In the initial nine months of 2024, Warren Buffett has divested an astonishing $133 billion in stocks from the Berkshire Hathaway portfolio. This divestment includes over two-thirds of the company’s holdings in both Apple and Bank of America. Despite these extensive sales, Berkshire Hathaway maintains a stock portfolio valued at approximately $300 billion.
A number of investors interpret Buffett’s actions as a signal that the stock market is overvalued. His decision to reduce stakes in Apple and Bank of America implies a belief that these shares might be trading at or above their intrinsic worth. Acquiring stocks that are overvalued can hinder investors’ ability to achieve substantial returns.
Conversely, Buffett’s acquisition of $550 million in Domino’s Pizza shares during the third quarter is quite telling. Although this amount is modest relative to his $36 billion in stock sales, it constitutes 3.7% of the entire company. Domino’s fortressing approach has facilitated growth in its global market share.
The company demonstrates robust profitability, enhanced operating margins, and returns capital to its shareholders. However, Buffett faces the hurdle that Domino’s, with a valuation of under $16 billion, is comparatively small for Berkshire’s usual investment size. He has encountered similar challenges with other potentially appealing stocks in 2024 being too small to noticeably impact Berkshire’s vast portfolio.
In his shareholder letter from February, Buffett stated, “Only a select few companies in this country are genuinely capable of moving the needle at Berkshire, and they have been thoroughly evaluated by us and others. Some of these we can assess; others remain challenging to value.”
Buffett seeks smaller-cap possibilities
“If we can assess their value, they must be attractively priced,” he added.
Buffett’s investment capabilities are limited by the size and valuation of candidate companies. For instance, the market price of Bank of America has risen to approximately 1.8 times its tangible book value, a level that Buffett finds excessive. Similarly, Apple shares are trading at nearly 32 times their forward earnings, a considerably higher multiple than what Berkshire paid during acquisition.
Even with these large-cap restrictions, smaller firms like Domino’s Pizza seem more appealing. Domino’s forward price-to-earnings ratio of 27, while still somewhat high, presents a more favorable comparison to other rapidly growing quick-service restaurants. Buffett’s purchase of Domino’s indicates there may be additional investment opportunities in the stock market that Berkshire’s massive size prevents them from capitalizing on.
The market presents a plethora of opportunities within mid-cap and small-cap sectors. Stock valuations imply that Buffett might lean towards investing in companies with market capitalizations smaller than that of Domino’s. The S&P 500 trades at a forward P/E ratio of 22.1. Excluding large-cap stocks, smaller equity valuations appear more attractive, with mid-caps at 19.5 and small-caps at 17.1.
Buffett encourages investors to explore smaller companies.
This may entail examining individual stocks, such as Domino’s Pizza. Alternatively, investing in an extended market or small-cap value exchange-traded fund would provide exposure to these possibilities. The Vanguard Extended Market ETF tracks nearly all stocks aside from those in the S&P 500 and boasts a low expense ratio of 0.06%.
The Avantis U.S. Small-Cap Value ETF utilizes valuation and profitability criteria to select stocks and possesses a fee of 0.25%. Whether selecting individual stocks or ETFs, Buffett’s investment strategies indicate greater potential for investors in smaller companies. Investors would be wise to consider this insight from the Oracle of Omaha.
