Learn the stock market in 7 easy steps. Get spreadsheets & eBook with your free subscription!

Held for Trading Securities [In-Depth Guide]: Company Investment Portfolios

Every wonder why Warren Buffett buys all those stocks and what the goal is behind them? Also, wonder why he mentions that valuing Berkshire Hathaway on its earnings is not the best method?

Much of that stems from his investment portfolio and how the portfolio is treated based on gains and losses in the income statement.

In our continuing series on the different companies’ investment portfolios out there, such as insurance, banks, and others such as Amazon, Microsoft, and Google, we will discuss the held for trading securities.

Each of the marketable securities we have discussed is treated differently in accounting and impacts the companies’ financials.

Many of these businesses create tons of free cash flow and sometimes don’t have anywhere to put it to generate decent returns for their shareholders.

Instead, they use marketable securities as a place of creating value for its shareholders until a more lucrative project comes along.

In today’s post, we will learn:

  • What is a Held for Trading Security?
  • What is the Difference between Held for Trading and Available for Sale?
  • Where are Held for Trading Securities Reported
  • Impact of Held for Trading Securities

Okay, let’s dive in and learn more about held for trading securities.

What is a Held for Trading Security?

According to Investopedia:

A held-for-trading security is a debt or equity investment that investors purchase with the intent of selling within a short period of time, usually less than one year. Within that time frame, the investor hopes to see appreciation in the value of the security and sell it for a profit.”

The held for trading security is part of the batch of marketable securities that include:

The basket that holds all the marketable securities include the above examples:

  • Available for sale
  • Held to maturity
  • Held for Trading or Trading securities

How these marketable securities are accounted for dictates how the debt or equity securities list when purchased by the company on both the balance sheet and income statement.

As mentioned above, the held for trading securities are meant to be held for a shorter period, but they are available for longer holding periods.

These securities have many different accounting treatments, depending on their classification and the company’s intent when purchasing them.

Because of the intent on a quick turnaround, most of the securities in this basket are short-term or liquid investments, such as equities or stocks.

Many insurance companies use this type of investment to match the duration of their premiums, depending on the length of time customers hold their insurance.

On the balance sheet, the held for trading securities list in the current asset section is more liquid, meaning they can convert to cash quickly.

The held for trading securities report at the fair value of the investments, which means they will rise and fall with the stock market’s motion. And any gains or losses from these changes in the fair value report as a separate line item on the income statement.

The reporting on the income statement leads to volatility in this line item as a stock portfolio can swing quite a lot, which leads to wild swings in earnings for that company.

A great example of this is Berkshire Hathaway because of the nature of Buffett’s portfolio. He holds $350+ billion in equity securities, and during March, when the market fell, the earnings for Berkshire tanked along with it, leading to the company reporting a loss for the quarter.

C:\Users\davea\Downloads\brk income.png

Even though all the other aspects of the business were performing well, the line item reporting the gains or losses from equity investments was a loss, which drove down the rest of the income.

Likewise, when the market took off, Buffett’s portfolio grew by leaps and bounds, driving up the company’s income.

Held for trading securities, also known as trading securities, will list items on companies’ balance sheets. They are interchangeable terms and are both current assets.

These securities types can generate profits for the company either from selling these securities for a profit or by the change in fair value on the balance sheet, a line item on the income statement.

The gains or losses are listed on the income statement as unrealized or realized; in other words, if you sell the security for either a gain or loss, it will list on the income statement as such.

The changes in fair value on the balance sheet lists on the income statement as an unrealized gain or loss; unrealized gains or losses stemmed from the fact that the security is not bought or sold during that accounting period.

C:\Users\davea\Downloads\mkl income.png

The above income statement from Markel (MKL) illustrates the point. Notice that they have separate line items that highlight changes from securities sale, plus any changes in fair value.

Notice that the last nine months show a loss for that period, which stems from the downturn during March 2020, leading to a loss in earnings.

The initial cost basis of the investments equals the securities’ fair value at the purchase time. For example, if you buy two securities A and B. Security A is worth $15 at the time of purchase, and Security B is $520.

Then on the balance sheet, the total fair value of those securities would total $535.

More on this in a moment.

Let’s take a look at the difference between held for trading and available for sale.

What is the Difference Between Held for Trading and Available for Sale?

Available for sale securities or AFS and held for trading (HFT) are similar; they are securities, debt, and equity meant for short holding periods.

Available for sale are also debt and equity securities listing at fair value on the balance sheet.

But one big difference is their treatment in accounting. AFS securities list on the balance sheet at fair value and the fair value changes report as unrealized gains/losses on the comprehensive income section below the income statement.

They are also a separate component of shareholder’s equity, reporting on the other comprehensive income section.

Trading securities or HFT are current assets, like the available for sale securities; they also list fair value on the balance sheet and the changes in that fair value record.

But the main difference is the unrealized gains/losses list as a separate line item on the income statement and count towards the company’s net income or earnings.

Cash flows from the trading securities also flow to operating cash flows. Cash flows from purchases or sales of AFS and held to maturity are investing cash flows.

The main difference between the main three marketable securities is their accounting treatment. Many of the actual securities held in each category are similar.

Current assets such as liquid marketable securities are available for sale and trading securities.

Held to maturity securities are noncurrent assets.

A simple explanation of the transfer of security from purchase to the sale of the security below:

Available for sale security

Changes in fair value list on the balance sheet and the changes listed on the comprehensive income statement

Any changes also list in the accumulated other comprehensive income as shareholders’ equity

Any interest, dividends, or sales list as net investment income

Held to Trading or Trading security

Changes in fair value list on the balance sheet and any changes list as a line item on the income statement

Any sale for a gain or loss lists as a separate line item on the income statement

Any interest, dividends, or any other income list as net investment income

Let’s move on and look a little deeper into the accounting treatment of held for trading securities.

Where is Held for Trading Securities Reported?

As mentioned above, the held for trading securities list on the balance sheet at fair value.

When the company buys a trading security, say Markel buys Visa for $200 a share. The company lists that purchase as a held for trading security or trading security at $200 on the balance sheet.

Now, let’s say that six months have passed, and now they are compiling their balance sheet, they look at the fair value of Visa, and now the price is $220 a share, which means that Markel will list that as $220 on the balance sheet.

C:\Users\davea\Downloads\mkl balance.png

But now that extra $20 in value “earned” by the company goes on the line item of gains/losses on the income statement as an additional $20 the company earned.

As more time goes by and we are now three years past the purchase of that trading security when the company reports its balance sheet, it assesses the fair value based on the current price, which is now $310.

Then on the income statement, the line item will record $110 until Visa is sold, and the company records any changes in fair value compared to the original purchase price.

Until Markel sells Visa’s stock, any of these fair value changes are an unrealized gain or loss. Once the company sells its share of Visa, then it becomes a realized gain or loss.

Okay, let’s move on next to the impact of these marketable securities on its financial results.

Impact of Held for Trading Securities

Held for trading securities occupy a large part of the assets of many large corporations such as Berkshire Hathaway, Markel, and Alleghany. All of those companies function in the insurance industry, for the most part.

And all three have large investment portfolios comprising debt and equity securities that are both available for sale and held to trading.

C:\Users\davea\Downloads\brk balance.png

From the asset section of Berkshire’s balance sheet, we can see that the company holds $245.3 billion in equities. That is a big chunk of change, and we may wonder why Buffett invests in equities?

Buffett believes that the investments he chooses help grow Berkshire’s value because of the method he uses to buy these stocks. His value investing style tends to grow these “wonderful” companies, building the asset value and shareholder value.

Instead of investing in low-yielding investments such as long-term bonds, which have returns of approximately 3% to 4%, he instead chooses stocks, earning Buffett around 18% to 20% compounded annually for the last 50 years.

As the other businesses that Buffett owns such as Geico, National Re, BNSF, and others grow their value and contribute cash flow and earnings to the Berkshire coffers, Buffett then takes those funds and invests them in stocks.

Because of his success as an investor, he can drive shareholder value by using those funds to invest in the market or buy other companies outright that will drive more value.

But the basis of all the success is the investment portfolio.

He also takes the “float,” or profits from his insurance businesses to invest in the markets, growing their value. Most insurers use the debt markets or bonds to invest because they are more safe, secure investments.

But Buffett is different in temperament and skill level, so his investments are not as risky as others. His cash cushion’s nature allows him to invest those funds without worrying about a run on the cash in the insurance business.

Another benefit is the liquidity available with the equity portfolio, as held for trading securities are current assets. If any of these companies need cash quickly, they can turn over their portfolios for cash.

Granted, it could be at a loss compared to fair value, but they are more liquid than many companies’ inventories.

As the unrealized gains/losses add or subtract to the company’s net income, those earnings lead directly to the company’s retained earnings. In Berkshire’s case, those gains in fair value lead to higher shareholder equity, which is good for shareholders because that is equity that we own when we buy Berkshire.

These are all concepts to consider when analyzing any of these companies’ marketable securities portfolios, such as Berkshire, Markel, Allegheny, Microsoft, Apple, and Amazon.

Investor Takeaway

As investors, what can we take away from learning about marketable securities and all the different components?

The first idea is understanding the different line items and their meanings and their impacts on a business.

When a company generates cash flow, they have four ways to use those funds:

  • Dividends/share repurchases
  • Reinvest in the company with new projects
  • Make an acquisition
  • Sit on the cash

But the final option isn’t that great, and if opportunities to reinvest in the company are lacking and you already pay a dividend, then the options are few.

The business can either put the money in the bank and wait or pay out a special dividend to shareholders, which is nice. But not always the best for us in the long run.

Suppose the company is struggling to find projects to grow its value because the last thing anyone wants to do is destroy value. In that case, the option is to use marketable securities to grow the value.

Depending on the company’s goals, they have different options, and in more aggressive companies like Berkshire, the choice is investing in stocks.

For those more conservative companies, the choices are the use of the different debt vehicles, all of which help.

Many companies choose a mixture of different classifications depending on their goals and long-term plans.

But as investors, it is a good idea to understand these types of investments and their goals to grow value for our company.

Not everyone can be Warren Buffett, which is okay because a company like Prudential, which buys bonds as its main investment, does quite well.

With that, we will wrap up today’s discussion on held for trading securities.

As always, thank you for taking the time to read today’s post, and I hope you find something of value on your investing journey.

If I can be of any further assistance, please don’t hesitate to reach out.

Until next time, take care and be safe out there,

Dave