It’s always good to see what lessons we can learn from investing masters like Warren Buffett, especially in this volatile market, writes Greggory Warren of Morningstar’s Ultimate Stock Pickers.
While Warren Buffett’s legendary Berkshire Hathaway portfolio remains relatively concentrated, with just 27 stock positions overall (and its Top Ten holdings accounting for around 95% of the total stock portfolio), there are more than a handful of names trading at prices that our analysts consider attractive right now:
Wells Fargo (WFC)
Wells Fargo continues to get a lot of attention from Buffett, with Berkshire adding more than 32 million shares to its stake over the last four calendar quarters.
In his annual letter to shareholders, Buffett noted that he expected an increased dividend at Wells Fargo this year to help make up for some of the income it would lose as Goldman Sachs (GS), General Electric (GE), and Swiss Re (SSREY) all repaid their obligations to Berkshire.
Our analysts continue to view Wells Fargo as one of the clear winners of the financial crisis. Besides gaining a nationwide footprint, the firm has used its package-based sales approach and its concentration on getting every customer’s deposit account to achieve stable, higher-than-average net interest margins, which has directly contributed to enviable returns on equity.
While they expect future asset growth to be significantly lower than historical rates, Wells Fargo’s returns should still be the envy of the industry.
US Bancorp (USB)
Accounting for 3.4% of Berkshire’s $52 billion stock portfolio at the end of the second quarter, the insurer’s holdings in US Bancorp have not changed all that much since the first quarter of 2009.
Our analysts note that during the recent credit crisis, US Bancorp never had a single quarter where it lost money. While returns on common equity did dip as low as 8.4% in 2009, they recovered to 12.8% in 2010, and are likely on their way back to 17% or 18%.
Having actually ramped up its capital investment during the crisis—improving its technology and buying multiple banks, trust businesses, processing portfolios, and credit card portfolios—US Bancorp grew, rather than shrink, over the past couple of years.
Our analysts believe that the bank’s fundamental earnings power will emerge in 2011, reaching its post-crisis capital levels by the end of the year, and leaving room for a large ramp up in share buybacks and dividends in 2012.
ConocoPhillips (COP)
Buffett has acknowledged (on several occasions) that the timing of Berkshire’s initial purchase in ConocoPhillips—when oil and gas prices were near their peak in 2008—was a major mistake, and has been selling down what was at one time an 84 million-share stake in the energy firm ever since.
Having initiated his last major sale of the stock during the second quarter of 2010, it looks like Buffett is content to hold the remaining 29.1 million shares left in Berkshire’s portfolio.
Morningstar analyst Allen Good feels that ConocoPhillips made significant progress last year executing its returns improvement plans by divesting $15 billion worth of assets—including its stake in Lukoil—and repurchasing $4 billion worth of stock.
Despite the positive response by investors to these initiatives, management recently announced plans to spin off the downstream assets. While still short on details, the spin-off planned for the first half of 2012 brings some uncertainty to the shares.
In the meantime, though, an increased asset-divestiture program and about $1 billion in share repurchases per month (along with higher oil prices and improved refining margins) should add support to the company’s stock price over the near term.
|pagebreak|Procter & Gamble (PG)
A legacy holding from Berkshire’s investment in Gillette, which P&G acquired in 2005, Buffett had actually added to the stake prior to the collapse of the credit and equity markets, but has since trimmed the stake down to its current 76.8 million shares (compared to 105.8 million at the end of the second quarter of 2008).
That said, P&G remains a cornerstone of Berkshire’s equity portfolio, accounting for 9.3% of total stock holdings and yielding 3.4% at today’s prices. Our analyst Lauren DeSanto believes that P&G has been getting little credit as a safe-haven stock over the last two years, but feels that this could change, as markets have turned more volatile.
While a run-up in commodity and energy costs has impacted margins over the last year, DeSanto believes that the firm’s geographic reach and brand mix have given P&G a sufficiently diverse toolkit to help it navigate the ups and downs of the ongoing economic recovery.
She also notes that over the last three years, P&G has generated $35 billion in free cash flow, and has effectively returned this value to shareholders in the form of dividends and share repurchases.
American Express (AXP)
American Express is another cornerstone of the Berkshire equity portfolio, accounting for 15% of total stock holdings at the end of the second quarter.
Buffett has not made any meaningful changes in its stake in American Express since before the financial crisis—which was a sound move, as the stock has risen more than 300% in value since the markets bottomed in March 2009 (even after taking into account the recent sell-off in the markets).
While not currently trading below our analyst Michael Kon’s consider buy price, he feels that it is worth keeping an eye on (especially as markets continue to trend lower). Kon notes that while Visa (V) and MasterCard (MA) are global giants that dominate the global payment industry, American Express’ closed-loop credit card network has enough scale to garner a wide economic moat.
In order to grow, the firm has opened up its network to issuers and merchant acquirers. With this strategy, American Express is attempting to expand its distribution platform and steal market share from Visa and MasterCard.
While investors typically think of American Express as a network first and a credit card lender second, Kon believes the firm’s underwriting practices before the most recent cycle, and the losses incurred thereafter, should alert investors to the importance of taking a much closer look at American Express’ loan book before pulling the trigger.
Johnson & Johnson (JNJ)
Much like Procter & Gamble, J&J was a source of cash for Berkshire following the collapse of the credit and equity markets. Buffett started rebuilding that stake almost immediately, though, with Berkshire holding 42.6 million shares at the end of the second quarter.
Trading much closer to our analyst Damien Conover’s consider buy price, J&J reported second-quarter results that slightly exceeded his expectations due to better-than-expected top-line growth. Having largely passed the major patent cliff facing the rest of the drug industry, with the loss of patent protection on its antipsychotic Risperdal and neuroscience drug Topamax, J&J is in a much better position than many of its peers.
With new potential blockbusters hitting the pipeline and a revitalized device segment (aided by the acquisition of the fast-growing orthopedic company Synthes), Conover sees both the drug and device segments at J&J poised for strong growth, which he feels should help offset any of the issues the firm faces in its consumer division.
Moody’s (MCO)
While Buffett has trimmed his stake in Moody’s (from 48 million share before the financial crisis to 28.4 million shares at the end of the second quarter), it is still a Top Ten holding at Berkshire.
While not currently trading below our analyst Michael Corty’s consider buy price, he feels that investors are likely to assign a lower relative valuation multiple to the stock than they have historically, given their concerns about future regulatory changes for the credit-rating business.
Despite the heightened regulatory scrutiny, Corty notes that Moody’s still has a large market share in the credit-rating business, and generates high profit margins with very little capital investment required.
Corty notes that when handicapping potential regulatory changes, investors should remember that sometimes what should happen is different than what is most likely to occur, especially as government entities tend to maintain the status quo without an easy substitute for the current system.
The possibility of fundamental regulatory and market changes can’t be ignored, though, and the firm’s long-standing wide economic moat has taken a hit.
|pagebreak|Kraft Foods (KFT)
As we noted, Buffett was a seller of Kraft shares in the most recent period, reducing Berkshire’s stake to 99.5 million shares (or 6.7% of the insurer’s stock portfolio at the end of the second quarter), but expects to be a long-term holder of the packaged foods giant.
Much like Buffett, our analyst Erin Lash was quite skeptical of Kraft’s acquisition of Cadbury when it was announced 18 months ago, and she sees the firm’s announcement of its spin-off of Cadbury/Nabisco from the core grocery operations as vindication of her view. While Lash believes the move to break up the firm is a value-enhancer, Kraft’s shares are not trading at a large enough discount to her fair-value estimate to recommend purchasing the shares.
That said, she sees the global snack business potentially garnering an EBITDA multiple of 13 times (in line with the multiple that Kraft paid for the Cadbury business), with the North American grocery business seeing an EBITDA multiple of eight times (due to a slower growth profile, albeit with respectable margins), which is reflected in her current fair-value estimate.
Wal-Mart (WMT)
At 4% of Berkshire’s total stock portfolio, Wal-Mart is another top ten holding for the insurer. Buffett’s decision to double his stake in the retailer during the third quarter of 2009 may not have been the best move, though, given that the firm’s shares have been relatively flat since the market bottomed in March 2009.
Our analyst Michael Keara thinks that this situation is unlikely to change in the near term, believing that the stock will at best remain range-bound, buoyed by buybacks until the company begins to stem its recent market share losses.
Keara notes that for the first time ever, Wal-Mart is actually losing domestic sales to competitors. He believes the retail price leader defending its market share, not massive share repurchases, is the only thing that will move shares materially higher.
With the stock trading around 15% higher than his consider buy price, Keara suggests that investors not only wait for a better price, but for signs that Wal-Mart is serious about defending its market share, before looking seriously at the company’s shares.
M&T Bank (MTB)
While not a Top Ten holding, Berkshire holds a $470 million investment in M&T Bank.
Morningstar analyst Jim Sinegal believes the management team at M&T Bank has proven its mettle through recessions that have decimated many of its peers. In his view, the bank’s conservative underwriting standards and substantial core earnings power should enable it to continue improving its performance at a faster pace than its competitors.
Sinegal does note, however, that the bank’s merits are no secret to market participants, with the shares continuing to trade above his consider buy price. That said, he feels these high-quality bank shares would be an acceptable, if not exceptional, long-term investment when purchased at a reasonable price.
In the meantime, M&T Bank offers an attractive quarterly dividend, having avoided a cut to its payout during the financial crisis.
Read more from the Ultimate Stock Pickers Team here…
Related Reading:
