Income investors and traditional investors alike often look to investing gurus such as the Oracle of Omaha, Warren Buffett, for advice on what to include in their portfolios. With Berkshire Hathaway's (BRK.B) most recent SEC filings, a flurry of analysis followed. Here, I take a closer look at the fundamentals and medium-term prospects for the share prices of four of Mr. Buffett's dividend picks outlined in DividendInvestr's SA piece of May 17, 2012.
As my Seeking Alpha colleague mentioned in his excellent overview of Mr. Buffett's portfolio update, The Bank of New York Mellon Corporation (BK), Wal-Mart Stores Inc. (WMT), Wells Fargo & Company (WFC), and IBM (IBM) merit a more in-depth investigation. I'll first present in a quote what DividendInvestr writes in his piece about each of these, then expound with some additional analysis of my own specifically geared toward the value-conscious dividend investor:
The Bank of New York Mellon Corporation is a $25.5 billion global financial services corporation, also known as the oldest banking company in the U.S. and the world's largest deposit institution. The company has $325.3 billion in assets, which makes it the 11th largest banking institution in the United States.
This dividend-paying company has a dividend yield of 2.4%, which is 70 basis points below the average yield on its industry as a whole and 40 basis points above the yield on the S&P 500. The company's payout ratio stands at a low 24%. The bank's main competitors, namely Barclays (BCS), State Street Corporation (STT), and BlackRock (BLK), yield 2.06%, 2.18%, and 3.29%, respectively. The company boasts attractive valuation, with a current P/E of 10.1 and a forward P/E of 9.4, below the industry's averages of 11.4 and 10.1.
In the first quarter 2012, Berkshire Hathaway increased its stake in The Bank of New York Mellon by 3,813,551 shares at an average price of $22 a share. At the end of the quarter, including the newly added shares, the company reported owning a total of 5,806,610 shares, worth $122.7 million at current stock prices. The stock of The Bank of New York Mellon is currently trading at $21.13 a share, below Berkshire Hathaway's acquisition cost basis.
From a technical and fundamental perspective, I'm actually not too keen on BK. Expenses for the corporation have traditionally been high, and management has not demonstrated an ability to adapt to changing financial situations. Still, with relatively stable equity share prices (beta 0.86), BK represents a middle-of-the-road income pick for the dividend investor. Tangible book value per share has increased steadily since 2009 ($5.42 in '09, $6.22 in '10, $7.75 in '11). However, both return on assets and return on equity fell from 2010 to 2011, the first from 1.1% to 0.9% and the second from 8.4% to 7.8%.
Overall, I believe Barclays represents a much stronger (though slightly lower yield) pick for the value-conscious dividend investor. With a positive earnings per share trend over the last five quarters, superlative operating earnings yield at 32.2%, and (in my opinion) an exaggerated sell-off in the last two months, BCS is a strong candidate for growth into the future, especially when compared with BK. By sacrificing 0.3% of dividend yield, investors can make a much better long-term equity investment.
Wal-Mart is a multinational retail operator of discount department store and warehouse store chains in the United States and internationally. This $203 billion retail giant has total annual revenues of $447 billion and sits on $6.6 billion in cash. The dividend aristocrat has a dividend yield of 2.70%, which is 60 basis points above the average yield on its peers and 70 basis points above the yield on the S&P500. The company's payout ratio is at a low 32%. The retailer's main rivals, including Target (TGT) and Costco (COST), yield 2.20% and 1.10%, respectively. The company has appealing valuation, with a current P/E of 13.1 and a forward P/E of 12.2, below the corresponding industry ratios of 15.7 and 13.5.
In the first quarter of 2012, Berkshire Hathaway bought 7,671,000 shares of Wal-Mart at an average price of $61 a share. At the end of the quarter, the company reported owning some 26,763,842 shares of Wal-Mart, which translates into a $1.59 billion stake. Shares of Wal-Mart are currently trading at $59.35, below Berkshire Hathaway's average acquisition price per share in the first quarter.
I'm with Mr. Buffett and Berkshire all the way on this one. From a dividend yield, P/E, PEG, and EPS perspective, WMT is a great buy. I'd add that revenue growth outpaced the industry, clocking in at 7.6% over the last year. EPS this year should be even greater than 2011, as economic conditions in Wal-Mart's consumer environments stabilize. Moreover, looking at annual results from Q1 of last year as compared to the same period this year, net operating cash flow increased by a jaw-dropping 175.27%, to just over $5.4 billion. Given all these factors, WMT wins over its main rivals as discussed above but also over peers in the food retailing industry such as Andersons (ANDE), CVS Caremark (CVS), Costco Wholesale , Kroger Co. (KR), Casey's General Stores Inc (CASY), and more.
Wells Fargo & Company is a $170 billion multinational financial services company engaged in banking, insurance, investments, mortgage banking, and other banking operations. The company has $1.33 trillion in assets and is the 4th largest banking institution in the United States. This financial giant sits on $363 billion in cash and pays a quarterly dividend, with a dividend yield of 2.60% and the dividend payout ratio of only 20%.
Wells Fargo's main rivals, including JP Morgan (JPM), Citigroup (C), and Bank of America (BAC), have dividend yields of 3.15%, 0.10%, and 0.50%, respectively. The bank has attractive valuation, boasting current and forward P/Es of 11.2 and 9.6, below the industry's averages of 11.4 and 10.1.
In the first quarter of 2012, Berkshire Hathaway added 10,631,300 shares of Wells Fargo at an average price of $31 a share. At the end of the same quarter, the company reported a stake of 162,500,228 shares in Wells Fargo. This stake equals some $5.24 billion at current share prices. The company's stock is currently changing hands at $32.24 a share, slightly above Berkshire Hathaway's average acquisition cost per share in the first quarter.
Again, WFC's technical indicators and fundamentals lead me to avoid this one in a potential dividend portfolio. Starting with the technicals, MACD indicates a bearish trend; relative strength is neutral; the current price of WFC shares is under technically indicated support levels; and 10, 21, and 50-day moving averages are bearish. But more troubling than these is the fact that WFC performed incredibly poorly in Q1 2012. From Q4 2011, loans and leases held fell by 0.4% (much worse than peer institutions), and over $3.2 billion of loans were classified as "nonperforming" - in the words of one Standard & Poor's analyst, "far higher than in prior quarters." Moreover, P/E valuation is actually relatively high by my analysis, despite the "attractive valuation" contended in the original overview. Higher regulatory costs and WFC's greater exposure to elements of the financial crisis lead me to believe that other institutions are better suited to adapt in this volatile market for financial equities. I'd actually pass over WFC for peer JPM: gross profit margin is extremely high at near 90%; net profit margin is near 19% (much higher than the industry average); net operating cash flow Q1 annually increased by over 171%; and I believe the market actually hasn't forgiven JPM for the trading loss fiasco of late. In the short term, I'd avoid JPM; for long-term, value-conscious, dividend-focused investors, JPM is a fine pick - especially considering its significantly higher dividend yield relative to WFC. Overall, even when looking at peers in the financial sector such as Moody's Corp (MCO), Leucadia National (LUK), Pico Holdings (PICO), Life Partners Holdings (LPHI), Manhattan Bridge Capital (LOAN), ING (ING), Microfinancial Inc. (MFI), and others, JPM is a strong candidate for this hypothetical portfolio.
International Business Machines is a multinational technology company that provides computers, software, servers, and consulting services. This IT giant has a market capitalization of $231 billion and a stockpile of cash totaling $11.9 billion. The company pays an annual dividend with a current yield of 1.70%, which is 20 basis points above the industry's average, but 30 basis points below the yield on the S&P500.
The company's peers, namely Hewlett Packard (HPQ) and Microsoft (MSFT), are currently yielding 2.15% and 2.60%, respectively. Dell (DELL) does not pay any dividends. IBM has a low dividend payout ratio of 22%, slightly above the industry's average of 17%. The company is attractive on valuation, with a current P/E of 14.4 and a forward P/E of 13.1, below the industry's ratios of 19.5 and 15.3.
In the first quarter 2012, Berkshire Hathaway acquired 489,769 shares of IBM at an average price of $195 a share. At the end of the same quarter, the company reported a total stake of 64,395,700 shares, which translates into a $97.48 million position in IBM. IBM's stock is currently trading at $199.04 per share, 2.07% above Berkshire Hathaway's average acquisition cost per share in the first quarter.
Yes, on all fronts. IBM has outperformed the S&P 500 this year; revenue growth has been higher than the industry average; historically, revenue growth and EPS accretion has been strongly correlated; management is sound; return on equity is strong; the list goes on and on. Potential value-related downside risk on IBM could stem from the economic slowdown continuing into the future; credit crunches and IT spending cuts have cut into IBM's profits over the last several years. However, for longer term investors, this should be no problem.
Thus, some food for thought. Of course, investors with a long-term emphasis on income generation may not care much about the price at which their prospective equities are trading. As the original piece mentions, Berkshire Hathaway opened completely new positions in General Motors (GM) and Viacom (VIAB), and some individuals may feel inclined to match Mr. Buffett's picks stock for stock. Still, this analysis will hopefully help inform prospective investment decisions - for dividend generation or capital growth alike - and may even help potential investors initiate positions at lower price levels in the future, hiking up dividend yields. Regardless, one thing will remain a constant: Mr. Buffett's portfolio and future SEC filings will be carefully watched into the future. More to come.