Buy These 4 Stocks for Less than What Buffett Paid

Warren Buffett, the famed value investor with an estimated net worth of $47 billion, on Feb. 26, released his annual letter to shareholders of Berkshire Hathaway (NYSE: BRK-B), Buffett’s holding company and primary investment vehicle. The letter provided readers with the most up-to-date details of Berkshire’s common stock investment portfolio, along with the Oracle of Omaha’s trademark witticisms offering insight into his approach to investing.

It’s common knowledge that Buffett has posted eye-popping returns on his investment holdings over time. Since 1965, Berkshire Hathaway has posted annual returns of 20.2%, or more than double the S&P500’s return of 9.4% over the same period. But somewhat surprisingly, he is actually losing on four of the 14 positions he detailed in the letter.

Given Buffett’s track record and long-term bias, it’s reasonable to expect that these holdings could rally sharply going forward. And the fact that individual investors can buy the stock at a point below where Buffett paid for it further pushes the odds in their favor. Admittedly, Buffett occasionally does miss the mark, but my analysis suggests he will eventually be proved right on the four positions on which he reported an unrealized loss as of year-end.

1. ConocoPhillips (NYSE: COP)
Amount Berkshire has invested: $2 billion
P/E: 11.6

Buffett first began to buy shares of ConocoPhillips in the first quarter of 2006, then significantly added to his stake throughout 2008, when crude prices were near their highs. Oil subsequently pulled back sharply, and for a time, it looked like Buffett had a real stinker on his hands.

But shares of ConocoPhillips have rallied in the past year and stand at their 52-week highs. Shares are still cheap in terms of a low earnings multiple, not to mention if you think oil will continue to be expensive in the future, as Buffett does. The current dividend yield is 3.4%. Management has a reputation for allocating capital to shareholders in the form of dividend increases and share buybacks, which is likely something that drew Buffett to the stock.

About 44% of ConocoPhillips’ reserves are natural gas. There is a secular industry trend that is shifting toward increasing natural gas usage, given it is a cleaner fossil fuel and in abundant supply domestically, which lowers dependency on other countries for the U.S. energy supply. Conoco also has plans to divest less appealing assets that could allow it to return some $10 billion to shareholders in the coming years. Given these factors, Buffett will likely be proven right for sticking with the stock.

2. Kraft (NYSE: KFT)
Amount Berkshire has invested: $3.1 billion
P/E: 14

Buffett’s average cost on Kraft is roughly $33 a share. He has stated that the sum of its different business units, which include food businesses in North America, Europe and emerging markets, as well as a domestic beverage, cheese and food service businesses. He doesn’t give detailed thoughts on his estimates of intrinsic value, or what he thinks the stock is worth, but he generally looks for annual shareholder gains of about 20%.

Buffett was critical of Kraft’s Jan. 2010 purchase of Cadbury. He thought Kraft was overpaying, but the move was completed and has since created a very formidable global food competitor. The company is now the largest candy and confectionary player in the world, ahead of privately-held Mars, which snapped up Wrigley (a former Berkshire holding) back in 2008.

The combination of the two giant food firms should allow for cost-cutting and related synergies and could help Kraft continue to grow earnings by double digits. In the past three years, sales have grown almost 10%, while earnings have expanded at a nearly 14% annual clip. This is impressive for such a large firm, and the Cadbury acquisition is likely to provide a number of opportunities to boost sales and cut costs to improve the bottom line further. Given Buffett’s total return requirements and Cadbury synergies, the shares could double within the next four years.

3. Sanofi-Aventis (NYSE: SNY)
Amount Berkshire has invested: $1.7 billion
P/E: 8

Buffett has previously recommended a basket approach when it comes to investing in Big Pharma. It may be because the drug-development process is hard to predict with any certainty, so why not spread your bets around? Buffett also owns Johnson & Johnson (NYSE: JNJ), so in his mind, the two large companies are probably sufficient diversification.

Sanofi is a logical choice, given its extremely low earnings multiple and above-average dividend yield of 3.2%. Recent profit growth has been decent, earnings have expanded nearly 11% on average during the past three years. The company is struggling to boost sales, but has a number of potential drugs in its pipeline that could be bona fide blockbusters, including Lixisenatide for the treatment of diabetes and Jevtana for the treatment of prostate cancer. Sanofi is also growing briskly in emerging markets, which could eventually give way to billions of dollars in additional sales.

4. U.S. Bancorp (NYSE: USB)
Amount Berkshire has invested: $2.1 billion
P/E: 12.6

Berkshire’s holding of U.S. Bancorp pales in comparison to the $11.1 billion of Wells Fargo (NYSE: WFC) it owns, but Buffett still holds U.S. Bancorp’s management team in high regard.

Prior to the financial crisis, U.S. Bancorp posted impressive returns on equity (ROE) in excess of 20% — something Buffett values dearly. ROE fell into the single digits during the financial crisis, but has recovered, reaching nearly 13% during its most recent fiscal year.

Shareholder returns should continue to improve along with the economy, and the bank should increase its dividend again at some point. The current dividend is a bit stingy at 0.70%, but all banks are waiting for government approval to start paying larger dividends to shareholders.

Action to Take —>
Sanofi stands out for its rock-bottom multiple and has solid upside potential given its well-respected pipeline of drug candidates in the advanced stages of the approval process, such as those mentioned above. ConocoPhillips also looks interesting, with its reasonable valuation and strategy of trimming operations while increasing dividends and repurchasing stock. Of course, any company that Buffett holds in his investment portfolio is worthy of further analysis, but the opportunity to undercut his purchase price is an opportunity that likely won’t last long.

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