On Feb. 27, Warren Buffett released his highly anticipated shareholder letter to the world. On page four of the letter, Buffett touted his “Big Four” investments and detailed that Berkshire Hathaway (BRK.A) (BRK.B) increased its ownership stake in each company.
However, Berkshire only actively purchased more shares in two of its Big Four. The other two bought back their own stock, which Buffett pointed out increased Berkshire’s ownership stake (through fewer shares outstanding).
By his estimates, every percentage point increase in Berkshire’s ownership in the Big Four firms boosts its annual earnings by $500 million per year.
Not every one of Berkshire’s Big Four are buys, but given the stellar track record of the Oracle of Omaha (Berkshire’s stock has returned 20.8% annually since 1965 — more than double the market’s return of 9.7%) each are worthy of detailed analysis. Furthermore, three are especially appealing investment candidates at current share prices.
Warren Buffett Stocks to Buy: American Express Company (AXP)
Dividend Yield: 1.9%
American Express’s (AXP) current woes are well documented. Last year, Amex shocked investors by detailing that membership warehouse giant Costco Wholesale Corporation (COST) was ending its 16-year relationship of offering Amex cards exclusively to its members. Citigroup is set to take its place within the next couple of months.
This wasn’t the only customer concentration. In addition to Costco, Amex co-brands cards with Delta Air Lines, Inc. (DAL), JetBlue Airways Corporation (JBLU) and Starwood Hotels & Resorts Worldwide Inc (HOT), which collectively account for nearly a quarter of its charge card activity.
That increases the risk of customer defection, as illustrated by the Starwood bidding war between Marriott International Inc (MAR) and China-based Anbang that could put its card relationship up for grabs.
The news coming out of Amex isn’t at all inspiring, but its struggles are already discounted into the stock. The forward price-earnings multiple is only 11, which over the past decade is lower than all but during the depths of the Credit Crisis. This is well below its peak multiple of over 20 times, which occurred both in 2006 and 2013. Its five-year average P/E is 15.2.
The relative valuation also looks compelling. Archrivals Visa Inc (V) and MasterCard Inc (MA), which are admittedly safer because they are growing faster, have more diversified customer bases, don’t take on debt to fund card purchaser loans and trade at forward price-earnings multiples of 27 and 26, respectively.
Add it all up, and there is a compelling case to be made that Amex’s earnings multiple is depressed and the bad news is fully priced into the valuation. Buffett expects better days ahead, increasing his ownership stake to 15.6% after AXP share repurchases. Berkshire’s stake at the end of the year was $10.5 billion.
Investors who have a moderate time horizon of 12-18 months would be best served investing in American Express. Its woes are well documented, but it is a world-renowned brand name and trades at too large a discount to Visa and MasterCard.
Warren Buffett Stocks to Buy: The Coca-Cola Co (KO)
Berkshire has owned Coca Cola (KO) shares since 1988 and it is easily Buffett’s best stock purchase of all time. His firm ended the year owning 9.3% of Coke, up ever slightly from the previous year due to Coke’s share buybacks.
Berkshire’s ownership stake totaled $17.2 billion at the end of the year — against a cost basis of only $1.3 billion. Back when Buffett started buying Coke, he said it was a position he would own for the long haul, and has been drawn to its steady global market growth and a distribution network that ensures its namesake cola and a large stable of energy drinks (Powerade), orange juice (Minute Maid) and bottled water (Dasani) are readily available throughout the world.
Unfortunately, Coke is the least appealing investment of Berkshire’s Big Four. The 3.1% dividend yield is compelling, but valuation is not. The forward P/E is currently 24, which is too rich considering its top-line trends are flat at best.
Analysts expect mid-single digit sales declines in the coming two years, although profits could hit $2 per share. Take a pass on Coke for now, but if the dollar starts to decline, sales growth will likely turn back positive.
Warren Buffett Stocks to Buy: International Business Machines Corp. (IBM)
Buffett disclosed the purchase of additional shares of International Business Machines (IBM) in the shareholder letter. Berkshire’s ownership stake rose to 8.4% of the entire company, up from 7.8% a year earlier, for a total position size of $11.2 billion.
Investing in IBM offers a rare opportunity for investors to get in at an overall cost below Berkshire. Its IBM purchase was at a total cost of $13.8 billion as of year-end, indicating a loss of 19% since Buffett began buying the stock.
Buffett has famously eschewed technology-based companies, preferring businesses with competitive advantages that can last decades or longer. After the shareholder letter, he conceded he could end being wrong on IBM, but it’s hard to bet against him given the stellar overall investing track record at Berkshire.
IBM hasn’t grown sales in nearly a decade, but has steadily boosted its earnings and cash flow. The philosophy has been just that, to sell out of more commodity-based businesses (computers, servers) and into faster-growing and more profitable ventures, such as cloud computing and data analytics. It doesn’t care if total sales shrink, as long as profits move forward.
Indeed, sales have fallen 1% annually over the past decade, but earnings per share, due in large part to massive share buybacks, are up nearly 11% over that same period. At a forward P/E of 11, the risk/reward looks very favorable. Plus, investors are getting paid to wait: IBM’s dividend yield is 3.4%.
Warren Buffett Stocks to Buy: Wells Fargo & Co (WFC)
Buffett also bought more shares of Wells Fargo (WFC) during 2015. Wells is Berkshire’s largest stock position; year-end market value was $27.2 billion, more than double its cost basis.
Berkshire ended the year owning nearly 10% of Wells Fargo. Don’t expect it to acquire much more stock; a position size above 10% would likely trigger the need for a Federal Reserve review of its ownership stake.
Buffett has owned Wells Fargo since 1989 and has increased his stake steadily since the Credit Crisis. The bank has a reputation as the best run in the country and sticks to plain vanilla lending and borrowing activities.
A key indicator of the bank’s success is its return on equity. ROE was nearly 13% last year and will likely increase along with interest rates. Most other banks are lucky to earn ROEs of 10%.
Wells’ dividend is 3.1%, also above the market average. Investors won’t have the opportunity to undercut Buffett’s average purchase price, but the stock is trading down toward its lows over the past year. The forward P/E is again reasonable at 11.
IBM and Wells Fargo look equally appealing. Though they operate in very different businesses, both sport above-average dividend yields and very reasonable low double-digit earnings multiples.
They aren’t fast growing, but offer a very compelling combination of yield, principal preservation and moderate growth over the long haul.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.