Buffett Bailed — But Should You?

by Lawrence Meyers | August 23, 2012 6:00 am

The closely watched Warren Buffett of legendary Berkshire Hathaway (NYSE:BRK.A[1], BRK.B[2]) sold large stakes in Procter & Gamble (NYSE:PG[3]), Johnson & Johnson (NYSE:JNJ[4]) and Kraft (NASDAQ:KFT[5]) in the last quarter.

We all know that just because Warren Buffett does something, that doesn’t mean you should. If he decides to jump off a cliff in a tu-tu while screaming, “I love See’s Candies”, I would frankly suggest that it was time to short Berkshire. Fortunately, I don’t see him doing that and to be extra clear, the tu-tu line was a jest to illustrate the point.

In this case, however, you should do exactly what Mr. Buffett did. Procter & Gamble certainly appears on the surface to fit Peter Lynch’s criteria for a stalwart — the kind of slow growth company that is solid financially and will be around for a long time. It even pays a 3.4% dividend.

The problem, as I pointed out last year[6], is that the company is fairly priced for the year 2015. For today, it’s a bit like paying $40 for a candy bar.

Some might say that 3.4% yield is great for retirement accounts, but I’d counter and say that 3.4% yield is going to be chewed up by inflation. And when you combine that with no expected price gain over the next three years, you are wasting your money.

Like that candy bar, P&G represents empty calories. I told you to sell it last year and I’m so glad that Mr. Buffett, uh, took my advice.

That being said, I have another note on P&G a little further down, so don’t go away.

When discussing J&J, the outlook is even gloomier. I don’t consider 6% growth to be high enough for a stalwart. When you factor in an anticipated buyback of 7% of outstanding shares, you’re looking at effectively no growth at all.

I projected a fair value of $55[7] for 2015 last October. The stock was at $58 and is now at $67. So, yeah, I told you to sell and you gave up about 20% in capital gains. Mea culpa.

But now, the stock is priced for 2018. That 3.6% yield will be whittled down significantly thanks to inflation. While I would never short a company with this kind of free cash flow, I see about as much reason to hold it as I would a grenade missing its triggering pin.

Although Mr. Buffett criticized Kraft for purchasing Cadbury, he was opposed in that criticism by hedge fund manager Bill Ackman of Pershing Square. In 2010, Mr. Ackman presented a thorough thesis[8] on his own purchase of Kraft shares.

Last October, I opined that there was still upside in Kraft[9] at $34 per share. I agreed with Mr. Ackman’s analysis, and the stock just hit the low end of his expected 2-year range at $41.50.

I don’t think there’s anything wrong with Kraft and all the positive aspects of Kraft’s offerings in Mr. Ackman’s thesis still hold true. I think there’s growth here and a nice dividend — I suggest holding it unless you have a risk-reward profile that suggests more attractive opportunities await.

To that end, while Mr. Buffett has sold out, there’s a funny little wrinkle regarding Mr. Ackman. He sold out his Kraft position … to buy into Procter & Gamble! He tends to take positions in stocks that he feels are significantly undervalued and pushes for management changes — so I’d keep an eye on Procter & Gamble nonetheless.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.

  1. BRK.A: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.A
  2. BRK.B: http://studio-5.financialcontent.com/investplace/quote?Symbol=BRK.B
  3. PG: http://studio-5.financialcontent.com/investplace/quote?Symbol=PG
  4. JNJ: http://studio-5.financialcontent.com/investplace/quote?Symbol=JNJ
  5. KFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=KFT
  6. as I pointed out last year: https://investorplace.com/2011/10/procter-and-gamble-should-you-buy-the-dow-jones-pg-stock/
  7. fair value of $55: https://investorplace.com/2011/10/should-you-buy-the-dow-johnson-johnson-jnj/
  8. presented a thorough thesis: http://www.marketfolly.com/2010/02/bill-ackman-pershing-squares-kraft.html
  9. still upside in Kraft: https://investorplace.com/2011/10/should-you-buy-the-dow-kraft-foods/

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