466,381.87% return.
Buffett’s greatest lessons are investing with a long-term view and understanding the power of compounding. Even the best investors will fall short of their goal from time to time.
To beat the market requires looking different. But even if you can’t reproduce Buffett’s success, having a well-considered process and strategy in place goes a long way to achieving your investing goals.
Using the quantitative model I extracted from the book Buffettology, we can analyze, score and rank stocks according to a set of fundamental criteria that attempt to replicate Buffett’s core investing approach — i.e. buying high quality companies with competitive moats at reasonable prices. Each of the companies below passes the model I run with at least an 80% score.
The firm’s 10 years of consistent profits and decade of high ROE & ROTC indicate a competitive moat around the business.
While Buffett has shied away from technology companies in the past, Apple is now Berkshire’s largest position and for good reason when looking at how strong the company looks fundamentally.
One side note: Our Buffett model first scored Apple 100% in 2014, well before Buffett and Berkshire announced they were building a position in the company.
The stock has been hit due to concerns about the 737 Max problems and the unknown impact on the underlying business. However, Buffett has always said he wants to buy stocks of good companies when they go on sale.
The long term earnings consistency, along with strong returns on equity and capital are all positives for Boeing.
In addition, the company has been buying back stock and can pay off its liabilities with less than two years of its earnings, which is a positive in our model.
Like Apple, Buffett has a stake in Mastercard so this one should not come too much as a surprise but the stock gets 100% through the lens of our Buffett model.
Using two different expected future price return calculations, the stock looks like it has nice upward potential over the next few years.
Monster Beverage (MNST)
We know that Coca-Cola (KO) is one of Buffett’s largest and dearest holdings, and it has long been rumored that Coke may be interested in Monster as a takeover. Even if that doesn’t materialize, the shares look appealing given the qualities our Buffett model looks for. Monster gets 100%.
TJX Companies (TJX)
Management has been buying back stock over the past year and has shown an ability to generate around a 15% return on retained earnings over the past decade, which is a positive.
The shares look like they have the potential to produce a 20% long term annualized return if the profitability and returns in the past continue in the future.
The company is one of the leading landscaping, turf, snow removal equipment and irrigation system manufacturers.
This is a mid-size company with a $7.5 billion market cap that could rolled up nicely as one of Berkshire’s operating companies. Earnings have increased each year for the past decade, and the firm’s 10 year average ROE is 36.7%.
Read more articles by John Reese on MoneyShow.com here.