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5-Star Stocks in the Berkshire Hathaway Portfolio

We examine the holdings of the famed conglomerate.

Justin Fuller, 06/03/2008

Investment conglomerate Berkshire Hathaway BRK.B recently released its Form 13-F, which discloses its consolidated equity holdings as of the end of the first quarter. As I'm sure you know, Berkshire chairman Warren Buffett and his colleague at auto-insurer GEICO, Lou Simpson, are two of the managers I track while managing the Ultimate Stock-Picker's Portfolio.

Recent Commentary
At this year's Berkshire Hathaway annual meeting, also known as the Woodstock for Capitalists, Buffett indicated that he would be happy with 10% annual returns out of Berkshire's equity portfolio. I think these lower return expectations are largely due to Berkshire's now-massive size, which confines the conglomerate's investable universe to only some of the largest companies in the world, with growth expectations that are naturally lower because of their large size. While, on balance, I agree with this viewpoint, I'll also note that, by and large, the returns from Berkshire's equity portfolio have done better than these more-tempered expectations over the last few years, which I think is indicative of Berkshire's long-term investing philosophy, as well as Buffett's skills as a stock-picker.

Alternatively, Buffett also said that individuals who are managing vastly smaller amounts of money have an advantage, since their investable universe is much greater than most money managers. He went on to say that by diligently poring over thousands of these smaller securities, investors could potentially uncover some mispricings, although it is increasingly difficult these days, given the amount of eyes constantly scanning the world for new investments.

One other investing tidbit from this year's meeting that I found incredibly insightful was a comment from Buffett's partner, Charlie Munger, who said, "The whole secret of investment is to find places where it's safe and wise not to diversify." Essentially this means putting the most money in your best ideas, or those areas where you think you have an edge over your peers. I certainly try to follow this axiom while managing the Ultimate Stock-Picker's Portfolio, which is one of the reasons I try to limit the number of positions I have at any one time--presently, there are only 13 stocks in the portfolio.

Common Holdings
The Ultimate Stock Picker's Portfolio presently owns three stocks that are also in the Berkshire Hathaway portfolio: American Express AXP, Johnson & Johnson JNJ, and Anheuser-Busch BUD. The first two are rated 5 stars by Morningstar, while Anheuser-Busch has recently run up on speculation that it will be acquired by European beverage company InBev. Here is a snapshot of the analysis for each of these companies:PAGEBREAK

Morningstar equity analyst Michael Kon discussed American Express' first-quarter results last month, recently writing, "Despite the tough operating environment in the United States, American Express reported a solid start for the year. The firm earned $991 million in the first quarter, down 6% from last year. We were pleased to see that the bank was able to increase card-billed business by a healthy 14% from the year-ago quarter, most of it on the back of very strong growth in foreign markets. In the United States, card-billed business grew only 9% from last year, compared with 27% growth in card-billed business in foreign markets. Amex had to bump up its provision for loan losses by 48% from the first quarter of 2007, but this increase is in line with our expectations. We were pleased to see that some of the rise in credit costs was offset by an increase in the net revenue margin and higher fee income."

Morningstar equity analyst Damien Conover provided his overall take on J&J in the following snapshot from his Analyst Report, "Johnson & Johnson stands alone as a leader across the major health-care industries. The company maintains a diverse revenue base, a robust research pipeline, and exceptional cash-flow generation that together create a wide economic moat. Patent losses on antipsychotic Risperdal and neuroscience drug Topamax, as well as recent side-effect concerns with anemia drug Procrit, will weigh on near-term performance. However, we remain confident that the company's breadth can overcome these issues."

Morningstar Equity Analyst Ann Gilpin provided her opinion on A-B's potential acquisition by InBev, recently writing the following Analyst Note: "We've commented in the past on a possible InBev/A-B merger and have always believed that InBev would have to pay a substantial premium for A-B, which has the number-one and number-two beer brands in the world and controls half of the most profitable beer market in the world. Any proposal would also have to be substantial enough to convince A-B's board to end the independence of what has been a 150-year-old multigenerational family-run business. Given the lackluster performance of A-B's stock over the past five years, though, the family and the board may view a takeover by InBev as a good opportunity to cash out. In theory, an InBev/A-B merger makes sense, as A-B is entrenched in the very profitable U.S. market and InBev's strength lies in faster-growth emerging and developing markets. A merger of the two would create a beer powerhouse, generating roughly $20 billion in annual revenues and surpassing SABMiller SBMRY as the largest brewer in the world. In practice, though, we think an InBev/A-B combination would lead to a serious clash of cultures. InBev is managed by investment bankers who have run the business to the bone, squeezing out the highest possible margins they can get, while A-B has traditionally been much more liberal with its spending on things such as corporate overhead and advertising. While InBev might allow A-B to continue to run independently after a takeover, we think InBev's management would be more interested longer term in taking a machete to operating costs--something the folks at A-B may not be prepared to accept. At this point, the rumors are that InBev will take its offer directly to August Busch IV, who has already stated publicly that an InBev takeover would not happen on his watch. If he is reluctant to deal, InBev is expected to go to A-B's board and then eventually to shareholders in its attempt to take over the U.S. brewer."

5-Star Stocks
The table below lists the full Berkshire Hathaway portfolio, excluding some international names that the conglomerate is not required to disclose. I've also included the Morningstar Rating for stocks next to each one; as of mid-May, 13 stocks held by Berkshire are also rated 5 stars by Morningstar, which means our analysts think these stocks have good upside potential over the next three to five years.

 The Berkshire Hathaway Portfolio
American Express Co. AXP

CarMax Inc. KMX
ConocoPhillips COP
Johnson & Johnson JNJ
Kraft Foods Inc. KFT
Lowe's Companies Inc. LOW
Sanofi Aventis SNY
Sun Trusts Banks Inc. STI
United Health Group Inc. UNH
United Parcel Service Inc. UPS
USG Corporation USG
Wellpoint Inc. WLP
Wesco Finl Corp. WSC
Bank of America Corp. BAC
Comcast Corp. CMCSA
General Electric Co. GE
GlaxoSmithKline GSK
Moody's MCO
Norfolk Southern Corp. NSC
Procter & Gamble Co. PG
US Bancorp USB
Wells Fargo & Co. WFC
Anheuser Busch Cos. Inc. BUD
Burlington Northern Santa Fe BNI
Coca-Cola KO
Costco Wholesale Corp. COST
Gannett Inc. GCI
Ingersoll-Rd Company IR
Iron Mountain Inc. IRM
M & T Bank Corporation MTB
Nike Inc. NKE
Posco PKX
Torchmark Corp. TMK
Trane Inc. TT
Union Pacific Corp. UNP
Wal-Mart Stores, Inc. WMT
Washington Post Co. WPO
Under Review
Home Depot Inc. HD
Under Review
Comdisco Holding Co. CDCO
Under Review
Under Review
Wabco Holdings Inc. WBC
Not Rated

Berkshire Hathaway holdings as of 3-31-08. Star ratings as of 5-16-08.

Justin Fuller, CFA, is an equity strategist with Morningstar.

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