Warren Buffett has sold a staggering $133 billion worth of stocks from Berkshire Hathaway’s portfolio in the first nine months of 2024. This includes selling more than two-thirds of the company’s stake in Apple and Bank of America. Despite these massive sales, Berkshire still holds $300 billion in stocks.
Many investors see Buffett’s actions as a warning that the stock market is overpriced. His sales of Apple and Bank of America suggest he believes these stocks are trading near or above their actual value. Buying overvalued stocks makes it difficult for investors to earn solid returns.
However, Buffett’s $550 million purchase of Domino’s Pizza stock in the third quarter speaks volumes. While small compared to his $36 billion in stock sales, it represents 3.7% of Domino’s entire company. Domino’s fortressing strategy has enabled worldwide market share growth.
The company shows strong profitability, operating margin expansion, and returns capital to shareholders. Buffett faces the challenge that Domino’s, valued under $16 billion, is relatively small for Berkshire’s typical investments. He has found similar issues with other attractive stocks in 2024 being too small to significantly impact Berkshire’s massive portfolio.
In his February letter to shareholders, Buffett explained, “There remain only a handful of companies in this country capable of truly moving the needle at Berkshire, and they have been endlessly picked over by us and by others. Some we can value; some we can’t.
Buffett eyes smaller-cap opportunities
And, if we can, they have to be attractively priced.”
Buffett’s ability to invest is constrained by the valuation and size of prospective companies. For example, Bank of America’s stock price has climbed to about 1.8 times its tangible book value, richer than Buffett prefers. Apple shares trade at nearly 32 times forward earnings, much higher than the multiple Berkshire paid while accumulating its position.
Even with these large-cap constraints, smaller companies like Domino’s Pizza appear more attractive. Domino’s forward price-to-earnings ratio of 27, while still somewhat expensive, compares favorably to other fast-growing quick-service restaurants. Buffett’s Domino’s purchase suggests there are more opportunities in the stock market that Berkshire cannot leverage due to its enormous size.
The market offers myriad opportunities in the mid-cap and small-cap sectors. Stock valuations indicate Buffett would prefer to invest more in companies with market caps less than Domino’s. The S&P 500 trades at a forward P/E of 22.1. Excluding large-caps, the valuations of smaller stocks look more appealing, with mid-caps at 19.5 and small-caps at 17.1.
Buffett’s message to investors is to consider smaller companies.
This could mean looking at individual stocks like Domino’s Pizza. Alternatively, buying an extended market or small-cap value exchange-traded fund offers exposure to these opportunities. The Vanguard Extended Market ETF tracks virtually all stocks except the S&P 500 and has a low 0.06% expense ratio.
The Avantis U.S. Small-Cap Value ETF uses valuation and profitability filters to select stocks and charges 0.25%. Whether choosing individual stocks or ETFs, Buffett’s investment choices suggest there’s more upside for investors in smaller companies. Investors would be wise to heed this message from the Oracle of Omaha.
