Want A Higher Return With Less Risk? This Company Is A Better “Buy & Forget It” Investment Than The S&P 500

July 12, 2017

Want A Higher Return With Less Risk? This Company Is A Better “Buy & Forget It” Investment Than The S&P 500

  • Berkshire Hathaway offers similar diversification, a better book value, higher growth, and it doesn’t do stupid buybacks.
  • Share this article with those you know who are heavily invested in the S&P 500 and are buy and forget it investors, they’ll appreciate this and it might change their lives.


The predominant investing paradigm is to invest in the S&P 500 because of its low risk and  good diversification, and because it has done well in the past. Given this, most buy and forget investors simply put their money into the S&P 500.

Now, what if there was an investment that offered the same level of diversification, less risk, and a higher return? It would be logical for the buy and forget it investor to immediately invest in such an investment vehicle.

Today, I’ll explain why Berkshire Hathaway (NYSE: BRK.A, BRK.B) is a much better investment than the S&P 500. Let’s start by comparing the risk of the two investments.

Comparing The Risk

In order to mitigate risk, common investing knowledge advocates diversification. Surprisingly, the S&P 500 isn’t all that diversified as it is highly overweigh stocks that are currently hot, especially information technology.

Figure 1: S&P 500 sector allocation. Source: iShares.

22% of the S&P 500 is made up of IT, 14.54% financials, 14.51% healthcare, 12.2% consumer discretionary, and 10% industrials. Of the top 5 S&P 500 exposures, only the healthcare sector offers some kind of a defensive approach as in a recession, all other sectors would suffer significantly.

If we look at Berkshire, we can see that the large majority of earnings comes from a variety of businesses that range from “lollipops to jet airplanes.” 26% of earnings comes from railroads with Burlington Northern, 17% of earnings comes from utilities, and 16% from insurance. Thus when we compare it to the sector allocation of the S&P 500, we can easily say that Berkshire is equally as, if not better diversified than, the S&P 500.

Figure 2: Berkshire’s earnings distribution. Source: Berkshire Hathaway.

Thanks to the similar diversification, we can also say that the risk is the same. A look at some financial metrics will help us determine whether the returns will also be the same.

Financials Comparison

Figure 3: S&P 500 vs. Berkshire Hathaway. Source: Multiple sources.

The financials are totally on Berkshire’s side. The price to earnings ratio is lower for Berkshire and implies an earnings yield of 5.38%, while the S&P 500 earnings yield is 3.95%. This 1.4 percentage point difference might not seem like much but over the long term, it will be huge, especially for the buy and forget it long term investors.

The price to book value, which shows what the actual value of the underlying business is, is more than double on Berkshire’s side. This means that when a recession comes along and earnings get lower, Berkshire will have much more to offer to the investors seeking capital protection. Thus, on top of the diversification, the book value is an additional safety feature with Berkshire that isn’t present with the S&P 500.

The final and probably most important financial metric is the growth rate. The book value of the S&P 500 has grown at a rate of 3.8% in the last 10 years, while Berkshire’s book value has grown at 7.6%.

Figure 4: Book value growth. Source: Morningstar.

Thanks to higher book value growth and no lavish spending on expensive buybacks, Berkshire has also managed to grow earnings faster than the S&P 500.

Figure 5: Earnings per share growth comparison. Source: Morningstar.

This is curious because on average, S&P 500 companies spend more than 100% of their earnings on buybacks under the assumption that it will increase earnings per share. But the fact is that it doesn’t, and buybacks also don’t leave much money left for growth. Therefore, Berkshire’s revenue grew much faster than the revenue of S&P 500 companies.

Figure 6: Revenue growth comparison. Source: Morningstar.

So it’s clear that Berkshire has been better than the S&P 500 and thanks to the lower valuation and better financials, will probably be much better in the future.

Where Does The Difference Come From?

The main difference comes from the different allocation of capital.

Berkshire only does stock buybacks at maximum of 120% of book value and would never do buybacks at 300% of book value as most S&P 500 companies do. This is because you are then paying $3 for something that is actually worth $1. Yes, a company is temporarily pushing the stock price up when they do buybacks, but they are also destroying long term value. This is unfortunate because most investors are long term investors with the ambition of a cosy or early retirement.

Figure 7: The higher stock prices are, the more buybacks S&P 500 companies do. Source: FactSet.

When we sum up the buyback amounts and dividend distributions, there is nothing left for future growth as total shareholder distributions are over 100% of earnings.

Figure 8: Total S&P 500 distributions are 100% above earnings. Source: FactSet.

Let me also debunk the main argument for buybacks which is that buybacks decrease the number of shares outstanding and therefore increase earnings. The sad truth is that the number of shares outstanding for the S&P 500 has decreased just 4% since 2010 even though S&P 500 companies have been buying back at least 3% of outstanding shares per year in the last 7 years. The problem is that the higher the stock price is, the more stocks will be given to management. Therefore, it is in the managements’ interest to push stock prices up through buybacks no matter the cost.

Figure 9: Total number of outstanding shares for the S&P 500. Source: FactSet.


The conclusion is pretty simple. Those who want to invest without thinking or have a large part of their portfolio exposed to the S&P 500 can get better returns by simply investing in Berkshire, and this for less risk.

Berkshire is a company oriented to long term shareholder value creation, while S&P 500 companies are oriented to short term management wealth creation. You can decide where you want your money to be.

Now, one of the main concerns related to Berkshire is what will happen after Buffett and Munger, and what will happen to their insurance business when autonomous driving takes over. Keep reading Investiv Daily as tomorrow I’ll analyze those two topics in detail.