Mark LaMonica: James, we're going to talk about Buffett, who you've been writing a lot about recently. We know that everybody always follows, and I think you did say this in your latest article. Obviously, people follow what he does, what Berkshire has in their portfolio. Specifically, you were talking about what he's done with his largest holding, which is Apple. Maybe let's just start with what happened first, and then we can talk about what you think about that and how investors should think about it.

James Gruber: With Apple in the third quarter, which he just announced in terms of earnings as well as other things, he took down the Apple stake over that quarter by about 25%, and in the previous quarter, the second quarter, he'd cut it by 50%. All up, as of this year, I think it's around 66% in terms of his stake has gone down in Apple over that time, so over the nine months to the end of September, he's cut that stake very significantly, and that was his largest holding by far. He still is his largest holding, but he's cut it significantly down. Now, I think there are a few different ways to interpret this, and I wrote at the end of the second quarter that I thought he was going to cut more because the Apple investment didn't really stack up anymore for a few reasons. I got criticized for that because people said, well, he still owns a lot of Apple, which was fair enough, and therefore he might be just trimming after having run up since he started buying in 2016. That was one view, but I thought that the actual fundamentals of Apple had deteriorated, and that was part of the reason why he was selling.

There were a few reasons in terms of those fundamentals. One the valuation for Apple is very high. It's in the mid-30s P/Es. It's not really growing earnings by much these days. It was previously less so now. It's really in the single digits and not really growing much going forward unless AI really takes off. We'll see about that. Also, more importantly, I pointed out something that I don't think a lot of people picked up on, that Apple had continued to buy a lot of shares, and Buffett had previously praised that. That's one of the reasons why he was buying it, because in 2016, when he started buying, Apple was cheap. At one stage, it was on single digit P/Es, if you can believe that. They were buying back stock through those years subsequently very aggressively. He loved that because if you buy back stock at cheap prices and they increase, obviously, that's money well spent. Nowadays, they're buying back stock at 35-time earnings or whatever it is now. It's a different proposition from buying back when it's 9-times earnings. I just think that in Buffett's eyes, he views capital allocation from CEOs as very important. I would foresee that he wouldn't like what they're doing right now with that cash in terms of buying back shares at these prices. For all of those reasons, I think he was cutting back that Apple stake and may continue to cut it back more.

LaMonica: I think the interesting thing, and we'll get back to Buffett and Berkshire, but Apple, in many ways, has the same problem that he does. They still generate a lot of cash and they don't really know what to do with it. So it's the challenge he's facing. Now, they've done something differently with it, but it's interesting, those two companies looking at them side by side.

Gruber: You can view capital allocation through that lens. What do you do with such a large amount of cash? Now, they're obviously investing a fair bit into AI and other technology. They can drive earnings going forwards. They are paying some dividends. They can buy back shares. They can also potentially do mergers or acquisitions as well, which I haven't really been that fond of. So there are a number of different options, but when that cash pile grows so large, as it is in Apple's and Berkshire Hathaway's case, it gets more difficult to get decent returns on that cash in terms of paying out dividends that also has tax implications. So it's a complicated decision, but I just don't see that he thinks that buying back shares at this stage makes any sense whatsoever. He's actually doing something very different, which we can talk about a bit later.

LaMonica: Yeah, so why don't we dive into that now? Because one of the challenging things is we obviously don't know exactly why he's selling. We won't know what he ultimately does until he does it, but you did talk about what has happened. So where has that cash from this enormous sell-down of Apple gone?

Gruber: So in the third quarter, that sell-down, he sold also some other stock, particularly Bank of America, and he has now around $325 billion in cash. And of that, around $288 billion, he's invested in short-term treasuries. And that's an interesting move in itself. It's basically a pretty safe option. It's not long-duration bonds, it's short-duration. In essence, it's like a cash substitute.

LaMonica: Yeah, like very liquid, right?

Gruber: It is.

LaMonica: You can get out of that pretty easily if you want.

Gruber: That's exactly right. It's almost like a holding pattern in terms of his position now. So that's what he's doing with that cash right now. And it was very different to what Apple was doing. Apple was buying back its shares. In the third quarter, for the first time since 2018, Berkshire decided not to buy back its own shares. Which is clearly pointing out that he thinks the stock is fairly or overvalued, his own stock that is, and that it's not worth buying at the moment. So he's halted share buybacks of his own. So it's a very different strategy that he's employing.

LaMonica: And one of the interesting things I think about anytime Berkshire sells something, is Buffett, there's all these very famous investing quotes attributed to him. His favorite holding period is forever. Pretend, like the share market would be closed for 10 years. So I think as you said, this is a big signal that yes, something, either with Apple or perhaps the overall market, is not to his liking. If he's going to make moves like this and start selling shares off.

Gruber: He said at his annual meeting in May that he can't find anything to buy with the cash. He's been looking, he just can't find anything. And that's part of the issue and that's a broader issue about valuations in the market and what he can buy. And also is the sheer size of the acquisitions that he would have to make with that cash. And you're right, I mean people do speculate on why he's doing it. But if you look at for instance, his cash pile as a percentage of his total assets, they're at around 28%, which is a record high. The last time it was near this vicinity was in 2005. And we know what happened after that. It was around 25% of peak debt. He actually did that, that dropped a little bit down to 18% in 2007. So actually started buying stuff in 2006, 2007, as the share market started to deteriorate. And so it was a bit early. And then he bought obviously a lot more post-GFC with the cash that he had.

LaMonica: Yeah, and maybe seeing that scenario again obviously because during the GFC, famously, obviously it was very difficult, particularly for banks to raise funding. I know he went in and I think they were preferred shares, but gave a bunch of money or invested a bunch of money in Goldman when they needed to raise capital. And so perhaps this is what he's foreseeing.

Gruber: I don't know if he is foreseeing a GFC and I doubt it, that kind of thing is normally a 1 in 50 or 75 year event. How I would put it is that I think it's pretty clear he's playing more defense than offense. And I think throughout his career he's shown that he knows when to go aggressive or when not to. And I think this is one of those times where he's clearly signaling where it's time to play defense. With Apple it's a bit more nuanced. As I say, I think that he's not only cutting the stake for potentially market reasons but for Apple specific reasons, I think more so. He would hold on to that if the fundamentals probably did stack up. But I think that he's suggesting that they may not be any selling stock on that individual reason.

LaMonica: And one thing I thought was interesting in your article is one of his long time holdings is famously Coca-Cola. And you did point out that he has said in the past that Coke reached an extremely high, I think the late 90s valuation. And he did say, I wish that I had sold. Just given how expensive it was from an valuation perspective. And then I don't remember the exact amount of time, but it was something like 16 years for the share price to get back to that high. So maybe he's taking some lessons from his own history as well.

Gruber: I think you're right. He has regretted that. He said that on a number of occasions. He knew that Coke, I think it was valued in around 50 times PE or something it got up to in 1999, 2000. So it was very expensive. He knew it. And I also point out in the article that more broadly he was warning about a toppy market at that point. He did a number of talks privately to investors that eventually got out into the media, including to tech executives, which didn't go down well at the time, that he thought some of what was going on was ludicrous and that people would regret it later on. And it didn't take too long after that for things to start falling apart.

LaMonica: How do you see Buffett? Because you did describe him in the article as a value investor. And you mentioned some of this history, obviously under Ben Graham and that deep value cigar butt investing. And then the popular story is he meets Charlie Munger at this dinner party in Omaha. And Charlie is like, well, OK, don't just buy companies like this. Let's buy growth at a reasonable price. Great companies at a reasonable price. I mean, how would you see him? Do you see him as a pure value investor?

Gruber: I see him as both. I don't think there's a distinction in some respects. The two factors kind of coincided neatly in that. I mentioned 1968 when he shut down his fund. He realized then that cigars.

LaMonica: The cigar butt investing.

Gruber: Yeah, wasn't going to work with more money. So at that time, I think he had about $105 million at play, which was a reasonable amount at that time, and he was struggling to invest it. So I think he was realizing already that with larger amounts of money, that style of investing had limitations. And at the same time, he'd met Charlie Munger and Charlie Munger was in his ear about buying at a reasonable price. And he foresaw potentially that that was the way to go going forwards. And then that transferred into his investing in the early 1970s. And he bought See's Candies famously. That was a bit of an epiphany for him, I think in retrospect. If you read some of what he's written and talked about since in that he was a company that was a growth stock, a reasonable growth stock. And he held it. He still holds it. And as that played out, I think that that confirmed that belief in that style of investing, but value and growth is kind of an interesting one. I don't think they're separate. He still wants to buy cheaply. He won't buy expensive stuff. He wants to buy stuff, as you say, at a reasonable price who will pay for that growth. And the other thing to mention would be that he's always been an investor.

I think this is really ignored. He views stocks in some ways a little bit like a bonds plus strategy. What I mean by that is that. Right now he's investing in bonds? He thinks that in essence that bonds returns are on a risk-adjusted basis better than stocks. That's the core in essence he's making by investing $288 billion in short term treasuries. He wants to buy a stock that's returning, giving him a premium above those bonds and with a certainty that he can look out over 10 or 15 years and he's going to make a ton of money in a relatively safe way. And if you look at a number of those investments, whether it See's Candy, whether it's Washington Post, whether it's Coca-Cola, they had quite predictable earnings that he could have a reasonable guess at over 10 or 15 years and that he would have stable kind of returns and he would make a lot of money as a consequence. And he was buying them at a good price.

LaMonica: Yeah. So he's known obviously as the Oracle of Omaha that investors, as we were talking about, try to interpret everything he does. There are countless quotes attributed to him. What lessons, because you did outline some lessons for investors from this sale of Apple and some of the stuff Berkshire and Buffett, of course, are doing. What are those lessons? What can investors take from this whole episode? I know you've probably mentioned some of them in our discussion, but yeah, what can investors take from this?

Gruber: I think it's that there are times to be on defense rather than offense. It doesn't mean making big calls about a market. That it's going to crash or that it's a great buy from here. He's basically saying, look, there's more risks now. There may not be another period where there's less risk and he'll be aggressive in those periods. So I think that's the main takeaway. But as an individual investor, do you sell stocks as a consequence? That's what people will be asking. Well, I'd be saying, look, if you have a stock that's at 50 or 60 or 100 times earnings, there are risks there and you may want to think about that. And this might be the time to do that. That's, I think, one of the main lessons that Buffett is teaching is that if stocks are expensive and fundamentals are deteriorating, then it's time to think about selling. And that's the lesson that he's learned. But I wouldn't say dump everything over the long period, staying invested pays off. And I wouldn't be cutting and running as a consequence just due to Buffett.

LaMonica: Yeah, exactly. And obviously, there's lots of implications around taxes, depending upon your cost basis, how long you've held it. And then, of course, market timing works great in theory, but it's very, very difficult to do. So, yeah, challenging always to navigate all these different signals we're getting. And that's why I guess investing is fun and hard also.

Gruber: Yeah, it is. I would say study the best investors like this, but don't take extreme actions because of it. Think it through. Normally, being black and white isn't the way to go. You know, you can buy and sell at the edges on these kind of things, but on the whole, stay invested.

LaMonica: Yeah. And personally, the lesson I got is I'd like to increase my cash holdings to $350 billion. And I think that I would not have to worry about the share market. But anyway, James, thank you very much for joining us. Great article. So everyone give that a read. But thank you.

Gruber: Thanks, Mark.

This video is based on an article by James Gruber. Read the article titled Warren Buffett is preparing for a bear market. Should you?

Get more insights from Morningstar in your inbox