Warren Buffett (Trades, Portfolio)'s decision to sell Berkshire Hathaway's (BRK.A, Financial) (BRK.A) airline investments has attracted both praise and criticism.
Buffett revealed this decision over the weekend at Berkshire's annual meeting of shareholders. Critics seem to believe that this action from the Oracle of Omaha implies he's lost his way and doesn't understand the market anymore. Some have also suggested that he has violated his own investment rules. On the other hand, Buffett's supporters argue that this was the right call.
Knowing when to sell
Personally, I fall into the latter camp. Something that has helped Buffett stand out from the rest of the investment world over the past few decades is his ability to change direction when something goes wrong.
If a company no longer meets his investment criteria, he is more than happy to sell.
This is something many investors don't understand. They end up holding onto bad investments for years, avoiding solidifying a loss but at the same time incurring enormous opportunity costs.
It is difficult to tell how much money Buffett made or lost on his airline holdings. However, we can get a rough idea by looking at historical 13F filings and other SEC documents, as well as trading data for the stocks themselves.
The cost of selling
Berkshire first started buying Delta Air Lines Inc. (DAL, Financial) in the third quarter of 2016.
By the end of the fourth quarter of 2016, Buffett had acquired 60 million shares as an average price of between $39 and $49. He sold seven million shares in the first and second quarters of 2017 at prices up to $53.70.
He increased the position again in the second quarter of 2018, taking the holding to just under 64 million shares at an average price of $49.50. A further five million shares were added in Q1 2019 and then another million toward the end of February 2020.
For the sake of simplicity, I'm going to calculate as if Buffett maintained his initial position at 60 million shares acquired in the fourth quarter of 2016 at an average price of $44 per share. In calendar 2017, 2018 and 2019, shareholders received $4.21 per share in dividends from the company, giving Buffett an estimated payoff of $253 million.
It's impossible to tell the price Buffett achieved for selling the entire stake, but according to regulatory filings, Berkshire sold nearly 13 million Delta shares for about $314 million on April 2. This took the holding below the 10% ownership reporting threshold. Assuming Buffett continued to sell for the next week, he would have received a price for his shares of between $22 and $23 apiece.
If we take the lowest selling figure of $22 and the highest purchase price of $49, that suggests a total loss of 47%, including dividends.
On the highest sale figure, and lowest selling price, Buffett would have earned a loss of 30%. The actual figure is probably somewhere in the middle of these two numbers.
An analysis of his second-largest airline holding, Southwest Airlines (LUV, Financial), shows an average acquisition price of around $51.75 per share. Buffett started buying in the fourth quarter of 2016. In calendar 2017, 2018 and 2019, investors received total dividends on $1.96. According to regulatory filings, Berkshire sold 2.3 million Southwest shares for about $74 million on April 1 and April 2, suggesting a sale price of around $32 to $30.
At the high end of this estimate, Berkshire would have booked a loss of 34%, or nearly $1 billion. That is a big hit, but it is essential to quantify it in the grand scheme of things. Berkshire's operating income was nearly $6 billion in the first quarter of 2020. It freed up around $2 billion by selling Southwest, capital that can now be redeployed at higher return rates.
At a 10% per annum return, Buffett would have earned his losses back in approximately four years. With most analysts warning it could take many years for airlines to return to 2019 capacity levels, it seems to me that this is a fair trade-off of what's knowable for what's not knowable.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Berkshire Hathaway Sells Airlines as They Become Too Hard to Understand
- A Look at Carnival Corp Through the Eyes of Benjamin Graham
- Seth Klarman: More Research Is Not Always the Answer
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