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Berkshire Hathaway's 5-Star Stocks

How to profit by combining Morningstar's and Berkshire's best investment ideas.

Justin Fuller, 03/05/2007

Morningstar's 100 stock analysts cover 1,800 companies. Their full analyst reports are available through Morningstar Principia Stocks Advanced and Morningstar Advisor Workstation Office Edition.

In addition to its just-released shareholder letter, Berkshire Hathaway BRK.B also recently released its latest Form 13-F, which disclosed the investment conglomerate's stock holdings as of Dec. 31. Both Warren Buffett and Lou Simpson, his colleague at Berkshire's wholly owned auto insurer GEICO, manage Berkshire's equity portfolio, and I think comparing a cross-section of their picks with Morningstar's research can potentially uncover some very attractive investment ideas.

Just because Berkshire owns a stock doesn't necessarily mean that the price is still attractive enough for you to consider purchasing it. In fact, Buffett said in last year's Berkshire Hathaway annual shareholders' letter, "Expect no miracles from our equity portfolio. Though we own major interests in a number of strong, highly profitable businesses, they are not selling at anything like bargain prices." He went on to say, "The likelihood is that their per-share earnings, in aggregate, will grow 6-8% per year over the decade and that their stock prices will more or less match that growth."

While it is certainly possible that Buffett is being somewhat conservative in his assessment, and that for many investors 6% to 8% annual growth over 10 years would be welcome, I'd like to think that investors can do better by cherry-picking from Berkshire's portfolio, rather than simply replicating it. Before taking a look at what we at Morningstar think are the most compelling ideas from Berkshire's portfolio, I'll recap the conglomerate's most recent transactions.

New Additions
In its recent filing, Berkshire disclosed three new positions: Ingersoll-Rand Company IR, United Healthcare UNH, and US Bancorp USB. It should be noted that Berkshire had been accumulating its stake in US Bancorp since early 2006 but had been granted permission to delay the filing of this position over the last couple of quarters. Berkshire also modestly boosted its stake in Wells Fargo WFC and USG USG.

Our analysts believe that each of these stocks (with the exception of USG, which at this time we don't rate) is fairly valued, as each holds a 3-star rating. This means that our analysts believe the stock price will only grow by the company's cost of capital over the next year. Even though Morningstar doesn't rate USG at this juncture, I remain cautiously optimistic on this investment, given that the company is well positioned as the low-cost provider in the wallboard manufacturing industry after having emerged from bankruptcy in mid-2006.

Eliminations and Reductions
Berkshire also sold some stocks last quarter, eliminating its position in Sealed Air SEE and Target TGT. I was a bit surprised by the decision to jettison the Target shares, given that Berkshire owns positions in similar public mass-market retailers Wal-Mart WMT and Costco COST, not to mention its wholly owned subsidiary Nebraska Furniture Mart. However, it should be noted that Berkshire's buying and selling of Target seemed to coincide with my colleague Joseph Beaulieu's recommendation of the shares, given that it was rated 5 stars by Morningstar in February 2006, and is rated 3 stars (fairly valued) now.

Berkshire's position in Outback Steakhouse OSI was also liquidated, since the firm was acquired by a group of private equity funds last quarter.

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