Why Should You Avoid Warren Buffett’s Mid-Cap Picks

Warren Buffett of Berkshire Hathaway is undoubtedly the greatest investor of the last several decades. The Oracle of Omaha amassed an immensive fortune and ranks as the third richest person in the world with a net worth of $74.8 billion. Mr. Buffett’s company, Berkshire Hathaway has around $109 billion in its equity portfolio, which consisted of 47 long positions, the majority of which are from the large and mid-cap space. However, Mr. Buffett’s alpha is not generated as much from his positions in publicly-traded companies as from the vast number of subsidiaries concentrated around the holding companies. Additionally, when we looked at the historical data of Mr. Buffett’s mid-cap stock picks we noticed that between 1999 and 2012, these positions returned around 0.37% per month, which is only slightly above the S&P 500 return of 0.30% during the same period, while adjusted for risk under Carhart’s four factor model, we observed that his picks generated 25 basis points of negative alpha on a monthly basis.

This “underperformance” is not characteristic of Mr. Buffett alone. In fact, our empirical studies found that the majority of investors can’t generate sufficient returns from large and mid-cap stocks to justify their high fees. On the other hand, investors, including Mr. Buffett, also obtain significant returns from smaller-cap companies. Therefore, as the main focus of our strategy is small cap stocks, we consider that smaller investors that aim towards beating Mr. Market, should focus on Mr. Buffett’s smaller-cap stocks and avoid his mid-cap picks. In this article, we will take a look at the top five mid-cap picks from Berkshire Hathaway’s latest 13F filing. Berkshire disclosed positions in seven companies with market caps between $2.0 billion and $10.0 billion, which represent in aggregate 2.90% of its equity portfolio.

Warren Buffett portrait

In this way, USG Corporation (NYSE:USG) represents Warren Buffett’s largest mid-cap pick position. In the latest 13F, Buffett’s company disclosed holding 39.0 million shares of the company with a total value of $1.02 billion. Mr. Buffett has been holding shares of the manufacturer and distributor of building materials for over a decade and has seen the stock raise to highs of over $82 per share in 2005 and fall to $6 per share during the recession of 2008. During the last year, the investor raised his stake in USG Corporation (NYSE:USG) only once, during the second quarter, when he added some 4.11 million shares. Among more than 700 investors that we track, Mr. Buffett is by far the largest shareholder of USG Corporation (NYSE:USG), followed by Jeffrey Gates’ Gates Capital Management, which owned 6.74 million shares as of the end of 2014.

Next in line is Verisign, Inc. (NASDAQ:VRSN), a $7.50 billion provider of domain name registry and internet security. Mr. Buffett owns around 12.99 million shares of the company, valued at $740.15 million. The investor first reported ownership of the company’s shares in his 13F filing for the fourth quarter of 2012 and the stock gained around 70% since then. Verisign, Inc. (NASDAQ:VRSN) has posted strong revenue and EBITDA growth in the last several years. Among other shareholders of Verisign, Inc. (NASDAQ:VRSN) is Jim Simons’ Renaissance Technologies and D.E. Shaw, which held 4.56 million shares and 3.97 million shares respectively as of the end of last year.