Warren Buffett has proven to be one of the best investors ever. Since taking over as chief executive officer of Berkshire Hathaway in 1965, Buffett has delivered returns of 20% compounded annually. Put differently, if you had invested $1,000 in the company when Buffett took over, that investment would be worth $3,787,564 at the end of last year!
This track record of long-term success is why investors eagerly await Berkshire Hathaway's quarterly form 13-F. The Securities and Exchange Commission requires institutional investors to file a form 13-F, which discloses their quarterly securities trading activity.
Berkshire Hathaway completely closed out of three of its holdings in the second quarter, and one stock in that group was Marsh & McLennan (MMC -0.34%). Berkshire first bought the insurance broker in the fourth quarter of 2020. Here we'll explore why Buffett sold and whether investors should follow his lead.
Marsh & McLennan's insurance brokerage business has performed quite well
Marsh & McLennan's former CEO Dan Glaser perfectly summed up the business last year when he said, "When the world is unsettled, demand for our services rises." Marsh & McLennan advises companies on managing risks and connects them with insurers to help mitigate them. It also advises companies on corporate strategy, investments, and workplace issues.
Marsh & McLennan's insurance brokerage business is its bread and butter, and has been a key source of growth for the company. Although insurance may seem boring, insurance products will always be in demand, and these businesses can grow well during economic expansions and inflationary periods. In fact, this demand, which brings steady cash flows, is a big reason Buffett loves owning insurance businesses.
The past few years have been great for Marsh & McLennan's brokerage business, which earns commissions when it refers customers to an insurer. According to its Marsh Global Market Index, global insurance prices have risen for 23 consecutive quarters. As insurance prices rise, so do Marsh's earnings. So far this year the company's risk and insurance services revenue has increased 11% from the same period last year, and was the key to the company's 8% total revenue growth.
It was an excellent holding for Berkshire Hathaway
Berkshire Hathaway first acquired shares of Marsh & McLennan in the fourth quarter of 2020 and began trimming its position throughout 2021, but continued to hold a portion of it until the most recent quarter. From the end of 2020 to the end of this year's second quarter, Marsh & McLennan's stock rose 60% and proved to be another solid Buffett investment.
Data source: YCharts
Marsh & McLennan was an excellent performer for Berkshire Hathaway, so I was a little surprised to see Buffett and his team completely close out the position. While Berkshire tends to hold its largest positions for a long time, it's not unusual for Buffett to open and close its smaller holdings more frequently.
Marsh & McLennan trades at a high valuation
While I can't say for sure why Berkshire sold Marsh & McLennan, one possible explanation is its valuation. Marsh & McLennan has become slightly more expensive since Buffett's first purchase. At the end of 2020, the company traded at about 3.5 times sales. Today it's valued at more than 4.5 times sales, its highest valuation during the past decade.
Data source: YCharts
Perhaps Buffett doesn't believe the insurance brokerage business will continue to perform as strongly as it has. Maybe Buffett and his team anticipate a slowing economy ahead, and they believe Marsh's lofty valuation isn't justifiable in that type of environment.
Should you follow Buffett's lead?
Berkshire made a nice profit on its Marsh & McLennan holdings. While we can't know exactly why Buffett and his team sold their position, it's not due to anything wrong with the business, which is still humming. The sale did free up more money for Berkshire, which is currently sitting on $147 billion in cash and short-term securities.
As far as Marsh & McLennan goes, the company has posted steady growth for years, currently has a 1.4% dividend yield, and has raised its payout for 14 years. So while Berkshire trimmed its stake in the company, Marsh & McLennan remains a solid stock to hold in the long term.
