Should you follow Buffett?
Yes... And No?
One of the biggest developments of last month was Buffett selling ~50% of his stake in Apple. The raw numbers were staggering — just this year, Berkshire has sold more than 500 million Apple shares worth more than $100 billion! What’s more interesting is whenever Buffett makes a sale, there is a barrage of reports and news articles stating why that company is a bad bet for investors and that we should also think about selling out.
Our view is that Buffett’s sales are never about market timing and are more about his personal investment philosophy. Buffett is a value investor at heart and sells the stock when it becomes too expensive for him. Last year, Apple was trading at a PE ratio of ~30 and accounted for close to 30% of Berkshire’s portfolio. This was at a significant premium compared to the other top two positions of Berkshire (Bank of America, PE 15 & AmEx, PE 20) and might have made Buffett cut his position.
Buffett famously said in 2006 that he regretted not selling Coca-Cola when it was trading at 50 times earnings in 1998. It proved prescient as KO 0.00%↑ took more than 15 years to regain the ATHs it reached in 1998.
Coca-Cola is a fabulous company that was selling at a silly price… You can definitely fault me for not selling the stock. I always thought it was a wonderful business, but clearly, at 50 times earnings, it was a silly price.
High PE ratios are a precursor to lower returns. Here is what Jim O'Shaughnessy found when he did an analysis comparing the long-term returns of high PE ratio stocks to that of the market (paraphrased and emphasis added for clarity):
Both All Stocks (comparable to Total Stock Market) and Large Stocks (comparable to S&P500) with high PE ratios perform substantially worse than the market. Companies with low PE ratios from both the All Stocks and Large Stocks universes do much better than the universe.
In both groups, stocks with low PE ratios do much better than stocks with high PE ratios. Moreover, there’s not much difference in risk. All the low PE groups provided higher returns over the periods, with lower risk than that of the universe. – Excerpt from “What works on Wall Street.”
This brings us to an interesting question — If Buffett trims stocks that he thinks are over-valued and since data shows over-valued stocks had lower returns than the market,
Should you follow when Buffett sells?
To test out this theory we leveraged this dataset from Dataroma. It contains all the trades made by Berkshire from 2007. There were more than 500 trades (sells) in the last 17 years.
One quick problem that you notice is that we have to disregard rebalancing trades. For example, the first sell in the list of Liberty Media is a rebalancing trade and has no material effect on the portfolio.
To avoid this and shortlist relevant trades, we came up with 2 criteria:
The activity should be a 100% sell (or)
It should be more than 1% of the portfolio
Cleaning the data (shared at the end), we were left with 136 trades. The findings were surprising.
Only 26% of the companies outperformed Berkshire after Buffett sold them.
On average, a portfolio of companies that Buffett sold would have underperformed Berkshire
Buffett is also not immune to making mistakes. He sold United Health and Home Depot in 2010 which is now up 23x and 15x respectively compared to the 5x return of Berkshire.
Let’s dig in: