Huafu Macro: Analyzing the logic behind Warren Buffett's significant reduction in Apple holdings

Key Findings

On the evening of August 3, 2024, Beijing time, Berkshire Hathaway, a company under Buffett's control, released its financial report for the second quarter of 2024, showing stable business performance. In terms of investment portfolio, the stock position has been decreasing for three consecutive quarters, while cash reserves (including short-term Treasury bonds) have surged from 28.6% in the first quarter of 2024 to 45% in the second quarter of 2024.

This change mainly stems from the reduction of Apple's shares, with Apple's proportion of secondary market stock investments dropping from around 40.3% in the first quarter to about 29.6% in the second quarter.

The significant reduction in Apple's holdings this time is extremely rare in Buffett's investment history over the past few decades. Why did Buffett significantly reduce his holdings in Apple? Possible reasons may include:

1. For tax considerations, to prevent future increases in corporate tax rates. Buffett's holding of Apple stock has a huge unrealized capital gain, and the U.S. election may bring uncertainty to tax policies.

2. The valuation of the U.S. stock market has reached overvaluation levels. In an uncertain market environment, maintaining sufficient cash reserves can prepare for future investment opportunities and provide protection during market turmoil.

3. Concerns about the risks of commercial applications in the field of artificial intelligence. Explanations such as concerns about a U.S. economic recession, diversifying investments to reduce portfolio concentration, may not align with Buffett's investment philosophy over the past few decades.

Report Details

1. Analysis of Buffett's Significant Reduction in Apple Holdings

On the evening of August 3, 2024, Beijing time, Berkshire Hathaway, under Buffett's control, released its financial report for the second quarter of 2024. The report showed that Berkshire Hathaway's cash reserves reached a historical high of $276.9 billion, a significant increase from $189 billion at the end of the first quarter of 2024.

In the secondary market stock investments that the market focuses on, the top five major holdings of Berkshire Hathaway remain unchanged, namely Apple, Bank of America, American Express, Coca-Cola, and Chevron.

However, the number of shares held in Apple has significantly decreased, from around 790 million shares at the end of the first quarter of 2024 to about 400 million shares at the end of the second quarter. This also means that Apple's position in the secondary market stock investments has decreased from around 40.3% in the first quarter to about 29.6% in the second quarter. The current position has decreased by nearly 20 percentage points compared to Apple's nearly 50% stock position at the end of 2023.

Looking back at Buffett's investment career, it is easy to see that the speed and magnitude of this reduction in Apple holdings are extremely rare in his investment history over the past few decades. According to the disclosure data from Berkshire's 13F filings released quarterly since 1998, there has never been a strict case of a company's holdings decreasing by 10 percentage points in a single quarter.

Buffett's holdings in BNSF in the first quarter of 2010 due to privatization, Gillette in the fourth quarter of 2005 due to acquisition by Procter & Gamble, and Wells Fargo in the third quarter of 2005 due to Berkshire gradually increasing its holdings and applying to the SEC to hide holding information have experienced fluctuations of more than 10 percentage points However, there are significant differences compared to the sale of Apple Inc. this time.

If we consider the holding information disclosed by Buffett in his annual shareholder letters in earlier years, we can find that since 1976, there have been several instances where Buffett's annual holdings have decreased by more than 10 percentage points:

① Sold General Foods Corporation in 1985 (Philip Morris offered a high price for acquisition); ② Sold Exxon Mobil Corporation in 1985 (held for less than 2 years, sold too early after making a profit); ③ Completely exited IBM in 2017 (this was one of Buffett's rare investments in technology stocks, but despite enduring 6 years in the U.S. tech stock bull market, the investment did not perform well, leading Buffett to exit IBM and significantly increase his stake in Apple); ④ Sold Renault Industrial Company in 1984 (exited after holding for 4 years and making a profit, later the company underwent mergers, renaming, and leveraged buyouts).

Apart from these, Buffett has hardly ever carried out operations similar in speed and magnitude to reducing his holdings in Apple in 2024.

Why did Buffett significantly reduce his holdings in Apple? We believe the possible reasons could be as follows:

First, for tax considerations. Buffett's holdings in Apple already have a huge unrealized capital gain. According to Buffett's remarks at the shareholder meeting on May 4, 2024, one important reason for reducing Apple's stock is the expectation of continued increase in future corporate tax rates, with the upcoming U.S. election potentially bringing significant uncertainties.

Second, the valuation of the U.S. stock market, especially in the technology sector, has reached historically high levels. Buffett believes that "the market now exhibits more casino-like behavior than when I was young." In an uncertain market environment, maintaining sufficient cash reserves can prepare for future investment opportunities and provide protection during market turmoil.

Third, concerns about the commercial application risks in the field of artificial intelligence, worrying whether massive AI investments can generate substantial income and profits, and whether AI-enabled Apple phones can bring new growth points for the company. Some other reasons commonly used as explanations may not be very convincing in our view, such as concerns about the risk of U.S. economic recession, diversifying investments to reduce portfolio concentration, etc., which may not align well with Buffett's investment philosophy upheld over the past few decades.

1.1 Berkshire's Investment Portfolio Cash Reserves Soar

On the evening of August 3, 2024, Beijing time, Buffett's Berkshire Hathaway company released its financial report for the second quarter of 2024. According to our calculations, the stock position in Berkshire's investment portfolio has been declining for three consecutive quarters, with the stock position in the second quarter of 2024 at 52.2%, a significant decrease of 15 percentage points from the first quarter.

However, these funds have not been transferred to fixed-term securities investments (mainly foreign government bonds and U.S. Treasury bonds, including a small amount of corporate bonds). The position in these bond investments in the second quarter of 2024 was 2.79%, a decrease of 1.38 percentage points from the first quarter. The cash and cash equivalents position (including U.S. short-term Treasury bills with a maturity of less than 3 months) has surged, rising from 28.6% in the first quarter of 2024 to 45% in the second quarter of 2024 Adequate cash reserves reduce the short-term market volatility risk faced by the investment portfolio, while also preparing for future investment opportunities.

Since the end of April 2024, US technology stocks have risen significantly, with Berkshire's stock price continuously underperforming the S&P 500 index until July 10th. On July 12th, after the Nasdaq index hit a historical high, it began to turn downwards, while Berkshire, with a more diversified business, gradually regained lost ground and started to catch up with the S&P 500 index.

1.2 Recent Operating Performance of Berkshire Hathaway

The latest quarterly report of Berkshire Hathaway shows that as of the end of the second quarter of 2024, Berkshire's total assets were $1.1089 trillion, liabilities were $500.9 billion, and shareholders' equity was $608 billion.

In terms of stock investments in the secondary market, Berkshire's holdings are approximately $284.9 billion, with the top five holdings contributing close to 72% of the weight. Among them, the holdings of Apple Inc. are valued at $84.2 billion, Bank of America at $41.1 billion, American Express at $35.1 billion, Coca-Cola at $25.5 billion, and Chevron at $18.6 billion.

In the second quarter of 2024, Berkshire Hathaway's quarterly operating income reached $93.653 billion, a year-on-year increase of 1.24%. The pre-tax net profit from operating activities excluding stock investment income was $13.302 billion, a year-on-year increase of 16.24%. The operating business achieved stable performance growth. Including stock investment contributions, and deducting the impact of taxes and minority shareholder equity, Berkshire Hathaway's net profit attributable to shareholders in the second quarter of 2024 was $30.348 billion (after tax), a year-on-year decrease of 15.49%.

This was mainly due to a $9.2 billion decrease in pre-tax profit from stock investments compared to the previous year. Due to the new accounting standards in the US requiring unrealized gains and losses on stock investments to be included in the income statement, Buffett believes that net profit indicators may mislead investors unfamiliar with accounting rules. Therefore, he repeatedly emphasizes in his annual shareholder letters that the focus should be on the company's operating profit indicators, which have been steadily increasing in recent years.

In terms of revenue composition, Berkshire Hathaway's insurance underwriting business revenue in the second quarter of 2024 showed stable growth compared to the same period in 2023, increasing from $20.561 billion in Q2 2023 to $21.953 billion in Q2 2024. Manufacturing, service, and retail business revenue increased slightly from $42.126 billion in Q2 2023 to $42.245 billion in Q2 2024, with manufacturing revenue growing while service and retail revenue declined The revenue from the railroad business decreased from $5.828 billion in 2023 Q2 to $5.805 billion in Q2 2024, while the revenue from utilities and energy business decreased from $21.116 billion in 2023 Q2 to $19.491 billion in Q2 2024.

In terms of pre-tax net profit composition, Berkshire Hathaway's insurance underwriting business contributed $2.847 billion in pre-tax net profit in the second quarter of 2024, showing a significant improvement compared to the previous year. Insurance investments contributed $4.068 billion in pre-tax net profit in the second quarter of 2024 (Buffett's stock investment portfolio is not included in this record), showing a substantial increase from the profit in Q2 2023.

The railroad business contributed approximately $1.622 billion in pre-tax net profit, which remained relatively stable compared to the same period last year. The utilities and energy (BHE and PTC companies) collectively generated $0.525 billion in net profit, with PTC company's revenue declining but profit increasing, while BHE company is in a situation of increasing revenue but decreasing profit.

The numerous manufacturing companies controlled by Berkshire Hathaway contributed $3.129 billion in pre-tax net profit in the second quarter of 2024, while service and retail companies contributed approximately $1.111 billion in pre-tax net profit. The profit growth in manufacturing to some extent offset the decline in profit in service and retail. The pre-tax profit from stock investments in the second quarter of 2024 was $23.857 billion, showing a decrease from the second quarter of the previous year ($33.061 billion in pre-tax profit).

Buffett encourages shareholders to ignore quarterly investment gains and losses, as these numbers often lead to significant fluctuations in net profit or losses. He emphasizes that Berkshire Hathaway will only use cash in situations where the risk is low and substantial returns are expected. Despite Buffett's appreciation for Apple's pricing power and customer loyalty, he mentioned at the May annual meeting that reducing Apple's stock holdings is reasonable due to potential tax rate increases.

By selling stocks to raise funds, he not only increased the company's cash reserves but also took advantage of the higher interest rates on current U.S. Treasury bonds and deposits to preserve and increase asset value. This operation not only ensures asset safety but also reserves sufficient flexibility for future investment opportunities, enabling quick actions in the market when favorable opportunities arise to seek and invest in the next potential assets.

1.3 Reasons for Buffett's Significant Reduction in Apple Inc. Holdings

According to Berkshire Hathaway's latest 10-Q quarterly report and previously disclosed 13F quarterly holding data, Berkshire Hathaway's cash reserves surged to $276.9 billion in the second quarter of 2024, mainly due to the significant reduction in Apple Inc. shares Warren Buffett sold 120 million shares of Apple stock from January to March 2024, and further sold approximately 390 million shares from April to June. Currently, he still holds about 400 million shares of Apple stock. In addition, the increase in cash reserves also came from the sale of other stocks, including Bank of America. Since the third quarter of 2022, Berkshire Hathaway has achieved net stock sales for seven consecutive quarters. Since mid-July, Buffett has been selling a large amount of Bank of America stock.

Buffett once considered Apple as one of Berkshire's important assets. This unprecedented large-scale reduction may indicate a significant change in his view of Apple. The possible reasons for Buffett's reduction of Apple stock are as follows:

First, for tax considerations, to prevent future corporate tax rate increases. Second, in a market environment with high valuations, maintaining sufficient cash reserves to prepare for future investment opportunities. Third, concerns about the risks of commercial applications of artificial intelligence. Other explanations such as concerns about the risk of a U.S. economic recession and diversifying investments to reduce portfolio concentration may not align well with Buffett's investment philosophy over the past few decades.

Article by: Jin Han (S0210523060002), Yan Xiang (S0210523050003), Source: Huafu Research Macro, Original Title: "Analysis of Buffett's Significant Reduction in Apple"