Buffett Buys: Morningstar Review

11/18/2005 12:00 am EST


Don Phillips

Managing Director, Morningstar, Inc.

"Periodically, we review the stock holdings of Berkshire Hathaway, run by Warren Buffett, one of the all-time great investors," says analyst Dreyfus Neenan in the always exceptionalMorningstar from Don Phillips. Here’s his reviews of Buffett buys.

"Each quarter, Berkshire files form 13-F with the SEC, which discloses its consolidated equity investments. Berkshire's equity portfolio is only marginally larger than in 1998. Buffett has bought very few stocks over the past six years, which isn't surprising given his negative view of stock-market valuations during and after the bubble. Berkshire continues to struggle to find bargains, as evidenced by a cash hoard that is approaching $50 billion. Although Berkshire has made several small acquisitions this year, cash seems to arrive in Omaha ever faster.

"However, we note that equities have increased markedly this year. We have seen some action in stocks from Berkshire lately, as it has disclosed new investments in Home Depot (HD NYSE), Lexmark International (LXK NYSE), and Tyco International (TYC NYSE). We also understand that Berkshire also has a stake in European home improvement retailer Kingfisher (KGFHY Other OTC), although Berkshire doesn't have to disclose this because it owns the local shares in London, not the US ADRs.

"What's more, we think that investors currently have a rare opportunity to buy a stock at the same time as Buffett and at a lower price to boot! When Anheuser-Busch (BUD NYSE) announced that Berkshire was buying the stock, the price was around $45, and had been falling. Since it takes time to acquire large quantities of stock, we can infer that Berkshire's average cost to that point is probably greater than $45. Intriguingly, Anheuser-Busch's price now is much lower.

"Meanwhile, prospective investors take note: As of October 20, 2005, 11 of Berkshire's stocks boasted our highest 5-star ratings; we think these stocks are excellent candidates for further research. In addition to Lexmark and Anheuser-Busch, these stocks are:

Gannett (GCI NYSE)
Coca-Cola (KO NYSE)
Outback Steakhouse (OSI NYSE)
Sealed Air (SEE NYSE)
Pier 1 Imports (PIR NYSE
Washington Post (WPO NYSE)
Wells Fargo (WFC NYSE)
Wesco Financial (WSC ASE)

"How does the portfolio look in aggregate? If it were a mutual fund, Berkshire's equity portfolio would rank 16th in size among domestic-equity funds. If you threw in cash, Berkshire's portfolio would rank third. But whereas most funds would spread those assets among a hundred or more holdings, Berkshire concentrates them in just a few dozen stocks. Berkshire's top holdingsCoca-Cola, American Express, Procter and Gamble, and Wells Fargo dominate the portfolio, and more than 90% of Berkshire's equity portfolio resides in its top ten names.

"Buffett has always favored focusing his investments, arguing that diversification merely protects against ignorance. And diversification may reduce volatility, but it doesn't necessarily reduce risk. The two concepts are often confused. Volatility can actually help reduce risk because it allows more opportunities for a savvy investor like Buffett to load up on assets when prices are attractive. Buffett argues that the best way to reduce risk is to focus on companies you know extremely well and companies that boast strong competitive positions. If their earnings or share prices happen to bounce around a lot in the short term, who cares?

"Although Buffett often gets pigeonholed as a value investor, only 11% of Berkshire's portfolio resides in value stocks as Morningstar defines them. Among Berkshire's growth stocks are Comcast (CMCSA  NASDAQ), Moody’s (MCO NYSE), and Iron Mountain (IRM NYSE). Buffett wouldn't care where his stocks fell on the value/growth spectrum. In the Buffett world-view, the distinction between value and growth stocks doesn't enter the picture. Any company is a potential value, whether it's growing rapidly or not. Besides not caring about the distinction between growth and value, Buffett also lets his winners ride: He doesn't sell stocks when they get expensive, even if he regrets it later. Rather, he sells them when he no longer feels comfortable with the underlying businesses."

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