(10/22/12) What's Happening at Berkshire

Warren Buffett's lieutenants are getting into the action a little bit more every quarter. Let's see what they're up to, thanks to Greggory Warren of Morningstar StockInvestor.

Having had a chance to take a much closer look at the changes that were made to Berkshire Hathaway’s (BRK.A) stock holdings during the second quarter, we continue to view the equity investment portfolio at the firm as a work in progress.

While Warren Buffett has had (and continues to have) an outsized influence on the makeup of the portfolio, as time goes on we are getting more and more glimpses of just how his two lieutenants—Todd Combs and Ted Weschler—will approach their own portfolios.

Buffett noted recently that these two managers will be working with a “bank” of around $4 billion each (exclusive of any gains/losses on capital that already has been put to work), which is up from $1.75 billion each at the end of last year and $2.75 billion each at the end of the first quarter. We are seeing a far greater willingness on the part of the Oracle of Omaha to hand over more and more of the investment portfolio than we would have expected this early in the transition.

The fact that Buffett also has been willing to sell some of his own legacy holdings in order to fund their stock portfolios speaks volumes, in our view, about how much faith he has in these two managers. He even noted in a recent interview that Combs and Weschler have “terrific talent” and that Berkshire feels “very, very, very good about where we are now versus a few years ago in terms of successor investment management.”

That said, Buffett continues to hold sway over a meaningful amount of the equity portfolio—something we don’t anticipate changing too significantly in the near to medium term. This should not be surprising, given that Buffett (and his sidekick Charlie Munger) has been the driving force behind most of the larger holdings in Berkshire’s investment portfolio for the last four decades.

That’s not to say that Lou Simpson, the now-retired manager of the investment portfolio at GEICO (Berkshire’s auto insurance subsidiary), did not have an influence over the years. It’s just that his position sizes tended to be in the hundreds of millions, whereas Buffett’s traditionally have gone well into the billions.

At the time that Simpson announced his retirement in 2010, he was managing a total of around $4 billion in equities, accounting for 8% of Berkshire’s total stock holdings. This compares to the $8 billion that Combs and Weschler are currently managing, accounting for 11% of the insurer’s equity holdings at the end of the second quarter of 2012.

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While this means that Buffett continues to manage around 90% of the equities in Berkshire’s portfolio, the big positive from a succession perspective is that each of Buffett’s two lieutenants is managing about 5.5% of the total equities held by Berkshire. That's much closer to the level that Simpson had managed over the 30 years that he was running the investment portfolio at GEICO, and higher than we would have expected given the length of time that each of these managers has been with the firm.

Here are our key takeaways after spying the latest data:

Buffett continues to increase the size of the stake managed by Weschler and Combs. With Buffett’s two lieutenants now working with a “bank” of around $4 billion each, compared with $1.75 billion each at the end of last year and $2.75 billion each at the end of the first quarter, the two managers are working with as much capital as Lou Simpson was at the time of his retirement.

Buffett is willing to sell legacy holdings to fund portfolios managed by his two lieutenants. The fact that Buffett has been willing to sell some of his own legacy holdings—like Procter & Gamble (PG) and Johnson & Johnson (JNJ)—to fund the stock investment portfolios that are being run by Weschler and Combs speaks volumes, in our view, about how much faith he has in these two managers.

DirecTV makes the top ten holdings at Berkshire. With Berkshire’s top five stock holdings accounting for 74% of its portfolio and its top ten holdings accounting for 88%, it is difficult for a stock to crack the firm’s top ten holdings. That said, Johnson & Johnson, a major holding in Berkshire’s portfolio since the third quarter of 2006, fell off the top ten list after Buffett sold close to two thirds of Berkshire’s stake in the second quarter. DirecTV (DTV), which was only added to the portfolio in the third quarter of last year, took its place.

Sales of legacy holdings dominate selling activity during the second quarter. Besides selling J&J, Buffett sold 20% of his holdings in P&G and 25% of his Kraft Foods (KFT) position, while trimming down stakes in US Bancorp (USB) and ConocoPhillips (COP). Berkshire also sold down stakes in GE (GE), UPS (UPS), Ingersoll-Rand (IR), and Verisk Analytics (VRSK), most of which were holdovers from Lou Simpson’s GEICO portfolio.

Buffett’s lieutenants seem less wed to a buy-and-hold strategy. Looking more closely at the non-Buffett-related selling activity, Berkshire sold off its remaining stake in Intel (INTC), a position that was started during the third quarter of last year. Given this transaction, as well as some of the selling we saw in Visa (V), CVS Caremark (CVS), and Dollar General (DG)—all of which were purchased in the last year and a half— we believe the future will see a lot more buying and selling activity at Berkshire, given the willingness of both of Buffett’s lieutenants to move in and out of names in relatively short order.

Purchases were dominated by additions to existing holdings. Berkshire’s only new-money purchase during the second quarter was National Oilwell Varco (NOV). We believe that Buffett was the primary driver behind the additional purchases of shares of Wells Fargo (WFC), IBM (IBM), and Lee Enterprises (LEE), with his two lieutenants being the force behind the additional buying activity in DaVita (DVA), Phillips 66 (PSX), Bank of New York Mellon (BK), DirecTV, Viacom (VIAB), and Liberty Media (LMCA).