As markets continue to tumble, many investors are eagerly waiting for some indications legendary investor Warren Buffett (Trades, Portfolio), who has a strong track record of hunting for bargains during troubled times.
For more than a year, markets were perplexed by the abnormal cash balance of Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) and whether Buffett would ever get a chance to complete a large acquisition with that money, as there seemed to be no way that markets would enter bear territory any time soon.
However, what many considered impossible has happened, and both the S&P 500 Index and the Dow are trading more than 20% below their recent highs, according to Bloomberg data. This has improved the prospects for a large acquisition, and successfully completing one could be a catalyst that drives the share price of the conglomerate higher.
A big deal has been pending for a while
Most of the largest acquisitions or investments in the history of Berkshire were completed before 2016. The lack of billion-dollar investments since then, save for the $10 billion granted to Occidental Petroleum (OXY, Financial), has raised questions whether Buffett and Charlie Munger (Trades, Portfolio) have lost their touch of finding attractive investment opportunities.
Source: Reuters
This inactivity has already pushed the cash balance of the company to a record high of over $125 billion. According to GuruFocus data, the allocation to cash has never been this high.
Source: GuruFocus
With this enormous amount of liquidity, there’s no doubt that Buffett is carefully monitoring the current developments to identify misplaced bets. The recent investment in Delta Air Lines is proof of this. In September 2018, Buffett wrote in the Financial Times, “A simple rule dictates my buying: Be fearful when others are greedy and be greedy when others are fearful.”
As evident from his recent investment activities, the guru is living by what he has advocated for more than five decades. The Shiller price-earnings ratio reached a recent high of around 31 in December 2019 but has contracted since then as a result of the decline in stock prices in the last two months.
Source: GuruFocus
The historical average for the Shiller price-earnings ratio is 17, and the ratio of over 23 as of March 13 might prompt investors to wait for a better opportunity. However, data from GuruFocus reveals that both the energy sector and the financial services sector are trading below this mean, which is an indication of the opportunities available in some segments of the market. This is an ideal set-up for Buffett to go big, as there is plenty of cash available at his disposal.
Buffett might once again outperform the market
The decade-long bull run that started in 2009 made it possible for average investors to earn big on their investments. The growth and the eventual outperformance of passive strategies is a classic example of this. Fund managers who allocated significant amounts of money and time to beat the markets could barely do so as a result of the stellar performance of the broader market. Overvalued companies with inflated stock prices continued going higher, and value investors, including Buffett, could not beat the market.
Source: Financial Times data as of June 2019
Even though the performance has been lackluster in the last few years, Berkshire might stage a comeback, as it will not be as easy to invest in the current market. Historically, the success of Buffett was closely tied to his ability to keep his head high during turbulent market times and hunt for bargains. With the massive cash pile on hand today, the guru will likely end up betting on companies with attractive growth prospects at a cheap price. Securing a few such deals will help Berkshire post higher returns.
Empirical evidence indicates that Buffett found some of his best bets during adverse market conditions. For instance, the investment in American Express (AXP) in 1963 increased by 1,000% within a decade. However, he was brave enough to invest in the company when the largest credit card issuer in the world was suffering from the Salad Oil Scandal.
Berkshire’s investments in big banks such as JPMorgan Chase and Bank of America are two other examples as these were executed at a time every investor avoided the financial services sector.
The chances are that the guru will find a few good deals amidst this chaos created by the Covid-19 pandemic and the oil price war between Saudi Arabia and Russia. This will act as a catalyst for Berkshire share prices to deliver stellar returns in the coming years.
Sectors that Buffett may be watching
At the end of 2019, Berkshire had 70 million shares of Delta Air Lines and added another 976,000 in late February, according to company filings. In addition to this, Berkshire held 21.9 million shares of United Airlines Holdings (UAL, Financial) and 42.5 million shares of American Airlines (AAL, Financial) as well, which is a clear indication of the guru’s bullishness on the prospects of this industry. However, share prices of all these companies have drastically dropped since the beginning of this year.
Source: Yahoo Finance
This catastrophic decline in the market value of airline companies comes as a result of the decline in demand for global travel and leisure activities in the next couple of quarters. However, the long-term outlook has not changed materially for any of these companies. Buffett might well be interested in increasing his stake in all of these airline operators because of this apparent mispricing.
The energy sector may also be a top candidate because of the short-term pressure on oil prices. However, in the long run, the majority of oil companies with sound fundamentals can likely deliver attractive returns as the demand for energy commodities will soar along with the expected growth of the global economy. There is no acceptable and accessible substitute for crude oil, and this will ensure the success of large oil and integrated companies.
According to GuruFocus data, the energy sector accounts for only 0.53% of the guru’s portfolio, but this doesn’t rule out the possibility of Buffett betting on this troubled industry. As recently as last year, Berkshire invested in $10 billion worth of preferred shares of Occidental Petroleum, and according to the deal terms, Buffett received 80 million warrants to purchase common shares of Occidental at an exercise price of $62.50. At the market close of Thursday, shares were trading around $12.
Carl Icahn (Trades, Portfolio), in a statement released March 12, confirmed that he has increased his Occidental stake to 10% during the recent price drop, and that he is attempting to make some changes to the board of directors of the company. Berkshire might also be interested as well, and in any case, many energy companies are trading at very cheap valuation multiples. Even though there is no love from the market, Buffett might see things differently, the same way he has for many decades.
Takeaway: a bet on Berkshire is a bet on Buffett
There’s a reason why Warren Buffett (Trades, Portfolio) is considered the greatest investor of all time; he invested in unpopular, unloved sectors when everything was stacked against him. The guru was proven correct on many occasions, making him a household name.
Today, the new coronavirus and the uncertainty regarding oil prices have sent the markets on a freefall. If there’s one investor who would use this opportunity to do the right thing, it’s Buffett. Even though Berkshire Hathaway's share price has not performed as expected in the last few years, the current market turbulence could make this the inflection point. With over $125 billion in liquid assets, the conglomerate is in a great position to bank in on some great opportunities.
Disclosure: I do not own any stocks mentioned in this article.
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