Warren Buffett’s Top Stock Picks

Warren Buffett is the man. Widely regarded as one of the most successful investors in the world, Buffett is followed by ordinary investors as well as seasoned professional money managers. These managers even invest their client’s money in Berkshire Hathaway stock (BRK-B). Buffett has been consistently ranked among the wealthiest people in the world. As of November 2011, Buffett is ranked 3rd on Forbes world billionaires list with a net worth of $39 billion. It is impossible to travel back in time and invest with Buffett, but we may still invest in BRK stock or imitate Buffett’s stock picks today. He managed to beat the market over the last decade and index fund investors may benefit by imitating Buffett’s stock picks rather than S&P 500’s stock picks.

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We are going to take a closer look at the most bullish bets of Buffett’s Berkshire, which recently released its latest holdings in a 13F filing.

Coca Cola Co (KO): KO is the largest position in Berkshire Hathaway’s portfolio. As of December 31, 2011, the fund had nearly $14 billion invested in KO. Other hedge funds like KO too. There were 44 hedge funds with KO positions in their 13F portfolio at the end of the third quarter. Besides Buffett, Boykin Curry and Stephen Mandel were also bullish about KO. Curry’s Eagle Capital Management had over $500 million invested in KO and Mandel’s Lone Pine Capital had $171 million invested in the stock. KO purchased the North American bottling operations from Coca-Cola Enterprises (CCE) for about $12.3 billion in 2010, and sold its bottling operations in Norway and Sweden to CCE for around $822 million. We do not like this transaction because it reduced the international exposure of the company. Despite that, the company is still generating a large part of its revenue from various foreign countries, especially in emerging markets. Therefore, the stock seems to be a good choice for investors who seek for protections against a decline in US Dollar.

KO seems to be a bit overvalued compared with its peers though. It has a forward P/E ratio of 15.35 and its EPS is expected to grow at 6.78% on the average in the next five years. So KO’s P/E ratio for 2014 is 13.5, compared with 11.5 for Dr Depper Snapple Group Inc (DPS) and 10.8 for Pepsico Inc (PEP). These are rich valuations for low growth stocks but it is understandable. Investors are willing to pay high multiples for these businesses because they consider them as alternatives to long-term Treasury bonds. Both stocks have higher dividend yields than 10-year Treasury bonds and they have been consistently increasing their dividend payments. Pepsi increased its quarterly dividend from $0.15 to $0.515 over the last 10 years. Coca-Cola had a slightly lower growth rate. Quarterly dividends increased from $0.20 to $0.47 since 2002. Both stocks have stable businesses and low dividend coverage ratios, so dividends seem safe too. We recommend both Pepsi and Coca-Cola as long-term dividend plays. Pepsi is also almost as popular as KO among hedge funds. As of September 30, 2011, there were 38 hedge funds with PEP positions, including Boykin Curry’s Eagle Capital Management, Ric Dillon’s Diamond Hill Capital, and Bill Miller’s Legg Mason Capital Management.

International Business Machines Corp (IBM): IBM is Buffett’s new favorite stock which he started buying in early 2011. Buffett increased his IBM stakes by 11% during the fourth quarter. His fund had around $12 billion invested in IBM at the end of last year. We like IBM. Similar to KO, IBM also has an attractive global footprint. Though the company is faced with severe competition and pricing pressure, it has a competitive position in the industry and enjoys the benefits of economies of scale. It is also trading at attractive multiples. IBM has a low forward P/E ratio of 11.69 and its EPS expected to grow at 10.41% per year over the next five years. Therefore, IBM has a 2014 P/E ratio of only 9.59. Utility stocks with tiny growth rates usually had these multiples and double-digit growth stocks had PE ratios that are in the neighborhood of 16. If the economy recovers and investors become less risk-averse IBM’s stock price may increase by 60% over the next 3 years.

IBM is not the only technology stocks with low valuations. One of Its competitors, Hewlett-Packard (HPQ), also has a low forward P/E ratio of 6.49 and is estimated to grow at 5.55%. So HPQ’s 2014 P/E ratio is only 5.83. Both IBM and HPQ are popular among hedge funds. There were 43 hedge funds with IBM positions at the end of September. HPQ was also held by 43 hedge funds. Cliff Asness was bullish about both stocks. His AQR Capital Management had $71 million invested in IBM and another $16 million invested in HPQ.

A few other large positions in Buffett’s portfolio are Wells Fargo & Co (WFC), American Express Co (AXP), and Procter & Gamble Co (PG). Buffett has been investing in all these three stocks for two decades. All three stocks are trading at attractive multiples. WFC’s 2014 P/E ratio is 6.86, AXP’s is 9.1, and PG’s is 12.5. PG is a long-term dividend growth play and we expect Wells Fargo and American Express to have double digit average returns over the next three years. Overall we like Buffett’s stock picks. They are definitely attractive options for long-term value investors who seek a margin of safety.