INTRO: It’s no secret that over the past decade,
Warren Buffett hasn’t been at the top of his game.
In fact, between 2010 and 2020, he basically just matched the market.
This isn’t terrible performance given that most hedge funds don’t even match the market,
but for a legendary investor with an average annual return of 20.5%, it’s rather disappointing.
This has caused many to wonder if Buffett has lost his touch in the new digital world.
Despite this lackluster performance over the past decade, Buffett has actually been crushing
it in 2022.
In fact, Berkshire Hathaway is slightly positive on the year while the overall market has been
getting slaughtered.
Currently, Berkshire Hathaway is up 3% on the year while the S&P 500 is down 16%.
This recent move means that Berkshire Hathaway is officially outperforming the market not
just on an yearly basis, but since the bottom of the 2008 financial recession which is when
he quote on quote “lost his edge”.
So, here’s the top 5 reasons why Buffett had been struggling to beat the market and
how he’s overcame these challenges.
VALUE STOCKS: Likely one of the biggest reasons Buffett
has had trouble beating the S&P 500 is due to his focus on value stocks.
In recent history, value stocks simply haven’t kept up with growth stocks in terms of returns.
Between 2010 and 2020, growth stocks almost outperformed value stocks by a full 100%.
But, while growth stocks tend to outperform during bull markets, they also get crushed
during bear markets.
And given that the NASDAQ is currently experiencing a bear market, it’s not surprising that
many of the high growth names have gotten destroyed.
Since the start of the year, the growth stocks in the S&P 500 have underperformed Berkshire
Hathaway by about 25%.
Conversely, many value stocks have performed extremely well such as energy stocks.
Since the start of the year, the value stocks in the S&P 500 have outperformed the overall
index by nearly 10%.
So, in the current market environment, Buffett’s value centric investing philosophy is holding
up pretty well.
Aside from benefitting for a risk off market, Buffett has also moved towards embracing a
few high growth tech companies himself.
If we take a look at his holdings, we’ll see that Apple is by far his biggest position.
He currently has $133 billion in Apple which accounts for nearly 40% of his entire portfolio.
Another mega cap company that Buffett has recently embraced is Amazon.
His stake in Amazon isn’t nearly as large as his stake in Apple, but it is still a billion
dollar position.
Buffett has even ventured into some more early stage tech companies such as Snowflake which
isn’t even profitable yet.
Currently, these stocks are actually holding back Buffett given that they’re all down
by substantial amounts.
Apple is down 20%, Amazon is down 34%, and Snowflake is down over 50%.
So, if Buffett is able to post a positive return with all these tech companies being
down so much, imagine what type of returns he’ll be posting when these companies recover.
In the end, Buffett’s willingness to finally embrace tech while also maintaining his value
positions has enabled him to enjoy the best of both worlds.
TOO MUCH CASH: Another major issue that Buffet has faced
over the past decade is simply putting his money to work.
Recently, Buffett has been holding significant amounts of cash which of course produces little
to no returns.
His cash position has gotten slightly better over the past 2 years as it has dropped from
$128 billion to $106 billion today, but there’s still a long way to go.
But, wait a minute, why is Buffett even having trouble deploying his cash in the first place?
Well, at the core, Buffett is still a value investor and though he has embraced some growth
plays, he’s not willing buy when prices are quote “sky-high”.
Now, you might disagree with this statement given the recent sell off, but on a historical
basis, the market is still trading for a rich valuation.
For example, the median PE ratio of S&P 500 companies over the past 140 years is 14.89.
Today, the PE ratio of the S&P 500 stands at 20.34 which means that the average company
is still overvalued by 33%.
Similarly, the Buffett indicator which compares the US stock market with the US GDP suggests
that stocks are currently overvalued by 75%.
Now, I’m sure there’s gonna be comments down below that argue that these models are
outdated due to low interest rates, excessive money printing, and the rise of international
markets.
While you may be right, we have to acknowledge that Buffett is more of an old school investor.
So, I think its safe to assume that he gives at least some weight to the indicator that
was literally named after him.
Alright, so the overall market may seem overvalued from Buffett’s perspective.
But, regardless of the market environment, there’s always deals on the market right?
Well, there are always deals on the market, but the problem is that these are generally
underrated small cap companies that won’t really move the needle for Buffett.
For example, let’s say you find an extraordinary small cap company that’s worth $1 billion.
Even if Buffett bought this entire company and the company grew 10X within the next 10
years, he would only make $9 billion.
And while that’s an insane amount of money, it would only grow Buffett’s overall portfolio
by a mere 2.6%.
Considering this, investing in small cap companies is simply not a feasible option for Buffett.
He has to stick to companies that are worth tens of billions if not hundreds of billions,
and amongst these companies, it’s been extremely difficult to spot a deal.
One of the main ways that Buffett has been combating this issue is buy constantly growing
his existing positions.
Last quarter, for example, he bought $600 million worth of Apple stock.
But, this can only take him so far, and sooner or later he’s going to have to find new
companies to invest in.
BECOMING THE MARKET: As Buffett’s portfolio continues to grow
and he concentrates on large cap companies, one of the biggest hurdles he has to face
is unintentionally becoming the market himself.
I mean if you just keep adding large cap positions, you basically just become the S&P 500 yourself.
Buffett currently has 48 positions in basically every industry you can think of from tech
and retail to food and banking.
While this may not sound like a big deal, it is given that Buffett is currently breaking
his own advice.
One of Buffett’s most famous sayings is that “Diversficiation is protection against
ignorance.
It makes little sense if you know what you’re doing.”
Now, I don’t think Buffett is diversifying to protect against ignorance.
I think he’s diversifying in an attempt to deploy as much capital as possible.
But, this naturally comes along with the unintended consequence of limiting upside potential.
Aside from breaking his own diversification rule, Buffett is also actively breaking his
20 slot rule.
The rule suggests that an individual’s financial success could be improved if they could only
make 20 investments throughout their entire life.
The idea is that if an individual’s investment choices are heavily constrained, they would
be highly selective with each investment they make.
And hopefully, this selectiveness would improve their chances of making good investments.
Given that Buffett is currently holding onto 48 different positions, he’s clearly not
abiding by this rule.
But, this isn’t to say that Buffett isn’t trying his best to limit diversification.
Even though Buffett has dozens of positions, his portfolio is still extremely top heavy.
His top 10 positions, for example, account for 85% of his portofolio and his top 20 positions
account for 96% of his portfolio.
In other words, all of Buffett’s investments past the 20 slot rule only account for 4%
of his portfolio.
Despite all his efforts though, it’s only natural that the performance of Berkshire
Hathaway gets closer and closer to that of the market as they continue to grow and their
investments mature.
MISSING THE MARK: On top of all these external factors weighing
on Berkshire’s performance, it should be noted that Buffett has made a few major mistakes
himself.
For example, in the early 2010s, Buffett wanted to get in on all the tech growth, so he decided
to buy a legacy player which was IBM.
In 2011, he announced that he purchased $10.7 billion of IBM at $170 per share.
While IBM did reach about $200 per share in 2013, it has since been on a decline, and
Buffett eventually ended up selling his shares for a loss.
While this was no doubt a subpar investment, Buffett also made one the worst investments
of his career within the past decade which is of course Kraft Heinz.
While Buffett maintains that both Kraft and Heinz were great companies fundamentally,
he has admitted that he overpaid for the Kraft portion of the business.
Aside from paying a premium for the company, Buffett went on to oversee a merger of the
two companies which hasn’t been all that successful.
I have a full video on the downfall of Kraft-Heinz if you’re interested.
But in essence, the company couldn’t keep up with the prices of generic brands or the
healthniess of up and coming brands.
So they’ve been stuck in this weird middle ground that doesn’t appeal to either demographic.
On top of this, Kraft-Heinz has been involved in an accounting scandal, they’ve had to
write off massive losses, and the CEO left during the peak of their troubles.
As you would guess, all of these issues have resulted in Kraft-Heinz stock getting obliterated.
They’re currently down over 50% from their peak in 2017.
Despite this horrendous performance, Buffett has continued to vouch for Kraft-Heinz, but
it should also be noted that he has been transparent that he would’ve sold the stock a long time
ago if he was able to easily liquidate his massive position.
Fortunately though, it does look like Kraft-Heinz has finally bottomed out and it’s starting
to form an upward trend.
So, hopefully, Kraft-Heinz won’t weight down on Buffett’s portfolio moving forward.
SHIFTING PRIORITIES: While everything we’ve covered so far in
the video are valid points, something that we shouldn’t overlook is Buffett’s age.
Buffett is currently 91 years old.
This isn’t to say that Buffett is too old for this or anything like that, but it does
bring up the question: How much does Buffett even care about beating the market anymore?
When you’re over 90 years old, I suspect that you would care a lot more about living
out the last of your days to the best of your ability as opposed to beating some vain metric.
Now, Buffett clearly still enjoys investing and talking about stocks.
That’s why he continues to lead Berkshire and regularly participates in press events.
But, with that being said, I think Buffett has several priorities that are higher than
beating the market like philanthropy.
Warren Buffett is the biggest philanthropist in the entire world having donated a massive
$42.8 billion.
And given that Buffett is looking to donate all of his wealth after he dies, I suspect
that his number 1 priority is to ensure that all of his wealth ends up in the right hands.
This aligns with what he’s been recommending as well.
After all, Buffett doesn’t even recommend that you invest in Berkshire.
He recommends that you invest in the S&P 500 instead.
Considering this, it’s pretty clear that Buffett isn’t exactly trying to appeal to
investors meaning that maximizing returns is not his top priority.
At this point, it seems like he’s just looking to see how far he can take it while having
some fun.
And it just so happens, that he’s beating the market once again.
Do you guys think that this is just some random fluke, or do you think Buffett will continue
to lead the market?
Comment that down below.
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