Warren Buffett’s Top Stocks: 4 Potential Longs, 1 to Avoid

By Ashish Sharma - May 17, 2012 | Tickers: AXP, KO, IBM, PG, WFC | 0 Comments

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Legendary investor Warren Buffett’s Berkshire Hathaway recently filed its 13F form with SEC. The following is a list of its top holdings as of March 31, 2012.

IBM is my favorite long candidate in the above list. I also like Coca-Cola, Wells Fargo and American Express. Procter & Gamble is the only company in the above list where Buffett reduced his holdings and I am not too positive on it. Here is a look at the key investment argument for these companies in detail.

The Coca-Cola Company (NYSE: KO): My Take – Buy

Coca-Cola is a good long term growth story with a stable business model. Coca-Cola derives more than 50% of its revenues from international markets and has good exposure toward emerging markets, making it a good proxy for global growth. Even in developed markets it continues to grow its volume and market share.

In 1Q12 the company reported 5% global volume growth, which was geographically broad-based. While US (+2%), Germany (+3%) and Japan (+3%) continued to grow at low single digit, volume growth in emerging markets was stronger with China up 9%, India up 20% and Brazil up 4%. In revenue terms Coca-Cola grew 5.6% YoY, which compares favorably with the most of large cap consumer staple peers.

Going forward, I expect this top line growth to continue and profit growth to outpace the top line growth.  In addition to operating leverage from the top line growth, bottom-line should benefit from the company’s restructuring initiatives to save costs.  The company’s strong profitability and cash flow should not only enable it to fund acquisitions, capital projects and dividend payments but also repurchase shares thereby providing and an extra boost to EPS.

Wells Fargo & Company (NYSE: WFC): My Take – Buy

Wells Fargo is one of the safest large cap banking stock with solid capital ratios. Its Tier I common ratio was 9.95% at the end of last quarter (~7.8% on Basel III basis). Thanks to its solid fundamentals, Wells Fargo is authorized to purchase more shares in 2012 than they did in 2011 (~86 million).

I expect Wells Fargo to be a beneficiary of flight to quality. The poor financial state of its competitors presents a significant market share gain opportunity to Wells Fargo. In addition, the company’s significant cost cutting opportunity through “Project Compass” should help it increase its EPS even in a slow growth environment.

The company is likely to achieve 4Q12 expense run rate of ~$11.25 billion versus ~$13.08 billion in 4Q11 due to its cost cutting initiatives. Wells Fargo is currently trading in line with its peers at 8.69x 2013 EPS estimates. I believe it deserves a premium to its peers given the company’s leading return on tangible equity and better book value growth potential. Hence, I’ll recommend buying the stock.

International Business Machine (NYSE: IBM): My Take - Buy

IBM is my favorite stock in the above list. The company has been a consistent performer and has outperformed S&P in six out of the last seven years. The company has doubled its profits and improved margins by over 800 bps over the past decade focusing on its high value businesses, while divesting the lower end work. This focus on high end is likely to differentiate it from the low end Indian IT peers and give it a better pricing power as low end IT work becomes increasingly commoditized. Hence, I expect IBM’s stock to performing better than Indian ADR’s like Infosys and Cognizant.

Going forward, initiatives like Smarter Planet, Analytics, Cloud and Growth Markets will be the major drivers for the company’s top line. On its recent investor day, IBM laid down a detailed roadmap to achieve $20+ EPS in 2015 from expected $15+ in EPS in 2012. Out of the $5 incremental EPS, revenue growth is expected to contribute 36%; improved margin from operating leverage, shift to high value businesses like software and productivity improvement is expected to contribute 30%; and share repurchases is expected to contribute remaining 34%. I see good chances that IBM will be able to surpass its $20 EPS target in 2015.  

IBM is a good defensive investment given its high exposure to recurring sales, cost cutting levers, solid balance sheet and a good potential to gain market share in the industry because of its focus on emerging trends. The stock doesn’t look pricey at 12x forward earnings and I would recommend buying it at these levels.

American Express Company (NYSE: AXP): My Take – Buy

American Express’ capital levels remain strong with its tier 1 common ratio at 13.4% at the end of the last quarter. American Express has the Fed approval for up to $4 billion in repurchases for 2012 and up to another $1 billion through Q1’13 thus placing it in a strong position for returning cash to the shareholders.

American Express’ business fundamentals remain solid and it reported 12.4% YoY billed business growth last quarter. The company continues to benefit from historically low credit losses. Although total 1Q12 provisions were at $412 million last quarter (up from 1Q11), they are still well below historical norms.

Going forward, I expect American Express to deliver strong operating performance and superior financial results. It is one of the better businesses to buy in financials given the improving credit environment. It also has low regulatory uncertainty unlike most of the diversified financial companies and is likely to see a multiple expansion as the broader macros improve.

Procter & Gamble (NYSE: PG): My Take – Sell

Procter & Gamble is the only company in the above list where Warren Buffett reduced his holdings. Even before Berkshire Hathaway filed its 13F form, I wrote an article citing three reasons to sell P&G. Berkshire reducing its position is another sign that there is something wrong with P&G. My key bearish arguments for a sell rating on the stock are its low organic growth versus peers, market share losses, rich valuations and an overly ambitious restructuring plan on which the company is likely to disappoint. Please visit my detailed bearish thesis on P&G here.

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