At the end of the second quarter, Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) had a record $277 billion in cash, cash equivalents and U.S. Treasuries on its balance sheet, more than double the level six quarters earlier. The giant conglomerate has also been a net seller of stocks over the past year and a half. Since December 2022, stock purchases have totaled $21 billion, but stock sales have totaled more than $137 billion.
Those capital allocation decisions could easily be interpreted as a warning from CEO Warren Buffett. He controls the bulk of Berkshire’s equity investment portfolio, so record levels of relatively liquid capital imply that he’s having a hard time finding stocks worth buying in the current environment.
One logical conclusion is that Buffett believes the stock market could decline sharply in the not-too-distant future. S&P 500 (SNP INDEX: ^GSPC) is up 45% since December 2022, well above its historical average, so it’s not hard to imagine a correction coming. However, investors should be careful how they interpret Buffett’s $277 billion “warning.” The situation is more complex than it first appears.
Buffett’s warning may not apply to the average investor
Berkshire Hathaway makes money in two ways. It owns dozens of profitable subsidiaries outright, and it owns stocks and bonds that effectively generate value through capital gains, dividends and interest payments. Buffett explained that strategy in his last letter to shareholders: “Our goal at Berkshire is simple: We want to own all or a portion of businesses that are economically viable and fundamentally sustainable.”
Importantly, Berkshire Hathaway has a GAAP net worth — also known as “book value” — of $602 billion. By that measure, Berkshire is worth more than any other company in the S&P 500. In fact, its GAAP net worth exceeds that of Apple, MicrosoftAnd Nvidia combined. Of that total, Berkshire had $285 billion invested in stocks at the end of the second quarter.
So, the conglomerate would have to buy $2.8 billion worth of stock to make its stake 1 percent of its portfolio. And even if that investment doubled in value, Berkshire’s portfolio value would increase by only one percentage point, and its net worth would increase by less than half a percent. In other words, an investment of that size would ultimately be insignificant.
Granted, that hurdle doesn’t always stop Berkshire from buying a stock. For example, it opened a position in Ulta Beauty in the second quarter, it was worth just $266 million as of June 30. Ulta, however, will never be a meaningful change for Berkshire, as further stock purchases are limited by Ulta’s $18 billion market cap.
Which brings us to an important question: How many companies are big enough to be a worthwhile investment for Berkshire? The answer is not many. Fewer than 200 publicly traded companies are worth more than $100 billion, fewer than 70 are worth more than $200 billion, and fewer than 30 are worth more than $300 billion. Even fewer fall within Buffett’s circle of competence, or that of his investment managers, Todd Combs and Ted Weschler.
Buffett said it in that recent shareholder letter: “There are only a handful of companies left in this country that can really make a difference for Berkshire, and they have been picked over and over again by us and others.” He ultimately concluded: “All in all, we have No possibility of dazzling performances.”
This hurdle doesn’t apply to the average investor, however. For most people, making $100,000 in the stock market would be a big deal, and there are no size-based restrictions on which companies retail investors can choose to earn those returns. Therefore, the average investor shouldn’t take Berkshire’s massive position in cash and Treasuries as a dire warning. It may say more about the size of the conglomerate than it does about the stock market.
Proceed with caution, but don’t avoid stocks completely
Readers should not interpret anything I have said as suggesting that I believe the stock market will only go higher from here. Recent economic data and elevated valuations suggest that a stock market correction or bear market is certainly possible in the short to medium term.
For example, the disappointing July jobs report earlier this month showed payrolls rose much less than expected, while the unemployment rate, while still relatively low, hit its highest level in nearly three years. That data raised questions about whether the Federal Reserve waited too long to cut its benchmark federal funds rate.
Adding to the uncertainty, the Labor Department recently said it may have overstated the number of jobs added in the 12-month period ending in March by 818,000. A weakening labor market, coupled with higher interest rates, could push the economy toward recession.
What’s more, the S&P 500 is currently trading at 25.9 times earnings, a material premium over the five-year average of 23.5 times earnings or the 10-year average of 21.6 times earnings. That means many stocks are expensive by historical standards, so investors could quickly turn bearish if future economic data suggests a recession is on the way.
Here’s the thing: The stock market may or may not fall in the coming months, but investment strategies that rely on attempts at market timing can be disastrous. So while investors should be especially careful about which stocks they buy in the current environment, avoiding the market altogether could be a costly mistake.
For example, Berkshire Hathaway has been a net seller of stocks since December 2022, but the S&P 500 is up 45% during that time. Investors who avoided the market during that time missed out on significant gains. Moreover, there’s no guarantee that the S&P 500 will give up all those gains, even if it falls sharply in the future. And investors who sell stocks to avoid losing money in a potential correction are also likely to miss out on the recovery that history suggests would follow.
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Trevor Jennewine has positions in Nvidia. The Motley Fool has positions in and recommends Apple, Berkshire Hathaway, Microsoft, Nvidia, and Ulta Beauty. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
Warren Buffett Issued a $277 Billion “Warning” for the Stock Market. Investors May Want to (Mostly) Ignore It. was originally published by The Motley Fool
