The great one turned 90 on Sunday.
Here's my belated best wishes to the Oracle himself. Those of us who study stocks for a living are truly blessed to have been (virtually) in the presence of Warren Buffett for so long. In doing the research for this column, though, I actually read Berkshire's second quarter 10-Q. With Buffett's decision to go whole hog on Apple AAPL, Berkshire owned $91.5 of (AAPL) shares June 30, a figure that, barring selling, would have easily crossed the $100 billion mark in August's amazing rally for Tim Cook's colossus. AAPL is a much larger holding for Berkshire than the other three (Bank of America (BAC) , Coca-cola (KO) , American Express (AXP) ) individually-mentioned holdings combined, and Warren has clearly caught the zeitgeist of this tech-infatuated market.
But then I read the other 53 pages of Berkshire's 10-Q, and the stock's relative underperformance actually made sense to me. This year (BRK.A) shares have fallen 2.3% in 2020 vs. the 8.8% gain posted by the S&P 500. Berkshire's operating businesses have been hit hard by the pandemic, and the company's operating cash flow turned negative (-$25 billion after capital expenditures vs. a positive cash flow of $14 billion) in the first half of 2020 after a solidly positive performance in the first half of 2019.
What's more, it is clear that Buffett and his lieutenants and potential successors lack the faith in the current market rally. Berkshire sold stock heavily in the second quarter. The cost basis of Berkshire's Investments in Equity Securities dropped to $96.1 billion at June 30 from $110.3 billion at year-end 2019. It is by analyzing the cost basis that an investor can truly see changes in the portfolio over and above appreciation and depreciation. Warren Buffett sold, and history has told us that he did not correctly time this most recent market rally.
But the real problem with Berkshire is the decision not to sell its Kraft Heinz (KHC) stake. Warren waxed lyrically about his Brazilian private equity buddies at 3G when the KHC deal was consummated in 2013. But KHC stock has been an absolute dog in the past few years, and, obviously, the pandemic has not helped. Berkshire owned 325 million KHC shares -- 26.6% of the total outstanding -- as of June 30. As Berkshire's 10-Q notes:
As of June 30, 2020, the carrying value of our investment in Kraft Heinz exceeded the fair value based on the quoted market price by $2.7 billion (20.6%).
Berkshire noted its reluctance to write down the value of its KHC stake from an accounting perspective, and KHC shares have actually eked a small gain this year and sit today at $34.63. Remember, though, this stock was threatening the $100 level in early 2017, and clearly the Street has decided that the value of the company has been substantially eroded in the period in which Berkshire has been its largest shareholder.
Similarly, Berkshire actually did take a write down on its holding in Precision Castparts, its last major acquisition, which occurred in August, 2015. Berkshire wrote down the value of PCC by $10 billion in the second quarter. This is a substantial portion of the $37.2 billion (including debt) Berkshire paid for PCC in August 2015.
So, that's the conundrum, and that's why, despite my great respect for the Oracle, I have never owned Berkshire stock.
There is a torrent of content in financial media composed of folks yelling at Warren to spend some of Berkshire's cash. That cash pile amounted to $143 billion as of June 30, and has grown from $125 billion a year-end 2019. But, aside from buying more and more and more Apple, investing in public companies in 2020 has not been easy. The writedown on Precision Castparts shows the consequences of buying an aviation supply company into the greatest pandemic the world has seen in 100 years. The Kraft Heinz non-writedown, however, shows Berkshire's bizarre love for a consumer products company that has very, very little appeal these days.
So, as much as it may have seemed so in August, investing is not easy. I like Warren Buffett's chances to come back from 2020's setbacks, just as he has done consistently for the past 60 years. I am focusing my investing resources elsewhere, though, and I would love to see more nimble portfolio management from those that would look to be in contention to take over at Berkshire from 90-year-old Warren and his 96-year-old "wingman," Charlie Munger.