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3 cheap stocks in Berkshire Hathaway's portfolio

Susan Dziubinski  |  30 Apr 2019Text size  Decrease  Increase  |  
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This weekend the Warren Buffett and Charlie Munger faithful will descend on Omaha, Nebraska, for Berkshire Hathaway's annual meeting. They'll stock up on See's Candies for family and friends, pick up a Berkshire 2019 mug at Borsheims, and listen to Buffett and Munger wax eloquent about their businesses, their performance, and just about anything else the audience asks about.

As we do each year, we'll be publishing several Berkshire-related articles and videos ahead of the meeting and taping an onsite video with our Berkshire analyst, Gregg Warren, after the meeting concludes.

Morningstar's take on Berkshire Hathaway's stock investments

We're sharing Morningstar's take on Berkshire's largest common stock positions as of its annual report. We have two caveats. One, Berkshire doesn't include Kraft Heinz (KHC) among its common stock holdings because Berkshire is part of a control group and must therefore account for this investment differently; we're including it here, though, because it is publicly available to investors. Two, Knauf completed its purchase of portfolio holding USG Corporation on 24 April; we've therefore excluded USG from the list.

Three stocks are, however, undervalued by our metrics. Here's a little about each.

Goldman Sachs (GS)

In the midst of a multiyear transformation, Goldman is reviewing its businesses in an effort to expand revenue and optimize expenses.

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“The current Goldman narrative reminds us a lot of Morgan Stanley after its Smith Barney merger, where the firm is on a trajectory of adding more stable, capital-light revenue streams, but the market isn't giving the company any credit for it,” explains sector director Michael Wong.

The company's digital banking platform and increasing emphasis on wealth and asset management should increase returns on equity. That said, Wong thinks it’ll take time for the company's initiatives to show in the bottom line, given where we are in the capital markets cycle and the company's investment cycle.

“Any revenue gains from expanding into new areas could be offset by a cyclical downturn in the company's traditional businesses,” says Wong. “While we see a material probability that the next two years may have flat to down earnings, we are fairly confident that the company will eventually be able to harvest its initiatives into higher returns on equity.”

The stock is trading in 4-star range as of this writing, suggesting shares are undervalued.

Kraft Heinz (KHC)

It hasn’t been a pleasant few months for the packaged foods giant: The company endured a profit contraction during the fourth quarter of 2018, cut its dividend, and revealed that the SEC was investigating its procurement accounting. Last week, it announced that CEO Bernardo Hess would be stepping down; Miguel Patricio – who has spent the past two decades at  Anheuser-Busch InBev  (BUD), serving as chief marketing officer from 2012 to 2018 – takes the helm on 1 July.

We’re hopeful the management shakeup signals a shift away from prioritizing near-term cash flows and outsize profitability and toward the company’s long-term competitive position, says sector director Erin Lash. Patricio’s rhetoric thus far suggests a commitment to investing more in its brands to reignite sales, she notes. We’re sticking with our $60 per share valuation after the announcement for now, waiting for more details on Patricio’s plans.

“However, we still view shares as undervalued given the pronounced pullback the last few months,” concludes Lash. The 5-star stock is trading more than 45 per cent below our fair value estimate.

 Wells Fargo (WFC)

One of the top asset gatherers in the US, Wells still has plenty of issues to overcome. Decent first-quarter results were overshadowed by a cut in full-year guidance, its ongoing search for its next CEO, additional public comments from regulators, and an extra $1.4 billion in regulatory and compliance spending, among other things. We recently trimmed our fair value estimate to $60 from $65.

In the meantime, Wells’ competitors are hitting new levels of operational strength and profitability, playing offense while Wells remains on defence, says analyst Eric Compton.

“We still believe the bank has an attractive line-up of business units and a core group of loyal, long-time customers,” admits Compton. “Indeed, account closures were well controlled even during the worst of its sales problems, demonstrating that customers are willing to stick with the bank.”

That being said, the stock requires patience – Compton thinks there may be years of work ahead. Shares are trading in 4-star range.

Susan Dziubinski does not own shares in any of the securities mentioned above

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