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Bull of the Day: Berkshire Hathaway (BRK.B)

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It’s no secret that the equity markets have been suffering lately. Investor sentiment has turned broadly negative and in many cases selling seems to beget selling, even when there’s no clear catalyst. We’ve seen downturns before that were the result of significant contagious events – the Asian Flu, the collapse of Long Term Capital Management, the Bursting of the Tech Bubble and the Financial Crisis of 2008.

We haven’t seen any compelling reason for the selling pressure of the past two months other than investor fear and the desire to protect the profits accumulated during the previous nine-year bull run. In many cases, investors seem to be dumping shares of even the healthiest companies as they race to the door.

One legendary investor has consistently recognized previous periods of turmoil as opportunities and used temporarily depressed share prices to bolster his portfolio at attractive prices.

Warren Buffett.

The Oracle of Omaha has a famous bit of advice about investing – “Be fearful when others are greedy and greedy when others are fearful.” – and he has consistently put his money where his mouth is, making shrewd investments in the strongest companies when sentiment is at its worst.

Owning shares of Buffett’s holding company, Berkshire Hathaway (BRK.B - Free Report) is like getting a ride on the Oracle’s coattails as he and his top lieutenant Charlie Munger put their combined 100+ years of investing experience to work finding opportunity amid the chaos.

Berkshire is currently a Zacks Rank #1 (Strong Buy).

Munger coined the phrase “lollapalooza effect” to describe how a confluence of cognitive biases can result in situations in which groups of otherwise well-informed people can act irrationally.

Berkshire has capitalized on the irrational behavior of investors countless times, possibly none more notable than their tremendously successful investment in Goldman Sachs (GS - Free Report) during the financial crisis in 2008.

The contagious effects of falling share prices, loan defaults and huge losses in derivatives trades threatened to bring down the entire investment banking industry.

Shortly after the fall of Lehman Brothers, Buffett recognized that Goldman was a significantly stronger enterprise than other investment banks, all of whom had seen their share prices pummeled.

During the height of the panic, Buffett invested $5B in Goldman in a private deal that gave him a large ownership stake in preferred shares that paid a 10% annual dividend as well as warrants to buy an additional 43 million shares of common stock at $115/share. It was a win-win situation as Goldman then enjoyed the credibility conferred by Buffet’s investment and was able to raise additional capital in an equity offering and ultimately survived the crisis as strong as ever.

Buffett’s profit on the trade is estimated at $3.1B – a fairly tidy return that was made possible only because of his willingness to make a huge bet just as most others were at their most risk-averse.

In the event of any sort of crisis situation in the future, what investor wouldn’t want Warren Buffett at the helm, making the tough choices for them?

Berkshire Portfolio

Berkshire tends to take large positions in high-quality, large-cap names and holds them for long periods of time, often adding to those positions during periods of opportunity.

Traders comb Berkshire’s quarterly SEC filings reporting their holdings and it’s not uncommon to see quick appreciation in any given name once the markets recognize that Buffet has spent the previous three months acquiring shares.

As of the end of the third quarter, Berkshire had approximately $86B – or 40% of its portfolio - in the shares of large banks, including $13B purchased during the quarter. Buffett loves banking and insurance businesses because of the natural spread between taking in deposits or premiums and investing/lending at significantly higher rates to make profits. He also favors what he calls “forever businesses” whose products and services are in demand in all economic environments.

Investment banks also tend to see improved financial results during tumultuous times because of both increased commissions and fees on a higher volume of customer business as well as increased margins on proprietary trading activity. It wouldn’t be surprising to see Bank of America (BAC - Free Report) and Goldman Sachs post increases in trading revenues during the second half of 2018.

Berkshire also has large positions in defensive names like Coca-Cola (KO - Free Report) and Kraft-Heinz (KHC - Free Report) . Selling the products consumers continue to buy in all economic conditions, these companies generally weather the storm much better than more cyclical names who depend more on economic growth.

Finally, Berkshire’s single largest position is currently in Apple (AAPL - Free Report) , worth about $45B even after a recent decline. Though investors currently fear a downturn in Apple’s flagship iPhone products, a recent decline of 20% seems like a severe overreaction even in the worst case iPhone sales scenario and it won’t be a surprise if we find that Berkshire has increased the position at attractive prices during Q4.

Invaluable Guidance

In declining markets it can be difficult for even the best-intentioned individual investor to discern when it’s time to get greedy. The financial news is sometime full of conflicting information about whether you should “buy the dip” or head for safety and wait. Making important decisions can be an excruciating process. Luckily, you don’t have to do it alone. You can let Warren Buffett help you out.

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