All of Warren Buffett's bad bets add up to a big year

Some stalwart U.S. stocks owned by Buffett, including Coca-Cola and Exxon Mobil, have limped through the latter stages of the bull market.

Most notably, IBM, which Buffett placed his first big technology sector bet on—and at what skeptics say was a lofty stock multiple—is now under fire for failing to deliver on earnings and being little more, in the skeptical view, than a fading stock reliant on buybacks and dividends.

And just last week, The New York Times noted that Chinese electric car maker BYD—in which Buffett has a significant stake—was tanking.

But now the good news for Buffett. While he may prefer to compete with the index on growth in book value of shares (and act as if all S&P dividends were reinvested when he runs the numbers, since he does not pay a dividend himself), Berkshire is way ahead of the index in market return this year. The S&P 500 was up 12 percent through Monday's close. Berkshire Hathaway, meanwhile, has generated a 28 percent return year-to-date.

In the prior two years, Berkshire ran basically neck-and-neck in stock performance with the index, barely losing out to the S&P 500 total return in 2013, while earning a narrow victory over the index in 2012, according to Morningstar data.

What's to explain the divergence between Buffett's stock and stocks?

While the headlines may not overstate the actual size of potential losses on individual stocks, they do overstate the importance of those losses to Berkshire Hathaway as a corporation. "Most investors overestimate the significance of Berkshire's equity portfolio," said Meyer Shields, Stifel analyst.

The bigger Berkshire gets, the more comments made by market pundits, including Buffett himself, on the difficulty he faces in trying to beat the S&P 500. But Shields said, "I also think investors have moved past the 'disappointment' of Berkshire's underperforming the S&P 500 over a five-year period, which probably contributed to past years' underperformance."

It's unlikely there is one single growth driver of Berkshire's performance in 2014, but possibly the most influential factor in boosting Buffett's stock is a change in the buyers of the stock.

"It's not wealthy individuals pushing up the stock. I don't think they have enough firepower," said David Rolfe, chief investment officer at Wedgewood Partners—which includes Berkshire Hathaway among its largest portfolio holdings. Morgan Koenig, Wedgewood's institutional client liaison, added, "We're seeing increased institutional ownership in a period when high-quality stocks are lagging the broad market."

In fact, Rolfe said it is the same stocks doing so poorly for Buffett that may offer a partial explanation for why Berkshire Hathaway is doing so well. "IBM, Coke, Exxon ... Look at stocks in the mega-cap sector, and look at the ones doing poorly ... and you start asking yourself, What else out there is big and part of my potential stock universe and has bulletproof earnings, and the shares aren't demanding in the context of the sixth year of a bull market?"

The book on Berkshire

If institutions were piling into shares of Berkshire earlier this year, they would have had good reason. Buffett has set a floor on the stock through his recent addition of a share buyback program, which he set at the level of Berkshire Hathaway shares falling below 1.2 times book value.

"That provides a margin of safety," Koenig said.

Berkshire shares traded very close to that limit earlier this year—they are now trading around 1.5 times book, which, while not nearly as attractive as 1.2 times book, is still not near a 20-year high for the company, Rolfe noted.

Is it already too late for other investors?

Wedgewood trimmed its Berkshire Hathaway position given the stock's performance. It is still among the investment firm's top three holdings but has come down from close to 10 percent to a little under 8 percent, Rolfe said.

"While achieving book value of close to 2 times may be a thing of the past given its size, trading in the 1.5 times to 1.7 times range is not out of line," said Paul Lountzis, president of Lountzis Asset Management, a longtime investor in Berkshire.Read MoreLearning to buy stocks like Buffett doesRolfe said that if it traded back down to 1.3 times book value, it would be back to a 9 percent weighting.

Rolfe said many institutions have stayed away from Berkshire historically because they make investments based on sector strategies. Berkshire does not neatly fit into any sector box. "But if I'm an institutional investor and I have to put money to work ... maybe I don't care anymore that it is a conglomerate," Rolfe said. "To hell with the sector mix. ... You have to think of where we are in the stock market now, and Berkshire may be easier to swallow as a holding."Other Berkshire boosters

Here are some additional factors that may have contributed to Berkshire's 2014 run:

Bolt-on acquisitions: There have been a number of deals that are either bolt-on (Van Tuyl, AltaLink, Duracell) or unique to Berkshire (Burger King/Berkshire Hathaway Specialty Insurance), which may be seen as positives. Shields said the Phillips 66 (a deal that occurred at the very end of 2013) and Duracell deals allowed Berkshire to "sell" its stock and buy entire businesses in a tax-efficient way, too. But Lountzis said these are still fairly small, and Rolfe said you don't tend to see these acquisitions reflected in the stock price before they show up in actual earnings results.

The current operating environment: Berkshire's underlying divisions are contributing high single-digit if not low double-digit growth, Koenig said. The insurance division in particular has done well this year, as there have not been a lot of weather events requiring payout. That sent the Berkshire insurance float—the cash generated from insurance policies that are ultimately needed for payouts but can be put to work in the market in the interim—up to $83 billion as of Sept. 30.

The future operating environment:

A flight to safety trade in a slowing global growth environment? "Could be, but one of many considerations," Lountzis said.

A double bet on the U.S.? With a positive outlook for U.S. growth and an improved outlook on the U.S. job market, Berkshire is both a play on the U.S. economic story and an investor in it through its stocks, so it can get twice the benefit, Shields said. Or as Buffett has often said himself, Don't bet against the U.S.

Copyright 2011 cnbc.com

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