Reading:Warren Buffett has sold $133 billion worth of stocks so far in 2024, but this small $550 million purchase sends an important message to investors.
Warren Buffett has attracted a lot of attention this year thanks to some very large, high-profile stock sales. The Oracle of Omaha sold a total of $133 billion worth of shares from Berkshire Hathaway's portfolio during the first nine months of 2024.
Some of the biggest sales include Apple(NASDAQ:AAPL)of which he sold more than two-thirds of Berkshire's stake, and Bank of America(NYSE:BAC). Despite the sales, Berkshire still owns $300 billion in shares, but only a handful of companies are safe from a reduction these days, it seems.
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Many see Buffett's massive stock sell-off as an important warning to investors that the stock market is overvalued and that investors should reduce their exposure to stocks. Indeed, Buffett's sales of Apple and Bank of America suggest that he believes both stocks are currently trading near or above their intrinsic value. Investors will struggle to earn solid returns by buying stocks above their true value. It may therefore be wise to reduce positions like Apple or Bank of America.
But Buffett doesn't think all stocks are overvalued right now. It's just that he faces a unique challenge as someone charged with managing $600 billion in assets when you include Berkshire's cash and Treasury positions. His stock purchases this year tell the whole story.
Image source: The Motley Fool.
Berkshire's largest stock purchase during the third quarter was approximately $550 million. Domino's Pizza(NYSE:DPZ). Yes, that pales in comparison to the $36 billion that Buffett and his team sold in other stocks during the quarter, and the purchase represents only 0.2% of the entire portfolio of actions. But the purchase represents 3.7% of the entire pizza supplier.
Domino's can be a great stock to buy. Its fortification strategy has enabled it to increase its market share throughout the world. It displays strong profitability at the store level, even if it cannibalizes itself by opening new locations near existing ones. This generates strong operating margin expansion and returns capital to shareholders. These are all signs of a great company.
Buffett's challenge is that Domino's market cap is currently less than $16 billion as of this writing. He could buy 20 companies the size of Domino's Pizza with Berkshire's cash if the market allowed him to do so.
He encountered similar problems with other stocks he found attractive in 2024: Ulta Beauty has a market capitalization of approximately $17 billion, SiriusXM has a market capitalization of approximately $9 billion, Piscine Corp. has a market capitalization of approximately $14 billion, and Hi has a market capitalization of $32 billion. The market limits how much of these stocks Buffett can actually buy.
He explained the challenge Berkshire faces in his letter to shareholders in February:
There are only a handful of companies left in this country that can truly make a difference in Berkshire, and they have been taken over again and again by us and others. Some we can value; some we can't. And if we can, they must be offered at attractive prices.
In other words, the big companies Buffett could invest tens of billions of dollars in aren't very attractive right now — at least not according to accomplished value investor Warren Buffett.
Bank of America's stock price has climbed to about 1.8 times its tangible book value, which could be more expensive than Buffett wants. (He notably stopped buying back Berkshire shares as the price was floating above 1.6 times book value.)
Apple shares currently trade at nearly 32 times forward earnings, far higher than the multiple Buffett initially paid during the stock accumulation between 2016 and 2018, when shares consistently traded well below 20 times the profits.
But smaller companies like Domino's Pizza seem much more attractive. The restaurant's forward price-to-earnings (P/E) ratio of 27 is still a bit expensive, but it compares favorably to other fast-growing quick-service restaurants. And while Buffett can only invest a limited amount without significantly changing the market, an individual investor should have no problem buying as much as he wants for his portfolio.
Buffett's decision to buy Domino's last quarter doesn't necessarily mean investors should follow his lead precisely. In fact, this may indicate that he believes there are far more opportunities in the stock market than Berkshire can actually exploit due to its size.
Domino's is a relatively small company for Berkshire to invest in, but it remains one of the members of the large-cap group. S&P500 hint. In other words, in the vast universe of the stock market, Domino's is bigger than about 80% of investable companies in the United States alone. Given that this is one of the smaller options Buffett could consider, that means there could be plenty of other opportunities in the mid- and small-cap markets.
Indeed, stock valuations suggest that Buffett would be much happier if he could invest more in companies with lower market capitalizations than Domino's. The S&P 500 is trading with a forward P/E of 22.1 as of December 2. Discarding the Magnificent Seven, large-cap stocks look a bit more attractive with a forward P/E of 19.5. However, the mid-cap S&P400 and small cap S&P600 each trade for just 17.1 times forecast profits. This gap was even bigger a few months ago.
So the big message Buffett is sending to investors is to consider small businesses. That could mean taking a closer look at individual stocks like Domino's Pizza, but it could be as simple as buying an index fund or exchange-traded fund (ETF).
Vanguard offers the Vanguard Broad Market ETF(NYSEMKT:VXF)which tracks the performance of virtually all stocks except those in the S&P 500. With an expense ratio of just 0.06%, this can be an inexpensive way to add exposure to small companies.
Another great option for those looking to focus on value stocks is the Avantis US Small Cap Value ETF(NYSEMKT:AVUV). It's technically an actively managed ETF, but it uses simple valuation and profitability filters to explore the universe of small-cap value stocks and eliminate potential value traps. It then invests in the remaining stocks, weighting each based on market capitalization. The results of the fund (and its predecessor at Dimension Funds) are well worth the 0.25% expense ratio thus far.
Whether you want individual stocks or ETFs, Buffett's buying decisions suggest there's a lot more upside potential for investors in smaller companies. They would do well to listen to the message he is sending.
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Bank of America is an advertising partner of Motley Fool Money. Adam Levy holds positions in American Century ETF Trust-Avantis Us Small Cap Value ETF and Apple. The Motley Fool holds positions and recommends Apple, Bank of America, Berkshire Hathaway, Domino's Pizza and Ulta Beauty. The Motley Fool recommends Heico. The Mad Motley has a disclosure policy.
