Monday, August 6, 2012

Berkshire Hathaway's 2nd Quarter 2012 Earnings: Net Seller of Stocks

Berkshire Hathaway (BRKa) released its latest quarterly earnings this past Friday. Some things that seem worth noting at first glance:

1) Berkshire's cash position continues to grow.

The pile of cash on Berkshire's balance sheet grew to over $ 40 billion. The company is now more than well-positioned for another very substantial acquisition.

2) Berkshire was a net seller of stocks during the quarter.

The Consolidated Statement of Cash Flows in the latest 10-Q (the cash flows from investing activities section) reveals more selling of equity securities than buying. That shouldn't be terribly surprising but is, at least, mildly interesting. More specifically, Berkshire bought ~ $ 1.9 billion in equities while selling $ 3.0 billion worth in the latest quarter.

Quarter-to-quarter changes don't mean a whole lot but, while I wouldn't read too much into it, the moves are still worth keeping an eye on.

Stepping back just a bit from the most recent quarter, Berkshire bought $ 5.3 billion of equities in the first half of 2012 while selling $ 3.8 billion. That's not exactly running away from equities. In any case, we'll get more details on changes to the portfolio when the 13F-HR is released later this month. The specific changes that occurred (buying and selling) should become less of a mystery at that time.

3) Berkshire sold a meaningful portion of one or more of its consumer stocks.

Based upon the latest 10-Q, the cost basis of the consumer products stocks dropped substantially (from $ 12,296 billion to $ 9,843 billion = a drop of $ 2,453) compared to the prior quarter. So that's where the bulk of the selling appears to have been done. To me, it's not all that surprising. Consumer stocks aren't expensive these days but nor are they cheap. Some, like Procter & Gamble (PG) for example, have even had some meaningful (though hardly catastrophic) difficulties in recent years. It's also likely just a matter of there being better places to allocate the capital (and not so much an indication that the consumer products stocks Berkshire owns are not sound long-term investments).

It's worth pointing out that the stock (or stocks) that were sold probably did not have an extremely low cost basis relative to current market value.

Why is that the case?

Basically, the math makes it unlikely that anything more than a token amount of something like Coca-Cola (KO) was sold.  Berkshire's cost basis for their Coca-Cola shares is less than 1/10th of the current market valuation of those shares. In other words, if they sold $ 3 billion of Coca-Cola's stock, there'd be less than a $ 300 million drop in cost basis. So the math just doesn't work (and their are several other reasons to doubt that it is Coca-Cola).

The bottom line is it's the shares Berkshire owns with a cost basis much more near the current market value make more sense as candidates that were sold.

With the limited information available, it's obviously difficult at best to guess why a stock (or stocks) may have been sold.

Some of the reasons that come to mind include:
  • A less optimistic (or downright pessimistic) view of the long-term prospects for a particular equity
  • An expensive share price relative to per-share intrinsic value
  • A relatively attractive alternative investment that requires freed up cash
Among others. Only time will really tell but, once again, the yet to be released 13F-HR should shed some light.

*****
Finally, it's well known that Warren Buffett and Charlie Munger prefer to own businesses "forever", whether outright or via partial ownership of common shares. There are practical differences between the two (owning outright vs partial ownership), of course, but they should mostly be treated as fundamentally the same during analysis.

Here's one of the practical differences that's unique to Berkshire. Once they've bought a business outright they will under almost no circumstances sell it. That's true even for the underperformers and the reasons for this is articulated in the Berkshire Owner's Manual.*

It's a principle Berkshire established a long time ago and they have stuck to it.

Prior post: Buffett on Errant Purchases: Why We Hold On To My Mistakes

In contrast, the threshold required to justify selling some of their common stocks, while still relatively high, is understandably lower. They're just not nearly as rigid about selling shares of a stock if better use for the capital exists elsewhere.

It's still a rather high threshold compared to many other investors. Buying a stock with the intent to sell it soon after at a particular higher price "target" or whatever is certainly not what they do. Berkshire buys with the intention of owning the shares for an extended period.

Now it's true that certain equities they own, at least if history is any guide, seem more likely than others to remain in Berkshire portfolio indefinitely. Those with unique durable competitive advantages aren't likely to be sold just because they've become somewhat expensive or have minor near-term difficulties.
(Once you own shares of an exceptional business at a fair price, hold onto it.)

Berkshire's bias remains long-term by any standard (and especially by today's standards) but even that ethos rightly has its limits.

The preferred holding period for many of the equity holdings in Berkshire Hathaway's portfolio is, if not "forever", an awful long time.

Adam

Long positions in KO and BRKb established at lower prices

* The owner's manual provides a good explanation of why they hold onto their poorly performing businesses, even if they are likely to remain that way for quite a long time. It's worth taking some time to understand their thinking. Check out the Business Principle # 11 in the Owner's Manual. More recently, Buffett also gave a good explanation of this thinking in the Manufacturing, Service, and Retailing Operations section of the 2011 Berkshire Hathaway shareholder letter.
 
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