One of the most common principles of investing is that you need to take on greater risk in order to earn greater rewards. However, occasionally, the market will offer investors a great price on a solid company, providing an opportunity to outpace the S&P 500's (^GSPC 1.15%) returns without as much downside potential.
Warren Buffett is excellent at spotting these opportunities. His investment strategy of buying wonderful businesses at a fair price has helped produce a compound annual return of 19.8% since he took over Berkshire Hathaway (BRK.A 0.94%) (BRK.B 0.97%) in 1965. That absolutely trounces the S&P 500's average total return of 10.2% during that period.
So, when Buffett sees an opportunity in the market, investors pay attention. In his most recent letter to shareholders, he indicated one stock that should be able to outperform the S&P 500 over the long run without as much risk to investors.
Image source: The Motley Fool.
A portfolio full of attractive businesses
Buffett and his team manage an equity portfolio worth over $384 billion. It's full of solid businesses and stocks Buffett says Berkshire could hold forever.
In his letter to shareholders, he called out American Express and Coca-Cola, two of Berkshire's top holdings, as investments he expects to maintain indefinitely. He added to the list Occidental Petroleum, of which Berkshire now owns approximately 28% of shares outstanding after a recent purchase.
All three companies have enduring competitive advantages and strong management teams in place. Their valuations are attractive in the current market. While Buffett has continued to add small bits to Occidental, he doesn't plan on taking majority control. Meanwhile, he doesn't expect to change Berkshire's stake in American Express or Coca-Cola.
Berkshire's biggest holding, by far, is Apple. Buffett has called Apple a better business than any Berkshire owns. But he's sold shares of the stock in each of the last two quarters. He explained the idea is to take the tax hit now while the laws remain favorable. He expects Apple to remain Berkshire's largest holding for the foreseeable future.
Buffett spent the last three quarters accumulating a sizable position in Chubb. The insurance stock continues to trade at a great value. Buffett sold other insurance and financial stocks to make room for it in Berkshire's portfolio.
But none of those are the one stock Buffett thinks should do better than the S&P 500. In a way, all of them are.
He thinks Berkshire Hathaway itself, including its equity portfolio, its wholly owned businesses, and its growing pile of Treasury bills, is the company to own. "With our present mix of businesses, Berkshire should do a bit better than the average American corporation," Buffet wrote in his 2023 letter to shareholders. And even though he expects above-average performance, he thinks Berkshire is well protected against economic downturns thanks to its massive cash position and limited capital needs. He says Berkshire "should also operate with materially less risk of permanent loss of capital."
Investors should note that Buffett stresses what he believes should happen. But predictions are hard, especially about the future, even for the Oracle of Omaha. What's more, he's not expecting the massive outperformance of Berkshire's past. "Anything beyond 'slightly better' ... is wishful thinking," he wrote.
Does Berkshire belong in your portfolio?
Warren Buffett is certainly a big believer in Berkshire Hathaway's future. Roughly 99% of his wealth is tied to the company. On top of that, much of his family is invested in the company as well. And he sincerely cares about building wealth for all of Berkshire's shareholders.
To that end, he's putting his money where his mouth is. During the first quarter, he spent $2.6 billion of Berkshire's cash buying back shares of its stock. That brings his total share repurchases to over $78 billion in just under six years. Each share repurchased increases the remaining shareholders' stakes in Berkshire's equity portfolio, its wholly owned businesses, and every asset on its balance sheet.
The stock currently remains attractive from a valuation standpoint. With shares trading hands at about 18.7 times forward earnings, the stock trades below the S&P 500's forward P/E ratio. That's despite Buffett's expectations that Berkshire's holdings should perform slightly better than the average American corporation. When you account for the massive cash pile on the balance sheet and the consistent share repurchases, that valuation looks extremely attractive.
