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Tuesday, 26 October 2010

Blue-Chip Specials From the Buffett Menu

By Andrew Bary

There's no quibbling with Warren Buffett's extraordinary overall investment record, which has resulted in a $205 billion stock-market value for (NYSE: BRKA - News) Berkshire Hathaway. But, in the past few years, Buffett has invested in some companies whose shares have been disappointing. Among them: ConocoPhillips, U.S. Bancorp, Kraft Foods, Sanofi-Aventis, Johnson & Johnson and even Wells Fargo.

All of these are strong, well-managed companies. Assuming Buffett hasn't erred, investors have the opportunity now to buy some of them for less than what Berkshire paid.

U.S. Bancorp, for instance, trades near 23, appreciably below Berkshire's average cost of $31. ConocoPhillips is at 61; Berkshire paid 73. French drug maker Sanofi's U.S.-listed shares, at 34, are below Berkshire's cost of $40 (Berkshire mainly owns the local shares). Kraft is at 32; Buffett paid 33. We based the cost figures on data in Buffett's annual shareholder letter.

Buffett wouldn't discuss his equity investments with Barron's. But in a CNBC interview in March 2009, he said: "I make plenty of mistakes. That's part of the game. You just got to make sure that the right things overcome the wrong ones." That's certainly true for Berkshire, whose Coca-Cola and Procter & Gamble holdings, which date back to the 1980s, are about 10 times above the company's cost. The P&G stake came from an investment in Gillette, bought by P&G in 2005.

With Conoco, Buffett told CNBC, he erred because he bought it when oil was above $100 a barrel; the shares tanked when crude collapsed. Berkshire, which lost more than $1 billion on that investment, has cut its Conoco stake by more than half since late 2008.

Wells Fargo is a Berkshire holding dating back 20 years. While Buffett has a gain on the banking giant, it is mainly from early purchases of the stock at depressed prices. In recent years, Berkshire has added to its holding at an average price around 32; Wells Fargo now is around 26. J&J, at 64, is close to Berkshire's cost of $60.

Berkshire's losers trade at reasonable valuations. Sanofi is valued at just seven times projected 2010 profits; Wells Fargo, for less than 10 times next year's estimated profits and for a historically low 1.6 times tangible book value. Long viewed as one of the best-run financial companies, U.S. Bancorp fetches 11 times projected 2011 profits.

Not surprisingly, Buffett had some nice things to say about his stocks in the 2009 annual letter that March. He wrote that Berkshire's decision to pare its stakes in ConocoPhillips, Moody's, P&G and J&J last year was driven in part by a need to raise cash for what turned out to be lucrative investments in Swiss Re and Dow Chemical convertible preferred. Buffett wrote those four stocks "likely will trade higher in the future."

Based on what Buffett has done in the market, he's gotten more bullish on Johnson & Johnson, and less excited about Conoco, Kraft and P&G this year; he has bought more J&J and pared his holdings of the others.

Buffett likes simplicity. He views Wells Fargo as a high-return bank that sticks to basics. In the third quarter, it paid an average interest rate of less than 0.5% on its deposits. In early 2009, when the stock was around 10, Buffett told a CNBC interviewer that, when the financial crisis ended, Wells Fargo could generate $40 billion of pretax profits before a provision of $10 billion to $12 billion for loan losses. That equates to roughly $4 a share in after-tax profits.

That scenario seems optimistic now, thanks to a weak economy, share issuance and regulatory changes that are cutting fee income industrywide. Wells Fargo also is grappling with the impact of possibly improper disclosures on foreclosures. Analysts see it generating $2.80 a share in profits next year and $3.50 in 2012. Those earnings could easily lift the stock above 30.

While still enormous at $55 billion on June 30, Berkshire's equity portfolio isn't the dominant driver of its stock price the way it was 15 or 20 years ago. Mattering more are Berkshire's wholly owned businesses, including the Burlington Northern railroad, auto insurer Geico, several utilities and large property and casualty reinsurance operations.

Buffett doesn't disclose the performance of Berkshire's equity portfolio. We estimate that it's about flat this year, versus a 5% gain for the S&P 500 (through Wednesday), after rising about 17% in 2009, a year in which the S&P climbed 23%.

Buffett has done very well with some $21 billion of non-traded securities purchased during the financial crisis, including $5 billion of Goldman Sachs preferred stock and $3 billion of General Electric preferred, both with 10% dividend yields and warrants that, in the case of Goldman, now are worth about $2 billion. In April, Barron's speculated Goldman probably would seek to redeem that high-cost preferred. The Wall Street Journal reported Thursday that Goldman is considering such a move.

Many pros believe that, after a disappointing decade, blue-chip stocks will be one of the best investments over the next 10 years. Investing in those with the Buffett imprimatur could be a great way to share in that wealth.

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