Warren Buffett sent a Valentine to the investment world last week in the form of his 13-F filing. This highly anticipated filing detailed changes to the Berkshire Hathaway investment portfolio. Highlights to many market commentators were his increased position in Apple (AAPL), a new position in Southwest Airlines (LUV) and the significant reduction of his position in retailing giant Wal-Mart (WMT).
Let me offer a caveat that Buffett followers should be aware of when reviewing Berkshire's changing stock positions. Most of the selections below the top six holdings of Kraft Heinz, Wells Fargo, Coca-Cola, IBM, American Express and Phillips 66 (top seven if you include the Bank of America warrants that have not yet been exercised) are now made by either Ted Weschler or Todd Combs, Berkshire's other two primary portfolio managers. Mr. Buffett has increasingly given more capital to Ted and Todd to invest. But while the stock selections may (or may not) be directly chosen by Buffett or, in some cases, might not be companies he would buy, Ted and Todd were hand selected by him and are generally aligned with his views on value and intelligent investing. Mr. Buffett is also sometimes coy about the role he plays in some of the investments, but has generally stated that only the biggest commitments are his.
Now, it was only fitting that a Valentine's Day filing indicated that the Oracle of Omaha had established a position in Southwest Airlines, the company with the ticker symbol LUV. However, the change that caught the eye of this long-standing Berkshire Hathaway shareholder was the firm's new position in Sirius XM Holdings (SIRI).
Buffett has historically been attracted to companies with very simple business models that are able to thrive and consistently earn profits over long periods of time. In a world that has become increasingly complex, I find Buffett's attraction to simple businesses to be incredibly appealing. In describing many of his investments, he often refers to the presence of economic moats. By this he means a competitive advantage that cannot be breached, much like a medieval castle typically possessed a moat filled with alligators around it.
The recent HBO documentary "Becoming Warren Buffett" described the economic moat Buffett saw in See's Candies, an operating company he purchased in 1972. The purchase of See's was a seminal event in Buffett's investment career. Charlie Munger remarked in 1996 that it was the first high-quality business that Buffett ever bought. Buffett has been quoted as saying "It's better to buy a wonderful business at a fair price than a fair company at a wonderful price." His modus operandi during his Partnership days was to channel his inner Ben Graham and buy cigar butts - marginally profitable companies that offered a free puff (profit) with little risk of permanent loss of capital.
Now, the concept of economic moats isn't unique to Buffett. The investment research firm Morningstar has adopted the concept and classifies moats into five main types: having very strong intangible assets (brand name), being a low-cost producer, selling a product with high switching costs, possessing a network effect, and having efficient scale.
Sirius XM is a classic Buffett-style play and has multiple elements of economic moats as described by Morningstar. Sirius XM is installed in about 75% of new vehicles being sold today, and buyers receive a free trial of the service. From a behavioral standpoint it is much more difficult to cancel a service that you have been receiving than fail to initiate a service you never had experienced. Additionally, as aging cars are pulled off the road, a higher percentage of cars - new and used - will be equipped with Sirius XM radio and a higher percentage of drivers will have experienced the service.
Much like another former Berkshire holding, Direct TV, Sirius XM also has a very robust network effect. As more and more people subscribe to the service, the set of product offerings continues to increase. The result is that the cost of new offerings are spread over a larger subscriber base, allowing the company to add services that appeal very strongly to selected audiences.
Now let me offer a second caveat to those who follow Berkshire's investments. We never fully know the specific reasons for the various investments the firm makes. In the case of Sirius XM, Berkshire already held shares of the Liberty Sirius XM tracking stock, and Liberty (which owns 65% of Sirius XM) has repeatedly expressed interest in acquiring the rest of the company. Both are somewhat smaller stakes for Berkshire, and the purchase of Sirius XM could be related to the dynamics underway between Sirius XM and Liberty Media.
It still makes sense for investors to consider shares of companies with economic moats when they are offered at fair prices. The other thing Buffett teaches us so well -- with many of his largest holdings in place for decades -- is that time is the friend of the wonderful business. Find your own good ideas that compound value over time, and go to the beach while your companies do the work. You, and ultimately your heirs or charities you support, will be very glad you did.