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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.

Chicago Bridge & Iron Company N.V. (NYSE:CBI) represents the third-largest mid-cap position in Berkshire Hathaway’s equity portfolio. Mr. Buffett holds 10.70 million shares of the company valued at $449.23 million. The stock of the engineering and construction company lost 45% in the last 52 weeks. The decline comes after a short-seller Prescience Point issued a report questioning Chicago Bridge & Iron Company N.V. (NYSE:CBI)’s accounting methodology applied during its acquisition of Shaw Group in 2012. Moreover, the decline was also supported by the fall of oil prices as the company is considered to have a lot of exposure to upstream oil production. Nevertheless, Mr. Buffett remained bullish on the company and so did David Einhorn of Greenlight Capital, who initiated a stake during the last three months of 2014. Greenlight reported holding 2.94 million shares of Chicago Bridge & Iron Company N.V. (NYSE:CBI) in its latest 13F filing, being the second-largest shareholder among funds that we track.

Chicago Bridge & Iron Company N.V. (NYSE:CBI)

Then there is WABCO Holdings Inc. (NYSE:WBC), in which Berkshire Hathaway owns 4.08 million shares, valued at $427.11 million. WABCO is engaged in the development and sale of stability, suspension, and transmission automation and air management control systems for commercial vehicles. Am0ng other billionaire investors that are invested in WABCO Holdings Inc. (NYSE:WBC) is Ken Griffin of Citadel Investment Group. During the last three months of 2014, Citadel cut its stake by 30% to 405,400 shares. On the other hand, Israel Englander of Millennium Management seems to be optimistic about WABCO Holdings’ prospects as Millenium surged its position by 4,400% to 101,200 shares. However, in the equity portfolio of all three funds the position in WABCO Holdings Inc. (NYSE:WBC) represents less than 1% of the total portfolio value.

The fifth-largest stake is represented by a $344.18 million position in Torchmark Corporation (NYSE:TMK). Berkshire reported holding 6.35 million shares in its most recent 13F filing, the position remaining unchanged for at least last three years. Torchmark positions itself as a low-cost provider of health and life insurance. The company’s stock has had a volatile year and only gained  around 3% during the last 52 weeks. On the other hand, Torchmark Corporation (NYSE:TMK) posted top and bottom line growth in the last several years. Among other shareholders of the company are David Harding’s Winton Capital Management and Ken Griffin’s Citadel Investment Group, which held 1.34 million shares and 810,200 shares respectively.

Disclosure: None