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If you've ever wondered why Berkshire Hathaway (BRK.A 0.32%) (BRK.B 0.04%) CEO Warren Buffett garners so much attention from Wall Street and everyday investors, look no further than his track record.
Over the nearly six decades since the Oracle of Omaha became Berkshire's CEO, he's doubled the annualized total return, including dividends paid, of the benchmark S&P 500 (19.8% versus 9.9%, as of Dec. 31, 2022). In aggregate, the S&P 500 has a total return of close to 31,000% since the mid-1960s, as of the closing bell on Dec. 15. Meanwhile, Berkshire Hathaway's Class A shares (BRK.A) are higher by an aggregate of more than 4,400,000%! Outperformance of this magnitude is going to get a portfolio manager noticed.
Warren Buffett and his investment team have long believed in buying into profitable, time-tested, brand-name businesses with trusted management teams. But the not-so-subtle secret to Berkshire's sustained outperformance might just be portfolio concentration.
Both Warren Buffett and the late, great Charlie Munger, who served as the Oracle of Omaha's right-hand man for 45 years, have held the belief that extra capital should be allocated to top investment ideas. Despite holding stakes in more than 50 securities (including index funds), as of Dec. 15, Warren Buffett's $374 billion portfolio at Berkshire had 65% of its invested assets ($243 billion) tied up in just three stocks.
Apple: $180,887,264,672 (48.4% of invested assets)
To quote Charlie Munger:
The idea of excessive diversification is madness. Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.
It's crystal clear by the nearly $181 billion of invested assets Berkshire has tied up in tech stock Apple (AAPL -0.21%) that Warren Buffett and his team view it as a truly exceptional business. Further, it's pretty clear evidence that portfolio concentration in top investment ideas is a given.
Apple's greatness can effectively be boiled down to its branding, innovation, and world-leading capital-return program.
Earlier this year, Interbrand's annual “Best Global Brands” report labeled Apple as the most-valuable brand for an 11th consecutive year. It's a well-recognized and trusted brand globally, and it has an exceptionally loyal customer base, which is likely to have been initially drawn in by one of its physical products (iPhone, Mac, or iPad). Interbrand also attributes the continued growth of Apple's brand value to having its proverbial fingers in multiple product and service channels.
This leads to the next point: Apple's innovation. Although it's been introducing new products for decades, the iPhone really put Apple on the map with consumers and growth-focused investors. Continued upgrades to iPhone have helped the largest company by market cap in the U.S. secure a majority share of smartphone sales domestically.
Moreover, CEO Tim Cook is overseeing the evolution of Apple into a platforms company. An emphasis on subscription services, while concurrently continuing to produce the physical products that endeared consumers to Apple in the first place, should enhance the value of its product and service ecosystem, improve its long-term operating margin, and minimize the revenue fluctuations that often accompany major iPhone upgrade cycles.
However, the factor Warren Buffett probably appreciates most about Apple is its unbeatable capital-return program. The company doles out $15 billion each year to its shareholders in dividends, and it's repurchased more than $600 billion worth of its common stock since the start of 2013.
Bank of America: $34,703,827,402 (9.3% of invested assets)
Although it's a distant second behind Apple, financial juggernaut Bank of America (BAC 0.95%) accounts for almost $35 billion of invested assets in the $374 billion portfolio the Oracle of Omaha oversees for Berkshire Hathaway.
There's arguably no sector Warren Buffett is more proficient in analyzing than financials. This is why you'll often find plenty of bank stocks, insurance companies, and credit-service providers in Berkshire's portfolio.
The reason Buffett gravitates to financial companies is that he understands the disproportionate nature of economic cycles. While recessions are perfectly normal, the 12 that have occurred in the U.S. following World War II have lasted between two and 18 months. By comparison, most periods of expansion endure multiple years, including two since World War II that lasted at least a decade. Buying cyclical financial stocks, like Bank of America, perfectly positions Buffett's company to take advantage of long-term economic growth.
But there's more to like about Bank of America than just macro factors. Among U.S. money-center banks, it's the most interest sensitive of the bunch. Every time the Federal Reserve raises interest rates, variable interest rates increase. Since March 2022, the federal funds rate has risen by 525 basis points, which represents the steepest rate-hiking cycle in four decades. Higher interest rates have ultimately lifted BofA's net-interest income by billions of dollars each quarter.
Furthermore, Bank of America has done a stand-up job of improving its operating efficiency. It's been investing in a variety of digitization initiatives that have steadily increased digital banking adoption rates. As more of its customers shift to online and mobile banking, BofA has had the option of consolidating some of its physical branches and reducing its operating expenses.
To keep with the theme, Bank of America has a pretty impressive capital-return program of its own. It's set to return nearly $7.6 billion to its shareholders via dividends over the next 12 months. Additionally, BofA's board regularly approves substantial buybacks when market conditions allow for it.
American Express: $27,367,247,457 (7.3% of invested assets)
The third stock that, collectively with Apple and Bank of America, accounts for 65% of the $374 billion portfolio Warren Buffett oversees at Berkshire Hathaway is credit-service provider American Express (AXP 0.36%).
AmEx, as American Express is commonly known, benefits from the same long-winded macro catalysts as Bank of America. Though there's no escaping spending declines and/or loan losses during economic slowdowns and recessions, the U.S. and global economy spend a disproportionate amount of their time growing. Buffett and Munger understood this, which is why Berkshire has been a continuous shareholder of American Express stock for more than three decades.
What makes American Express so special is the fact that it's playing both sides of the transaction aisle. On one hand, it's No. 3 in domestic credit card network purchase volume. Put another way, it's generating a healthy amount of fees from merchants while acting as a payment facilitator.
However, AmEx is also generating interest income and fees from its cardholders. During lengthy periods of economic expansion, when credit delinquency rates and charge-offs are low, American Express can really shine from an operating standpoint.
Something else that helps American Express thrive is its focus on higher-income individuals. The well-to-do are less likely to change their spending habits when minor economic disruptions occur or inflation picks up. This allows AmEx to move past challenging economic climates faster than other lending institutions.
Warren Buffett and his investing aides are likely also enamored with American Express's capital-return program. In March, the company's board approved a new share repurchase program for up to 120 million shares of common stock. Further, AmEx's $2.40-per-share base annual dividend works out to a 28.3% yield relative to Berkshire Hathaway's cost basis in its No. 3 holding.
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