5 Contrarian Stock Picks From The Buffett Portfolio

Includes: COST, GE, JNJ, MDLZ, USB
by: Vatalyst

Value investor Warren Buffett, through Berkshire Hathaway Inc. (NYSE:BRK.A), has an enviable long term record of success. Buffett, referred to as the “Oracle of Omaha” is perhaps America's foremost value investor. In this article I analyze Buffett picks from a contrarian point of view. I chose these five stocks because, despite Buffett's ownership, investors do not appreciate the earnings power behind these names. My analysis concludes that U.S. Bancorp, GE, Kraft, Johnson & Johnson and Costco are all buys right now.

U.S. Bancorp, Inc.(NYSE:USB)

U.S. Bancorp is trading at about $25 per share. Its 52 week range is from $28.94 to $20.10, and its market capitalization is about $48 billion. Its trailing P/E is 11, and it currently pays a dividend of $0.50, for an annual yield of 1.90%.

Buffett has bought, sold, and bought again large chunks of U.S. Bancorp's stock over the years. He currently owns 69 million shares, worth $1.76 billion. That amount comprises just over 3% of Buffett's portfolio.

It is easy to see why Buffett appreciates U.S. Bancorp. It is 150 years old, as midwestern as Buffett, and has long been well-run. U.S. Bancorp's trailing 12 month return on assets is now 1.42%, among the highest of any large bank in this country. And that number has been increasing every quarter of late, reaching 1.57% in the third quarter of 2011.

However, investors are not seeing the growth that U.S. Bancorp continues to experience. The bank has seen year over year quarterly revenue growth of 19.5%. There is no faster growing, or more profitable bank of similar size in the country. At its current valuation, investors are inappropriately tossing U.S. Bancorp into the heap of troubled banks with troubled balance sheets. As a contrarian, I view this as a mistake. I recommend purchasing this stock.

General Electric Company (NYSE:GE)

GE is trading around $15 per share, toward the lower end of its 52 week range of $21.65 to $14.02. Its market capitalization is nearly $168 billion, and has a trailing P/E of 12. It currently pays a dividend of $0.60 per share, for an annual yield of 3.7%.

Buffett has long had a position of a little under 8 million shares of GE. That amounts to less than 0.3% of his portfolio. Buffett is no doubt attracted to GE's worldwide leadership in everything from clean energy to aircraft engines, from appliances to medical imaging equipment. In short, GE is a proxy for the western world's economy, much like Berkshire Hathaway.

In GE's third quarter of 2011, it reported earnings from continuing operations of $3.4 billion, or $0.31 per share. This represented an 11% increase from the year earlier quarter. GE has also committed to a 10% to 12% profit increase for 2012.

A business as vast and broad as GE's always has issues, and GE is no exception. For instance, it has a nearly 50% market share of U.S wind turbines. However, a tax credit for wind energy production expires in 2012, and if it is not renewed, it is expected that the market for wind power in the United States will largely evaporate. But GE has weathered many a storm in its long history, and to me, it is a “forever” equity. Investors are getting caught up on minor aspects of GE's business and not seeing that it is a cash flow machine. GE has cash flow from operations amounting to $33 billion. With that amount, it has many investment opportunities in growth areas, like natural gas drilling and raw material production, where it can use its strengths.

Kraft Foods, Inc (KFT)

Kraft trades around $34 per share, near the high end of its narrow 52 week range of $36.30 to $29.80. It has a market capitalization of $61.4 billion, and a trailing P/E of 19. Kraft pays a dividend of $1.16, for an annual yield of 3.3%

Kraft purchased Cadbury Schweppes in early 2010 for some $19 billion. Buffett sold 25% of his Kraft shares in protest that the company had overpaid for Cadbury. But Buffett stilll holds nearly 100 million shares of KFT.

Kraft has an uncertain future. In 2012 it is to split up, and distribute, tax free, its North American grocery business, while retaining the candy, and certain snack food operations. Kraft had a very successful third quarter in 2011, with revenue growth of 11.5%, and, given the uncertainty of the technicalities of the corporate spin off that has lowered the share price, I recommend the company's stock. Kraft's split is a good move in the long-run, and investors are seeing this event as a negative. As a contrarian, you can take advantage of the situation.

Johnson & Johnson (NYSE:JNJ)

Johnson & Johnson trades at about $64 per share, near the midpoint of its narrow 52 week range of $68.05 to $57.50. It has a market capitalization of $175 billion, and a trailing P/E of 15.6. Johnson & Johnson pays an annual dividend of $2.28 per share, for an effective yield of 3.60%

Buffett currently owns 42.6 million shares of Johnson & Johnson, valued at $2.73 billion. He has this investment for good reason. Johnson & Johnson had its typically solid third quarter of 2011. Revenues increased to $16 billion, a 7% increase from the year earlier period. Profits for the quarter were $3.2 billion, a slight decline from 2010, but the 2011 quarter included several special items.

Johnson & Johnson is probably my personal favorite among large cap companies. It has recorded 27 years of adjusted earnings increases, and 49 years of consecutive dividend increases. It consistently has profit margins of 25% or more, and $11 billion more in cash than in debt. Johnson & Johnson's scope is nearly worldwide, and it is either number one or two in nearly all segments in which it competes globally. It spends nearly $7 billion a year on products research and development. It even carries AAA debt ratings from the major ratings agencies. Investors do not appreciate the stability of Johnson & Johnson's earnings. Investors see little to no growth, and inappropriately assign a lower multiple because of it. Buffett, in contrast, sees a wide moat business with nearly unassailable competitive advantages in OTC medicines, medical devices, and healthcare brand recognition. I recommend buy and hold for Johnson & Johnson shares.

Costco Wholesale Corp. (NASDAQ:COST)

Costco is trading at about $81 per share, near the high end of its 52 week range of $86.34 to $63.91. Its market capitalization is just over $36 billion, and its trailing P/E ratio is 25. Costco currently pays a dividend of $0.94, for an annual yield of 1.10%.

Buffett owns 4.33 million shares of Costco, with a current value of about $360 million.

In Costco's fiscal fourth quarter of 2011, sales rose 17% year to year, and profits rose by 11% to $1.09 per share. It has twice as much cash on hand as long term debt.

Costco struggled with economic conditions from 2007 into 2009. But it has come back and resumed its upward earnings trajectory these past two years. Of course, the market anticipated this but does not fully grasp Costco's entrenched business. A patient investor will be rewarded, as Costco has much room to grow. Investors are assigning a lower multiple to Costco than warranted because they fear a repeat of 2007-2009. Fears are overblown and Buffett knows it. Costco is a long-term holding.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.