Warren Buffett’s pharma bet, Apple, Costco sales explained: Bill Smead

  • Warren Buffett’s Berkshire Hathaway invested in AbbVie, Bristol Myers Squibb, Merck, and Pfizer in the third quarter.
  • Bill Smead, a veteran Berkshire shareholder and the boss of Smead Capital Management, praised the pharmaceutical bets as “wonderful” in an interview with Business Insider.
  • Merck’s healthy finances, powerful brand name, and strong cash generation mean it has “everything that Buffett looks for in a business,” Smead said.
  • Smead argued that Berkshire exited Costco at least partly on valuation grounds, sold several bank stocks to narrow its focus on Bank of America, and should have sold more Apple shares last quarter.
  • Visit Business Insider’s homepage for more stories.

Warren Buffett’s Berkshire Hathaway added AbbVie, Bristol Myers Squibb, Merck, and Pfizer to its stock portfolio last quarter.

Its push into pharmaceuticals is “wonderful” news and long overdue, Bill Smead, a longtime Berkshire shareholder and the founder and investment chief of Smead Capital Management, told Business Insider.

“I’ve always wondered why Buffett seems confident that certain companies will reinvest, but he never has been about the Mercks and the Pfizers of the world,” Smead said. After all, few if any S&P 500 companies have plowed their profits back into their businesses as consistently as Merck since its founding 130 years ago, he continued.

Merck’s solid balance sheet, strong brand, and robust free cash flow mean it has “everything that Buffett looks for in a business,” Smead added.

Smead’s fund counts Merck, Pfizer, and Berkshire among the 30-odd stocks in its portfolio, which was worth about $1.6 billion at the end of September. It also owns stakes in two of Buffett’s biggest holdings, American Express and Bank of America, and two of his former favorites, JPMorgan and Wells Fargo.

Buffett and his team may have about $6 billion riding on the four drugmakers for other reasons, including an aging US population.

“There are 73 million baby boomers that are gonna live a long time,” Smead said. “We’re gonna absorb a lot of pills and treatments, and we’ve got a lot of money to spend on keeping ourselves alive.”

Politicians and the public have also shifted from criticizing pharmaceutical companies for fueling the opioid crisis and inflating prescription-drug prices, to cheering them on as they develop COVID-19 vaccines and therapies.

“The vaccine is the best PR event that you could possibly have happen for an industry that has been beat up by both sides of the aisle,” Smead said.

Berkshire’s bosses likely saw the pharma stocks as a bargain too. Smead told his investors earlier this month that Merck, Pfizer, and another of his fund’s holdings, Amgen, “look very cheap to us” at a 30%-to-40% discount to the average S&P 500 stock.

Trimming Apple, ditching Costco, and selling the banks

Berkshire made other notable changes to its portfolio last quarter. It sold about 4% of its Apple shares, exited a Costco position that was worth $1.3 billion in June, and slashed its bank holdings for a second consecutive quarter.

Buffett and his team should have pruned their Apple stake even more, Smead said. The iPhone maker’s heady valuation and disproportionate weighting in Berkshire’s portfolio has attracted criticism from other value investors.

Berkshire probably sold Costco at least in part because of the big-box retailer’s lofty valuation, Smead continued. He flagged the risk that mature growth stocks will revert to more reasonable valuations in the coming months. 

Finally, Buffett likely boosted his Bank of America stake while dumping JPMorgan, Wells Fargo, and other bank shares in order to concentrate his portfolio.

“He’s already made good money on BofA and he thinks he’ll continue to do so,” Smead said. “What he wants is the best bank that’s going to make the most money off the millennials.”

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