This Is Warren Buffett’s New Favorite Stock — Does It Belong In Your Portfolio?

Our best investment ideas can sometimes come from paying attention to what some of the leading investors in the world are buying and selling. And when Warren Buffett himself is buying, it’s worth seeing if the stock has a place in your own portfolio. What stock has everyone’s favorite guru turned his attention to this time? Phillips 66 (NYSE: PSX).

#-ad_banner-#This week, Berkshire Hathaway (NYSE: BRK-B) revealed that it now owns over 10% of Phillips 66. The company has been accumulating shares of PSX since the second quarter of this year.

So is Buffett’s latest move a good buy for the rest of us?

Phillips 66 is a legacy of the old Conoco Phillips energy company. In 2012, the company split into two with one half becoming Conoco (NYSE: COP), the “upstream” company which conducts exploration and drilling of oil. Phillips 66 became the mid and downstream company. Phillips 66 doesn’t engage in exploration and production of oil and gas, but it transports and refines oil and gas and produces a variety of chemicals and lubricants.

Since the beginning of the year, the stock price of Phillips 66 has completely disconnected with the rest of the energy sector and rallied despite the continued downward trend of crude oil, as you can see in the chart below. The energy sector is represented here by the Energy Select Sector SPDR Fund (NYSE: XLE):

We’ve all been watching and waiting for signs that the price of oil will begin rising again after last year’s plummet. Typically, when supply exceeds demand, oil producers would cut back on production and try to stabilize the price.

However, despite the fall in the price of crude oil, drilling activity hasn’t slowed. According to a report by the U.S. Energy Information Administration, combined oil production in the major drilling regions, which make up 95% of total drilling activity in the United States, was up 25% over last year.

This is great news for Phillips 66. Phillips 66’s refining and transport businesses are more concerned with the volume of oil being drilled rather than whatever the current market price is at the time. The more oil being drilled, the more needs to be pumped through Phillips 66’s network of pipelines and refined in its facilities. Phillips 66 makes money no matter what the price of oil is, as long as production is occurring. The oil production boom in the United States has been huge tailwind for Phillips 66 and the company looks to continue to benefit for many years to come.

But Phillips 66 management isn’t relying on the current production pace of oil. Their latest strategies and decisions reveal a plan to grow earnings and EBITDA over the next 3 years. The company’s 2015 budget shows that it is investing over a billion dollars to grow its chemicals business, the division in which it earns some of the strongest returns.

The result of all this investment will be a huge increase in EBITDA in 2018 which will flow to the bottom line for shareholders.

Source: PSX Investor Presentation

For a company firing on all cylinders the way Phillips 66 is, the current valuation is stunningly low. Phillips 66 is trading at under 11 times last year’s earnings compared to the industry average of nearly 14. In addition to the capital appreciation from earnings growth and possible earnings multiples expanding, the company is serious about returning capital to shareholders. The company has retired more than 12% of its outstanding stock while almost increasing its dividend in by over 135% since 2013.

In a volatile and noisy market, Warren Buffett is signaling to his confidence in Phillips 66’s future. Investors who buy in now get a stock that can thrive in all oil price environments and is investing to grow its best divisions quickly. This stock is a market beater for years to come.

Risks To Consider: Phillips 66 is benefiting from high oil drilling activity. Should there be a significant slowdown, its refining and transport arms could see slowing growth.

Actions To Take: Phillips 66 is trading at a significant discount to its peers in the oil refining and transport business. If the stock were to trade up to the industry average P/E ratio, investors could see 20% gains in the first year on top of a rapidly growing dividend. This stock is a strong buy under $85 per share.

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