Warren Buffett Portfolio Investment Strategy

Not long ago, we shared our interpretation of Warren Buffett’s letter to Berkshire Hathaway shareholders. Also at the beginning of the year, we compiled a stock collection from the largest positions in the guru’s portfolio at the end of 2023. Today we will take the risk of evaluating the famous investor`s portfolio and maybe make some recommendations if we can find weaknesses. Intrigued?

Part one. Where portfolio information can be found?

First, let’s find out where we can find any data about the stocks in the portfolio. The most direct and correct way is to find a special Form 13F which contains a complete list of holdings. Under the rules of The United States Securities and Exchange Commission (SEC), all institutional investors managing capital of more than $100 million are required to fill out such a form quarterly. The document can be found on the official website of the commission, and it contains all securities purchased on the US exchanges, indicating the quantity and market value at the end of the period.

However, there are much simpler ways that will save you a lot of time. For example, CNBC provides Berkshire`s portfolio in detail, but there are Japanese shares too. Hedgefollow has detailed information as well with expanded data and graphics.

Part two. Buffett’s portfolio evaluation according to Eyestock rating

The portfolio contains several dozen positions, most of which weigh less than 1%, but almost half of the assets are invested in only one company — AAPL. Buffett is really betting on Apple, even though AI companies are now in vogue. This is what the portfolio structure looks like visually:

To make the task of analyzing portfolio performance a little easier, we made a small assumption. We left only those companies whose share exceeds 0.5% of the capital. That’s just 13 stocks, and together they account for more than 95% of the portfolio. To maintain proportions, we redistributed capital between them under the original allocation, and received the following portfolio:

Let’s calculate the portfolio rating according to Eyestock using the weighted method. A word of warning here is that our methodology does not allow us to evaluate banks, and there are as many as 2 on this list: Bank of America and Citigroup. We do not cover the banking business with analytics for several reasons, primarily because our scoring system is not suitable for them! Both the profitability and solvency of banks as well as insurance companies must be considered and assessed completely differently than companies that provide other types of services or produce products.

Therefore, to calculate the rating of Warren Buffett’s portfolio using the Eyestock model, we temporarily removed the shares of the above-mentioned banks from it, again proportionally redistributed the remaining 84.3% of assets between 11 companies getting a weighted average rating of 90%! How to understand this? According to our system, 100% is the watershed that separates every company from an outstanding business. You can draw a simple analogy and transfer this benchmark to a portfolio. Let us say: a 90% score is not bad at all, Mr. Buffett!

But for example, an unweighted FAANG portfolio receives a rating of exactly 100%! And a similar collection from the Magnificent 7 Stocks has almost 114%!

Part three. Assessing Buffett’s portfolio return

Now we suggest moving on to assessing profitability. Let’s make it clear right away that we are pursuing two goals. First of all, it’s very informative to look at Warren Buffett account not only as a table of holdings but also to evaluate the numbers and perhaps compare them with your own. We will endeavor to evaluate Berkshire’s portfolio using industry best practices and the highest analytical standards used by CFA Institute. Secondly, we will make it using the feature of Eyestock portfolio analyzer, thus demonstrating how all of us can evaluate our own portfolios.

The annual return of the current portfolio of the US stocks that Berkshire Hathaway holds on its balance at the end of 2023, according to our calculations, is 23.1%. The total return also includes dividends, but we do not take them into account, relying only on changes in share prices on the stock market. This is an excellent result, considering that the average annual return of the S&P 500 index over the past 10 years does not exceed 11%. Here we use geometric mean or return taking into account the reinvestment of profits in the next period.
Let’s make it clear in this case we are calculating the actual historical return for the last 5 years to obtain this result, after which, with a certain degree of confidence, we call this the expected return for the future. This is one of the accepted methods of portfolio valuation.
In addition to the return or profitability, there is a second most important metric when analyzing a portfolio — standard deviation of return. The deviation of returns is responsible for the risk of the portfolio and is calculated through a rather complex formula based on the standard deviation function. However, keep in mind that it will not be possible to correctly calculate the portfolio deviation simply — you need to take into account the correlation of each pair of shares for a proper calculation. This is what we do in Eyestock portfolio analyzer. The higher the standard deviation, the higher the risk of not achieving the average expected return. As a first approximation, you can conduct a superficial analysis by comparing the return and deviation and find out that the return is higher — and this indicates the high efficiency of the Warren Buffett portfolio.

Part four. What is the Sharpe ratio for Berkshire Hathaway portfolio?

But still, it is customary to measure efficiency by the Sharpe ratio. Its formula is common and understandable. This is still the same ratio of the portfolio’s return to its risk factor, only from the portfolio’s return you need to subtract the risk-free rate (the rate of return that you can get without any investment in stocks). At Eyestock we use the 5-year government bond yield for determining the risk-free rate, and we currently use 3.9% as the free rate of return to calculate the Sharpe ratio.

Thus, the Sharpe ratio for Berkshire stock pick turned out to be 1.07. The portfolio can be assessed as extremely efficient because, for every dollar that the company risks, it receives 1.07 dollars of an excess return! By the way, this ratio for such a portfolio is higher than if investing in an unweighted FAANG portfolio, but less effective than holding shares from the Magnificent 7. But it is very difficult to oppose something to the higher return of NVIDIA, Microsoft and Meta Platforms recently. In any case, we repeat, that a Sharpe ratio greater than 1 is an outstanding result. Do you want to build the same portfolio or check yours? You can use the Eyestock portfolio analyzer and evaluate your portfolio in a few seconds!

Part five. What else can you find out about your investment portfolio?

Risk-adjusted return has already been measured. It would seem that this is an exhaustive analysis. In fact, this is already more than the average investor makes in their own portfolio management. But that’s not all. At Eyestock we provide many additional metrics that allow you to evaluate your portfolio comprehensively and as efficiently as possible.

Want to know how likely you are to get your required return next year?

There is another great tool for assessing your portfolio, which is no longer found so often. But we do love it because it provides incredible information if used correctly. We are talking about Roy’s Safety-First Criterion (SFRatio).

By analogy with the Sharpe ratio, SF Ratio (you can find it as «Reliability» in our portfolio analyzer) is the ratio of the portfolio’s return to its risk, only now we must subtract from the portfolio’s numerators not the risk-free rate, but the level of the minimal required return. It’s different for everyone. We will use a fairly high level of 15%! I could be a kind of bottom line. How much return would you like to see if Buffett were your personal manager?

Getting just the ratio of these quantities is where most people stop. We are moving further. Let’s proceed from the assumption that the return received from investing in stocks is a value with a normal distribution. Then the SF ratio value can be converted mathematically into the probability of obtaining the required return! Isn’t this huge?
To do this, you need to: find out the portfolio’s return, calculate its risk, set the required return, subtract it from the portfolio’s return, calculate its ratio and find out the area of the figure that is obtained if you visualize the result on this graph powered by Analyst Prep:

Or simply use the functionality of our portfolio feature and find out that, for example, for part of the investments in American stocks at the moment, reaching an annual return of 15% or higher for Berkshire has a probability of 67% the next year and in long term as well.

Talking about profit is always more pleasant than thinking about risk, but ignoring it completely is unforgivable. We calculated the risk of the Berkshire stock portfolio using the historical Value at Risk estimate and came up with a value of 11.3%. What does Value at Risk or VaR equal to 11% mean? This value is the maximal loss value of the portfolio for a given time period within 95% probability. That is, most likely, temporary portfolio drawdowns will be within this value, but we need to be prepared for it. Are you ready to see an 11% sell-off in your portfolio? Not so scary if you don’t look at the value of $39 b!

Want to outperform Warren Buffett?

There are some other metrics that we have decided to provide to investors. They will definitely arouse the interest of those who have a deep understanding of investing and are passionate about the process. The information ratio measures the sustainability of a portfolio’s performance. A value less than 0 indicates that the portfolio is ineffective relative to the entire market. The higher the ratio, the more stable your portfolio is. Another key metric is Jensen’s Alpha. Alpha reflects a portfolio’s return relative to its expected return. If the value is less than 0, then the portfolio is less efficient than the market. The higher the ratio, the greater the added value from investing in the current portfolio. Typically used to select a mutual fund, but can also be applied to an individual portfolio of assets.

But we left the most important feature for last. So, we have 13 stocks, of which we have fairly accurately replicated the core of the Berkshire portfolio. We have exact weights for each position, which together give the return and efficiency that we described above. What if you change the weight of only one stock, reducing it by 1-2% and distributing it among others? How will this affect the overall portfolio? Let’s conduct an experiment and analyze all possible options! “You must be joking” — you might think. This will take forever? We managed to fit all these calculations into one magic button called Optimize weights. Pressing it will force our servers to work at full capacity and eventually give you a portfolio of the same stocks, but with such weights that will lead us to the highest possible Sharpe ratio — a key metric of portfolio performance, as we found out before. So, press, wait a few seconds….drum roll…

Sharpe ratio increased from 1.07 to 1.3! This is a great step. But let’s take a look at the portfolio, and even more carefully at its metrics. The weights were redistributed, the amount of profit per unit of risk increased, but the portfolio return itself decreased from 23% to 20%. This means that Mr. Buffett and the Berkshire team have really done a good job and have put together a portfolio with very high efficiency and returns. Invest like Buffett, invest better than Buffett. And use Eyestock portfolio as a tool to create the most effective one for your strategy and empower your investment decisions!