How Warren Buffett is Investing in 2023
We just got a rare update on how Warren Buffett is investing now in the year 2023. Buffett is universally regarded as the greatest investor ever, and thankfully for us, a few times each year Buffett is required to submit what is called a Form 13F. This document provides a behind the scenes look into all of the stocks Buffett and his investment team are buying and selling, and boy did this send some shockwaves throughout the stock market that you need to be paying attention to.
The first three stocks Buffett bought in the second quarter of 2023 are DR Horton, NVR, and Lennar. These three stocks were new additions to the Berkshire portfolio and are worth going into more detail on each one. DR Horton, ticker symbol DHI, has a 40 billion dollar market cap, and the stock currently trades at around 120 dollars per share. DR Horton is the largest homebuilder in the United States. The company designs and sells single-family homes primarily for the so-called entry-level and move-up markets.
Dr Horton's business model is incredibly simple. The company buys an empty plot of land; they then build a house on that piece of land. The goal of the company is to then turn around and sell that house for more than it cost DR Horton to build it. Buffett knows this industry very well, as Berkshire owns Clayton Homes, one of the largest builders of manufactured houses in the U.S. Additionally, Berkshire also owns John's Manville, a large building materials company. All of this to say that a homebuilding company definitely falls well within Buffett's circle of competence.
DR Horton built and sold a staggering nearly 83,000 houses in 2022. A significant part of the company's competitive advantage has to do with its large size. You see, the U.S. homebuilder market is one of the most fragmented industries in the entire country. What this means is that the majority of houses built in the U.S. are built by very small businesses. Many of these small home builders build just a few houses a year. DR Horton's advantage over the small home builders is a concept called economies of scale.
On the one end of the spectrum, you have DR Horton, a company that builds tens of thousands of houses a year, and on the other side, you have the small home builders that build less than 10 homes a year. Because DR Horton builds such a large number of houses, they are able to get better pricing for the building materials than their smaller competitors. Here is a tangible example to demonstrate this point: each of these new houses comes with a washer and dryer. Since DR Horton is building 80,000 houses a year, they need 80,000 sets of washers and dryers, one for each house they build.
If we assume each washer and dryer set costs one thousand dollars, that means DR Horton is spending 80 million dollars each year just on washers and dryers alone. Because they are spending so much money, DR Horton can go directly to the appliance manufacturer and demand better pricing. Compare that to the small business that only builds 10 homes a year. The small homebuilder doesn't spend enough money with the appliance manufacturer to get a better price; instead, the small homebuilder is likely forced to buy all their washers and dryers from an appliance store, likely paying nearly full retail price.
As a result, this is just one example, but you can see how DR Horton’s size would give it a cost advantage for nearly everything needed to construct a new home. The second new stock added to the Berkshire portfolio is NVR, ticker symbol, you guessed it, NVR. NVR has a 20 billion dollar market cap, and the stock currently trades at around 6,100. NVR is another large home builder, building single-family detached homes, townhomes, and condominiums under the Ryan Homes and NV homes brands.
Similar to DR Horton, NVR also focuses mainly on homes for first-time buyers as well as the move-up buyer. However, unlike DR Horton, which builds houses across the United States, NVR focuses mainly on the eastern half of the U.S. The reason this matters is that the demand for new home construction varies greatly by region, based on factors such as population growth and new family formation.
This map here shows the places in the U.S. where more new homes are being built. As we can see, places like Utah, Colorado, Texas, Florida, Tennessee, and the Carolinas are seeing tons of new homes being built. These states are experiencing rapid population growth, as residents from other states are flocking to these locations. More people means a greater need for houses, creating a massive tailwind for home builders that operate in those areas.
The third new stock in the Berkshire portfolio is Lennar, ticker symbol LEN. Lennar has a market cap of 33 billion dollars and the stock trades at 117 as of the making of this video. Just like the first two companies we talked about, Lennar is also a large home builder. I think by this point, you are probably seeing a theme here: Buffett and Berkshire are making a bet on the homebuilders. The investment thesis here is pretty straightforward.
According to some sources, the U.S. is facing a housing shortage of as much as 6.5 million single-family homes. This was the result of over a decade of underbuilding following the great financial crisis and the subsequent real estate crash. New home construction went from over 2 million a year to half a million in a period of just a few years. Recovery in new home construction has been slow, still remaining well below the pre-GFC levels of 2 million.
During this time, the U.S. population continued to climb from both existing citizens having children and people immigrating to the U.S. More people means more demand for housing. The lack of supply combined with the increased demand has sent prices of homes skyrocketing. These higher home values make it more profitable for home builders to build new houses, as the price they can sell each house for is higher. Even the home builders have this massive tailwind for years to come.
The stocks appear, at least at first glance, reasonably valued. DR Horton is trading at a P/E ratio of eight times, NVR is trading at 12 times, and Lennar is trading at eight times. Instead of betting big on just one of these companies, Buffett and Berkshire are taking what is referred to as a portfolio approach. Berkshire is buying smaller stakes in the largest players in the industry instead of betting a larger amount on just one company. Buffett took this approach when he invested in the airline industry, buying shares in all the major U.S. airlines.
Moving down our list of stocks Buffett has been buying, Buffett made big news recently when he announced he added significantly to his stakes in five large Japanese companies: Itochu, Mitsubishi, Mitsui, and Sumitomo. This group of companies is referred to as trading houses. Buffett first started buying stakes in these companies back in 2020 but recently boosted Berkshire’s stake in each of these companies to nearly 10 percent. Here's Buffett explaining his logic behind the investment during a recent trip to Japan.
"Why did this trip happen, and why did those investments happen to begin with? Well, the investments began maybe close to four years ago, and I was looking at company after company, as I’ll do every day, and I just thought these were big companies that were companies that I generally understood what they did. Some was similar to Berkshire in that they owned lots of different interests, and they were selling it what I thought was very a ridiculous price, particularly the price compared to the interest rates prevailing at that time. And so I started buying all five of the five largest trading companies."
A simple way to understand the Japanese trading houses is to think of them as almost miniature Berkshire Hathaways. With a market cap of nearly 800 billion dollars, Berkshire is the largest conglomerate in the world. As a conglomerate, Berkshire owns many different companies in a wide range of unrelated industries, everything from the railroad BNSF to the auto insurance company Geico to the restaurant Dairy Queen. The list goes on and on. The Japanese trading houses are similar; each one is a massive conglomerate with wide-ranging businesses.
To the average investor, the fact that the Japanese trading companies have hundreds of subsidiaries in various different industries makes them extremely difficult to analyze. This dynamic likely contributed to why the stocks traded at such low valuations when Buffett originally made his investment. Next up on our list of stocks Buffett is buying is Capital One Financial, ticker symbol COF. Capital One has a market cap of 40 billion dollars and trades at a P/E ratio of eight times. Buffett and Berkshire boosted their stake in Capital One by nearly 26 percent, making Berkshire one of the largest shareholders in the company.
Capital One is one of the largest credit card companies in the world. The credit card business model is relatively simple and an industry Buffett knows well, given the fact that Berkshire is by far the largest shareholder in American Express. Credit card companies make money in three main ways: interest, fees, and what is called interchange. Interest represents the biggest source of revenue for a credit card company like Capital One. Interest rates on credit cards are sky-high, with many credit card companies charging interest rates over 20 percent.
These include things like annual fees, cash advance fees, balance transfer fees, and late fees. The final main revenue bucket is interchange revenue. Without getting into the technical details, whenever a credit card is used, the business accepting the card payment pays a fee of a few percentage points of the total transaction. The portion of that amount that Capital One gets to keep is referred to as interchange. Capital One stock is down forty percent from its high back in August of 2021, as rising interest rates and fears about the economy weigh on the stock.
Credit card companies are very sensitive to a slowing economy. Credit card debt is typically what is referred to as unsecured, meaning that there is no collateral, AKA no asset the company can take from the borrower if they fail to pay back their loan. As a result, if someone can't pay back the credit card company, the company has to take a charge-off, essentially admitting that they are never going to get paid back. During difficult economic periods, these charge-offs can skyrocket, negatively impacting the profitability of credit card companies. This is the concern with Capital One and why the stock is down so much. Obviously, Buffett and his team think the stock is attractive at current prices.
The last stock Buffett bought in the quarter was Occidental Petroleum, ticker symbol OXY. Occidental has a market cap of 56 billion dollars and trades at a P/E ratio of 11 times. Occidental is an oil and gas company. As an oil and gas company, Occidental's profitability is highly dependent on the price of oil. As the price of oil rises, so does the company's profitability. While this may sound obvious, here are some mind-blowing numbers for you to demonstrate the point. During the year 2020, Occidental generated 1.4 billion dollars in free cash flow. During that time, the average price of a barrel of oil was 41.96.
In 2021, the average price of oil jumped to 70.86 a barrel. Occidental's free cash flow jumped up to 7.5 billion dollars. In 2022, the average price for a barrel of oil was a whopping 100.93. Occidental's free cash flow skyrocketed all the way to 12.3 billion dollars. Just to put that number in perspective, Costco did 3.5 billion in free cash flow last year, Tesla did 7.5 billion, and Walmart did 11 billion. Obviously, these companies are in different industries than Occidental, but it helps to show the point that Occidental produced a ton of cash as oil prices spiked.
Buffett and Berkshire owned 25% of Occidental Petroleum, making Berkshire by far the largest shareholder in the company. In addition to this 25% stake, Berkshire also has warrants to purchase an additional 83.9 million shares. If Buffett executes these warrants, this would boost Berkshire’s stake in the company to over 35 percent. This dynamic has even sparked rumors that Buffett may be buying out the rest of Occidental's shares. While Buffett has denied these rumors, it wouldn't be the first time he has done this.
In 2009, Buffett owned over 20% of the shares of the railroad BNSF when he decided to buy out the company. Only time will tell if the same thing will happen to Occidental. Buffett also sold a significant amount of stocks in the quarter: eight stocks to be exact. Buffett trimmed Berkshire's position in oil company Chevron by seven percent. Chemical company Celanese was sold down by 39%. The position in auto company General Motors was cut by 45%. Insurance company Globe Life was slashed by 60%. The stake in the video game publisher Activision Blizzard was reduced by 70%.
In addition to these trimmed positions, Buffett and Berkshire also sold out entirely of three stocks: pharmaceutical distributor McKesson, insurance and professional services firm Marsh McLennan, and finally, energy holding company the Test Energy. So there we have it. Make sure to hit that subscribe button because it is my goal to make you a better investor by studying the world’s greatest investors. Talk to you guys again soon.