Legendary investor Warren Buffett (BRK.B) (BRK.A) has specific criteria in what he looks for in a company. He wants a company that he can easily understand, has durable competitive advantage and trades at reasonable price. That is precisely the reason why he earned 30% a year in his more than 50 year investing career. Here are some of Buffett's favorite stocks that are on sale as a result of the recent turmoil:
General Electric Company (GE)
Warren Buffett described General Electric as a symbol of American business to the world. This is rightly so. GE is a leader in the business segments it operates. This conglomerate has durable competitive advantages in the markets it competes. The evidence is in the cash flow generating ability of the company. For the past 10 years, free cash flow has grown steadily by 3.1% a year despite the dip in the figures during recession. Meanwhile, shareholder equity has grown by 7.5% and return on equity averaged 17.34% during the period.
The stock has declined by 10.78% for the year and is 13.89% above its 52-week low. At the current price of $16.23, the stock is trading at 10.01 times forward earnings, 1.34 times book value and 3.7% dividend yield. Based on the latest filing, Berkshire Hathaway has 7.77 million shares of GE. It looks like Buffett has some margin of safety with his $3 billion deal of perpetual preferred of GE in 2008, which gives him a dividend of 10% a year. The upside is that Berkshire Hathaway has received warrants to purchase $3 billion worth of GE shares at a strike price of $22.25 per share. This simply means that Buffett believes that GE shares are worth more than $22.25. Ken Fisher has also increased its stake in GE by 14 million shares in his latest filing.
Procter & Gamble Co. (PG)
Shares of this consumer giant have declined by 4.06% for the year. PG is a typical Warren Buffett company that trades at reasonable price. The main competitive advantage of the company is its unparalleled distribution network for its brands across 80 countries. This translates to strong financial performance over the past 10 years. Both revenues and earnings have grown at an annual growth of 9% and 12.5% respectively. Moreover, shareholders were rewarded as net worth has grown by 26.4% a year, notwithstanding dividends and share repurchases.
With macro risks increasing, even a defensive stock like PG is being punished. The dividend yield of 3.40% alone is more than enough to compensate risks, considering that US Treasuries yield have fallen as investors flock to safe haven instruments. At the current price of $61.67, the stock is trading at 13.37 times 2012 earnings and 2.57 times book value. This is slightly higher than another Buffett stock, Johnson & Johnson (JNJ), which trades at 12.14 times 2012 earnings and 2.83 times book value. Moving forward, we believe that earnings should improve further as the company has eliminated less profitable brands and focus on good performing brands. Meanwhile, analysts are bullish on the stock. Investment bank Deutsche Bank has upgraded the stock to buy.
Ingersoll-Rand Plc (IR)
One of Warren Buffett’s priceless advices on investing is to invest in maximum pessimism. This advice holds true for cyclical stocks like Ingersoll Rand Plc. Earnings of cyclical companies usually are more volatile than an average company. As soon as earnings of these companies fall into cliff, shares would be trading at multi-year lows. In the case of Ingersoll-Rand Plc, this happened in 2008 when earnings turned negative and the stock immediately fell below $20 a share.
At present, the company is recovering although it has not reached pre-crisis level earnings. This is the reason why the market is not excited about the prospects of the company. With uncertainties all over the markets, the stock is trading at only 7.98 times 2012 earnings and 1.20 times book value. This is lower than similar companies in the industry. AAON, Inc. (AAON) trades at 14.38 times 2012 earnings and 3.75 times book value, while Lennox International, Inc. (LII) trades at 9.99 times 2012 earnings and 2.77 times book value. The stock has declined by 10% for the year. Meanwhile, analysts are bearish on the stock. Research firms Argus and Keybanc Capital Markets have downgraded the stock to hold.
United Parcel Service, Inc. (UPS)
Over the past 6 months, shares of UPS have declined by 18.29%. Investors are definitely concerned on the earnings outlook of this global package delivery company. Since majority of the company’s revenues are generated in the United States, any concerns on the future of the US economy will have an impact on its shares. While the long-term tailwinds for trade and commerce are still obvious, the issue is whether the company can weather should the economy go into another recession. In addressing the issue, one must look at the balance sheet of UPS. For the latest quarter, it sits on cash of around $5.64 billion and trailing operating cash flow of $4.14 billion. With the recent decision to raise freight rates, we expect that cash flow will be higher moving forward.
At the current price of $64.56, the stock is trading at 12.98 times 2012 earnings and a healthy dividend yield of 3.20%. This is slightly higher than FedEx Corp. (FDX) 2012 earnings multiple of 10.22 times and dividend yield of 0.60%. The premium valuation is attributed to higher net profit margins and return on equity of UPS over FDX. Warren Buffett owns 1.43 million shares of this stock.
U.S. Bancorp (USB)
Investors have overreacted with the current issues surrounding the global economy. Even a well-capitalized bank like USB is not spared. For the year, the stock has declined by 21.79%. It looks like that this bank stock is priced as if it needed a capital infusion to survive. Looking at its recent quarterly filing, it looks like that the bank higher capital ratios, deposits and sound balance sheet. Moving forward, we may see higher earnings as these banks have lower loss provisions. Yet despite these facts, the valuations are somewhat similar to banks that have legacy issues.
At the price of $21.07 a share, the stock trades at only 7.98 times next year’s earnings, 1.45 times book value and dividend of 2.30%. Similar quality banks like Wells Fargo & Company (WFC) and JPMorgan Chase & Co. (JPM) also trades at cheap levels compared to its peers. WFC trades at 6.79 times next year’s earnings, 1.04 times book value and 2% dividend yield. On the other hand, JPM trades at 6.25 times next year’s earnings, 0.82 times book value and 2.80% dividend yield. This is lower than the financial stocks valuation of more than 12 times next year’s earnings. Berkshire Hathaway owns 69 million shares, as of the latest filing.
Wal-Mart Stores, Inc. (WMT)
Shares of this retail giant have slightly declined by 4.22% this year. At the current price of $51.79, it is trading at 10.61 times next year’s earnings, 2.76 times book value and dividend yield of 2.80%. At these valuations, the market is not even paying for the future growth of the company. It may be right on how it is currently valuing WMT based on its domestic store performance, which has seen same stores sales decline in the recent quarters. However, it has discounted the possibility of its prospects abroad, as its international sales will have bigger contribution in the future. It is currently looking to buy some local hypermarkets to complement its international expansion.
In contrast, the market is paying up a premium for its competitors, Target Corp. (TGT), Costco Wholesale Group (COST), BJ’s Wholesale Club, Inc. (BJ). These stocks trade at more than 12 to 20 times next year’s earnings. However, WMT has better historical performance with earnings growth of 10% for the past 5 years and respectable returns on equity of 20%. Another positive about WMT is that it is repurchasing its own shares, which would mean higher earnings per share in the future. UBS has downgraded the stock to hold. Analysts have a price target of $60, implying an upside of 16% from the current prices.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.