Scott Olson
Talk about a market tell! The third quarter 13F Filing for Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B) just provided one. Investors should bear in mind that some of the buys and sells are by Warren Buffett, while the smaller trades are likely by Todd Combs or Ted Weschsler.
What’s particularly interesting is how closely they all hew to a common theme. The three new Berkshire buys were Taiwan Semiconductor Manufacturing Company Limited (TSM), Louisiana-Pacific Corporation (LPX), and Jefferies Financial Group Inc. (JEF). All three are cyclical growth companies. Positions increased were Chevron (CVX), Occidental (OXY), Paramount Global (PARA), and Celanese (CE). All four of these are also, broadly speaking, cyclical growth companies. Some of the buys and adds have nice dividends, but they are not stocks one would buy just for the dividend. All seven trade at cheap valuations, single digit P/Es in several cases. What makes them broadly similar is that they are all growth companies in cyclical industries rather than the sort of non-cyclical growth companies in tech/media which rose to the top of the indexes over the past decade.
The sells included longstanding holding VeriSign (VRSN), STORE Capital (STOR), Activision Blizzard (ATVI), U.S. Bancorp (USB), Bank of New York Mellon (BK), and General Motors (GM). All of these resemble the companies mentioned in this recent article as stocks Buffett bought when short term Treasury Bills provided very little return. ATVI was an arbitrage play, as Microsoft Corporation (MSFT) had a bid in place and was waiting for EU approval to close. The two banks had provided little either operationally or in stock price over recent years, but in a low rate environment had provided meaningful dividends. GM paid a good dividend and was also up in price from the point of purchase but faces future challenges. STOR, a real estate investment trust (“REIT”) which had a good dividend, is in the process of being taken private.
Taken together, the buys and sells are the two sides of a completely consistent message. Buffett and his lieutenants are moving away from positions which served as income-producing stopgaps. They were originally purchased as a best-available alternative when fixed T Bill rates were low. They are moving toward companies in which Buffett and his lieutenants see long-term growth even if an economic downturn happens between now and the resumption of growth in the economy. The move away from TINA stocks was discussed thoroughly in the article linked above. That article suggested waiting for the upcoming 13F Filing to discover what the filing revealed about the stocks he had chosen to replace them.
In the earlier piece, I expressed the view that the persistent buying in Chevron and OXY suggest strongly that neither is a short-term source of income, but rather a long-term position demonstrating the Buffett view that the future of carbon energy had improved during the current crisis. What the current group of purchases suggest is that this improving prospect for energy has taken place in the context of a general view that, in the long run, the economy will be strong. What follows is a brief discussion of several buys and sells:
The Largest Buy: Taiwan Semiconductor
Taiwan Semiconductor was the largest buy in Q3, and at a bit over $4 billion the one most likely to have been initiated by Buffett himself. TSM is generally regarded as the best semiconductor company, and its revenues have quadrupled since 2012 for an approximate 14% compounded annual return. Its earnings per share have quintupled over the same period. There have been no down years. It has a surprisingly low P/E of about 11.5% and a dividend yield of 2.6%. Its price is down 55% from its all-time high.
One caution is that an economic downturn would likely be accompanied by a downturn in the semiconductor industry, which is leveraged to economic growth. Another is the risk of some form of an attack on Taiwan by China. Seeking Alpha’s quantitative system nevertheless ranks TSM as a Strong Buy.
Other Buys: Louisiana- Pacific, Jefferies, Celanese, And Paramount Global
The size of the LPX buy was an order of magnitude lower than that $4 billion invested in Taiwan Semi. The amount, around $400 million, suggests that it was likely bought by one of the two Buffett lieutenants. At the same time its businesses – manufacturing products for use in new home construction, repair and remodeling; timber and timberland; and engineered wood products – are closely related to Berkshire’s large collection of housing and building-related subsidiaries. Buffett and his two lieutenants have privileged knowledge as to the current travails of housing and related businesses along with the experience to understand how strongly housing is likely to recover. Buffett clearly sees that the U.S. is underhoused and that housing-related businesses will prosper once mortgage rates normalize.
The size of the Jefferies (formerly Leucadia National) buy was another order of magnitude smaller than that of LPX. It, too, is familiar within Berkshire because of the joint corporate real estate venture Berkadia. Jefferies might be described as an investment or merchant bank of sorts, with a focus on several niches within an international marketplace. Its growth is lumpy, and, like the other companies bought by Berkshire in Q3, it is cyclical and currently cheap.
Celanese was an add by one of the Buffett lieutenants and is described on this site as “a technology and specialty materials company.” Its engineered materials and high-performance engineered polymers put it in the same category as Berkshire’s Manufacturing, Service and Retailing unit made up of businesses that are somewhat sensitive to the economy and rely on technology without being tech companies.
In a comment to the article linked above, one reader asked specifically if I thought Berkshire would add to its Paramount Global position which had been established in Q1 and added to in previous quarters at a substantially higher price. The answer is that one of Buffett’s lieutenants did indeed average down this relatively small position. An international media and entertainment company PARA has many risks to overcome and ground to make up from the pandemic lockdown, but it is a potentially lucrative bet on continuing economic recovery.
Sells: Activision Blizzard And GM
There were two reasons to reduce the position in Activision Blizzard. One is the uncertainty as to whether the Microsoft acquisition will ultimately close. Despite the fact that the deal is being examined in detail by the EU for anti-competitive impact, both parties say that the deal will happen, but what else would they say? At $74, ATVI is trading at an ominous discount to the deal price of $95, so that whichever of Buffett’s two lieutenants bought it may be giving serious thought to its stand-alone value. The second reason for selling is that it is the kind of reach for a small gain that the current T Bill rate has made less desirable.
GM was a purchase clearly motivated in part by its dividend. It moved up in price about as much as could be hoped for and the dividend became less valuable with a more than 4% return available from short Treasuries. it was time to move on from GM.
Sells: US Bank And Bank of New York Mellon
This is not the first bank stock sale that required some second-order thinking. Many writers on this site questioned the sale of JP Morgan. Now, only dirt cheap Citigroup (C) and Bank of America (BAC) remain in Berkshire’s portfolio. What can explain this? The answer that seems most likely is that rising rates have impact on banks in two directions – cost of funds and the yield available from loans. In the event of a recession, losses on loans might also be a factor. Add to that the timing of Fed rate actions. What if the relief afforded by higher rates was promptly reversed? A strong inversion of the yield curve might also adversely affect Net Interest Margin. But that may make it too complicated. At this point, the main virtue of USB and BK comes down to their dividends, and as with other recent Berkshire sells it is clear that 4% T Bill yields make the dividend less favorable.
What The Buys And Sells In Berkshire’s Portfolio Suggest About Buffett’s Thinking
Nobody really knows what it going to happen in the future, and Warren Buffett is far too wise and experienced to make a large bet on a particular future. What he does believe in strongly is the power of the U.S. economy to recover from whatever temporary conditions are thrown at it. That’s the essence of the long-term forecast that is broadly expressed in Berkshire’s Q3 Buys and Sells as reflected in its 13F Filing. The takeaway is that while purchases focused on value stocks sensitive to the economy, the total level of net buying was small compared to the cash available.
It’s not necessary to be exactly accurate, and a recession which leads to a final leg down in the bear market would not invalidate the new strategy of owning value-priced cyclical growth. What we do see in the buys and sells is strong confirmation that Buffett and his two lieutenants no longer find yield quite so compelling. At the same time, the 3Q buys did not contain any of the previously high-flying FAANG-type growth stocks. No Amazon.com, Inc. (AMZN), no Alphabet (GOOG, GOOGL), no Meta Platforms (META), no Tesla (TSLA). Practical tech in low tech products, yes. More OXY and Chevron. A comeback for housing even if you have to wait a bit.
In sum, you could say that Buffett is making a bet that, barring some unexpected event, the financial and economic world is likely to normalize and return to long-established patterns.
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