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Berkshire Hathaway Better Be Hiding Something Big From The Market

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About: Berkshire Hathaway Inc. (BRK.A), BRK.B
by: Dilantha De Silva
Dilantha De Silva
Long/Short Equity, Value, Growth At Reasonable Price, Research Analyst
Summary

Berkshire Hathaway might be slowly building a long position in a company, but it doesn't want the market to know which company it is.

Empirical evidence suggests a major announcement is on the cards, but it might take months before the grand revelation.

A careful analysis of Berkshire's recent investment decisions suggests the company might favor the tech sector and the energy sector in searching for a bargain.

Conspiracy theories have already surfaced.

Berkshire Hathaway might be secretly building a large position in a companySource

Every quarter, value investors look forward to getting a sneak-peek into Warren Buffett's thinking by carefully analyzing the 13-F statement filed by Berkshire Hathaway, Inc. (NYSE:BRK.A) (NYSE:BRK.B). Earlier in the month, the conglomerate filed its third-quarter reports, and the decision to invest in the pharmaceutical sector while trimming bank holdings garnered widespread attention among the investing public. The company bought back a record $9 billion of its stock as well. As the market remained laser-focused on the disclosed information around these developments, an important piece of information might have missed the attention of some investors. The below statement appeared on the quarterly documents:

"Confidential information has been omitted from the public Form 13F report and filed separately with the U.S. Securities and Exchange Commission."

Even though I closely monitor Berkshire's latest developments, I am yet to take a position in the equity securities of the company as I believe Berkshire might not generate alpha returns in the coming years because of its portfolio composition and the massive cash pile. If Berkshire is indeed up to something big, I am ready to pounce. For now, it's about making educated guesses and waiting on the sidelines until the company comes up with positive news.

Learning from the history books

This is not a first for close followers of Berkshire Hathaway. The conglomerate has, on a number of instances, decided to file information confidentially with the SEC to prevent the market from following its moves as it would crowd out the deal resulting in the lucrative investment opportunity vanishing before Berkshire could gobble up enough shares to move the needle. The investment in International Business Machines Corporation (NYSE:IBM) in 2011 and Phillips 66 (NYSE:PSX) in 2015 are two recent examples of Berkshire filing confidentially with the SEC.

Berkshire used similar disclosure statements in its quarterly filings prior to revealing the investments in IBM and Phillips 66, and it's reasonable to conclude that Berkshire is up to something this time around as well. Whether or not this new investment is the "elephant-sized" acquisition the market has been anticipating for so long is yet to be seen.

Warren Buffett does not deny the fact that he wants to keep confidential information as confidential for as long as it is legally allowed. Speaking to The Ledger in 2012, Buffett said:

How would you feel if you had to announce every story idea you had? There are only about three people I'd like to know what they are doing. But I don't feel entitled to know. In fact, I think it would be unfair.

The below is an excerpt from the same newspaper article that appeared in The Ledger in 2012.

He said that he did not believe that public investors should always be allowed to piggyback on investment ideas made by professional investors, especially before they are finished buying.

Empirical evidence suggests that Berkshire is most likely building a stake in a company that it sees as undervalued. More importantly, the company believes that disclosing the name of the company to the market will lead to a run on the company shares, suggesting it is in a deeply undervalued territory at the moment and is a highly liquid issue.

Good things take time

Warren Buffett, Charlie Munger, or their lieutenants are unlikely to be in a hurry to scoop up equity securities of a company they believe is undervalued. If Berkshire decides to release the confidential information to the market in the fourth-quarter filings, I would be surprised, to say the least, but I would not be complaining. When Berkshire followed a similar reporting treatment for its IBM stake, the company happened to be accumulating IBM stock for nearly nine months before revealing the investment to the market in November of 2011. The preferential treatment granted for Berkshire by the SEC in the past has not been limited for just three or four months, and there's every reason to believe that Buffett and co. might want to keep the investing public in the dark for as long as possible as it would provide them with the best chance to invest in this company while it is still undervalued.

It's time for an educated guess

There's no way of knowing what Berkshire is up to, and I sincerely hope a major announcement is on the cards regarding a multi-billion-dollar investment. If I had to guess the business sector Berkshire's secret investment represents, I'd say it has to be either the tech sector or the energy sector. As illustrated below, the technology sector already accounts for nearly half of Berkshire's portfolio.

Source: GuruFocus

What is even more interesting is the fact that the tech sector's weighting in Berkshire's portfolio has steadily increased over the last couple of years and is currently at a historical high.

Source: GuruFocus

Considering the increasing involvement of Greg Abel, Ajit Jain, Ted Weschler, and Todd Combs in the investment decision-making process of Berkshire, the high exposure to the tech sector does not come as a surprise.

The case for the energy sector is a complete contrast. Energy sector companies represent less than 0.1% of Berkshire's total portfolio at the moment, but accounted for more than 7% of the portfolio a few years ago. Earlier this year, Berkshire paid $9.7 billion to acquire the natural gas transmission and storage business of Dominion Energy (NYSE:D), and the company has a stake in Suncor Energy (NYSE:SU) as well. As illustrated below, the energy sector is the cheapest business sector from a Shiller P/E perspective.

Source: GuruFocus

I'm not saying that Buffett and co. will just have a quick look at earnings multiples and decide to go all-in on this beaten-down sector. Rather, Berkshire has a knack for picking up companies at dirt-cheap prices when everything seems to be going against such companies. Berkshire has a history of investing in energy companies, and its recent actions suggest the conglomerate does not believe the end for the oil industry is anywhere near. Considering the cheap valuation levels, the improving prospects, and the high dividend yields associated with many oil and gas companies, I would not be surprised if Berkshire's secret investment turns out to be a big oil company.

Now, it's time to crunch some numbers to see whether we can identify some potential companies Berkshire might consider including in its portfolio.

In its 13-F filing on Nov. 9, the company disclosed a total equity portfolio value of $228. 9 billion. In comparison, Berkshire reported an equity investment value of just over $245 billion in its 10-Q filing for the third quarter. The difference between the two values (after adjusting for the investment of around $7 billion in Japanese trading companies; Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo) comes to about $9 billion, and the undisclosed positions to the market might explain this difference.

For argument's sake, if we assume that the SEC did not waive the 13-D reporting requirement that triggers once a company acquires 5%+ ownership of a company and that Berkshire invested the entire $9 billion in just one company, this "secret" investment should be made in a company that has a market capitalization in excess of $180 billion (9/0.05). According to a screener I ran on Yahoo Finance, there are 587 stock tickers (many companies have multiple share classes so these are all included in the list) that boast a market cap of over $180 billion and this list includes Berkshire Hathaway as well. The below is the complete list of companies that meet the market cap criteria.

Source: Yahoo Finance

Berkshire owns a few companies in this list already, and if the company is building an investment behind the eyes of the market, it's likely to be a new holding.

Even though numbers suggest Berkshire's new investment will involve one of the companies in the above list, there are many ways how this theory could go wrong. For instance, the SEC might have waived the 13-D reporting requirement for a limited period of time, and the company might well be building a large stake in a company that is much smaller than the ones listed above. On the other hand, SEC rules say that a 5% investment in equity securities of American Depositary Receipts might not have to be disclosed if the ADRs represent less than 5% of the total outstanding shares of a Section 12 registered equity issuer.

My guess is that the new name would turn out to be a major tech or energy company, and it might take many months before any information is released to the market.

Conspiracy theories have already begun to surface

What makes investing in stocks interesting is the surprise element attached to this asset class. Saying I was surprised to find out that some investors believe Buffett might be building a large position in Tesla, Inc. (NASDAQ:TSLA) is an understatement. According to a few articles published by financial media companies such as TheStreet and Benzinga, a few million Tesla shares have gone missing over the last few quarters and Berkshire could well be the owner of these shares.

Not surprisingly, Buffett has previously confirmed that he would not be interested in investing in Tesla. Considering the aggressive management style of Elon Musk and the free cash flow profile, I doubt whether Berkshire would ever be interested in investing in Tesla if things do not improve dramatically over the next few years.

This better be something big

If Berkshire reveals a major position in a high-growth name, I would be very inclined to assess whether it's high time for me to include Berkshire in my small portfolio. The "mystery" surrounding the decision to keep an important piece of information off the market might send a false signal that a big announcement is on the way. It could very well turn out to be a non-material investment spread across many companies listed on U.S. markets.

Speaking to Business Insider, University of Maryland professor David Kass said:

He is undoubtedly building a large position now and may reveal it in his next 13F. Buffett has received confidentiality treatment in the past. I believe most recently around 2015 he was building a position in Phillips 66.

I have steered clear of Berkshire class B shares in the recent past because the company does not seem to be in a position to grow. In the meantime, the cash pile has continued to grow despite a few multi-billion-dollar investments in the last 12 months.

Source: GuruFocus

While I acknowledge that many investors invest in Berkshire for diversification benefits, that's not me. If Berkshire announced a major deal in the coming months, however, I will reassess the growth profile of the company to determine whether return expectations and risk characteristics match my investment objectives and risk profile.

Takeaway

Berkshire Hathaway might be building up a large position in a company, but there are many uncertainties that need to be addressed. For now, there's no reason for investors to be overly optimistic of what the future holds for the company, but putting the humongous cash pile to work is always a welcome sign. Despite the interesting developments, my thesis for Berkshire remains unchanged and I continue to sit on the sidelines waiting for a better opportunity.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.