Eight 5-Star Stocks from Berkshire's Latest Holdings

By Bill Bergman | Senior Stock Analyst

While  Berkshire Hathaway (BRK.A) (BRK.B) made only modest changes to its equity portfolio during the second quarter, based on data pulled from the firm's latest 13-F filing, the company was once again a net seller of equities during the period. We were, however, encouraged to find more than a handful of 5-star stocks in the company's most recent holdings. Earlier this year, we viewed Berkshire's portfolio as being flooded with buying opportunities for individual investors, as a review of the company's fourth-quarter filing uncovered 31 5-star stocks among Berkshire's equity holdings. By the time May rolled around, the number of stocks in the manager's first-quarter portfolio that were considered buyable by our analysts had dropped to 13, primarily due to the dramatic rise in equity prices since the beginning of March. As the market rally continued through the summer, the number of 5-star stocks in Berkshire's equity portfolio at the end of the second quarter had fallen to eight. We've highlighted these 5-star holdings in the table below and will delve more deeply into each of them as we discuss the moves made during the most recent quarter by this top manager.

Of the nine position changes in Berkshire's portfolio during the quarter, there was one new money purchase (where the company committed capital to a name it had not held previously) and what looks like one outright sale (where Berkshire completely eliminated a position in a security). The new money purchase,  Becton, Dickinson (BDX), was of big interest to the Ultimate Stock-Pickers team because it is a name we've highlighted several times in the last two months. As you may recall, Brad Meeks sat down in June with Alex Morozov, our analyst who covers the company (and is also the associate director for the Morningstar health-care team), to discuss the basis for his 5-star call on the firm. Alex Rambaldini sat down with Alex again at the end of July after Becton, Dickinson's stock took a hit following the firm's release of second-quarter earnings. Alex is still a big believer in the company and we're sure he was pleased to get additional support for his stance from the portfolio managers at Berkshire.

When Is a Sale a Sale?
Dispositions are always more difficult to gauge than purchases, because holdings can fall off 13-F filings for a variety of reasons. For example, Berkshire was a major holder of Gillette until that firm was acquired by  Procter & Gamble (PG) in 2005, after which Berkshire's holding in Gillette no longer appeared in its quarterly filing as it was reflected in its newly formed stake in Procter & Gamble. The same holds for Berkshire's position in Anheuser-Busch, which fell off during the fourth quarter of last year after  InBev  completed its $70 per share cash tender offer for the American brewer. It should come as no surprise then that Berkshire's disposition of  Constellation Energy Group  during the most recent quarter was a little bit more complicated than an outright sale.

According to analyst Travis Miller, who covers electric, natural gas, and water utilities for Morningstar, it looks like Berkshire's MidAmerican Energy unit took full advantage of weakness in Constellation's financial condition in September of last year to negotiate what ended up being a sweetheart deal for itself. MidAmerican provided $1 billion to Constellation in exchange for preferred shares that would later be applied to a $4.7 billion takeout offer by the Berkshire unit. When Constellation rebuffed that offer in December of last year, opting to sell nearly half of its nuclear power business to Electricite de France for $4.5 billion instead, it paid off the $1 billion obligation and handed over nearly 20 million shares of its own common stock and $593 million in cash to MidAmerican. The Berkshire unit sold one quarter of the equity stake during the first quarter and eliminated the position completely in May of this year.

Berkshire's Other Transactions
Much as they had during the first quarter, the managers at Berkshire made meaningful additions to Johnson & Johnson, which they had used as a source of cash during the fourth quarter of 2008 to help fund the purchase of preferred shares and warrants of  General Electric (GE) and  Goldman Sachs (GS). While the total number of shares Berkshire was holding at the end of the second quarter of 2009 is still 40% lower than it was a year ago, the firm has increased its stake in the consumer and health-care products company by 14% in each of the last two quarters.

Berkshire continues to whittle down its holdings of  CarMax (KMX),  ConocoPhillips (COP), and  UnitedHealth Group (UNH), and started to trim its positions in  Eaton Corporation (ETN),  Home Depot (HD), and  WellPoint (WLP). While three of these names appear on our list of eight 5-star stocks from Berkshire's latest holdings, it wouldn't be the first time we've come across actions by one of our top managers that run contrary to our own analysis. Portfolio managers, after all, will sell securities for a variety of reasons (like Berkshire did when it sold off more than half of its position in Johnson & Johnson during the fourth quarter of last year to help fund other purchases), many of which have no direct impact on our own valuation of a firm.

Eight 5-Star Stocks from Berkshire's Latest Holdings
	Star Rating	Fair Value Uncertainty	Moat Rating	Current Price ($)	Price/ Fair Value	Market Cap ($)
Becton, Dickinson (BDX)		Low	Narrow	67.74	0.73	16,216
Comcast Corporation (CMCSA)		Medium	Wide	14.55	0.58	41,756
ConocoPhillips (COP)		Medium	Narrow	43.25	0.62	64,136
Johnson & Johnson (JNJ)		Low	Wide	60.95	0.76	167,967
Lowe's Companies Inc. (LOW)		Medium	Wide	20.39	0.57	30,106
Procter & Gamble Company (PG)		Low	Wide	53.02	0.69	154,760
UnitedHealth Group, Inc. (UNH)		Medium	Narrow	28.39	0.59	33,001
WellPoint, Inc. (WLP)		Medium	Narrow	54.22	0.57	26,277
Stock Price and Morningstar Rating data as of 08-20-09.

 Becton, Dickinson and Company (BDX)
The medical supplies firm has reinforced its market-leading positions by building leading-edge quality and safety features into its syringes, scalpels, and other critical surgical tools and medical supplies. Alex currently has a $93 fair value estimate on the firm, and the low uncertainty rating leads to a relatively small margin of safety for what we feel is one of the more compelling buying opportunities out there.

 Comcast Corporation (CMCSA)
While Comcast has developed the widest cable television network in the United States, the firm's growth has slowed in the last year or two, with the stock recently down 50% from its 2007 peak. Morningstar analyst Mike Hodel cites the economic environment as well as longer-term technological and market concerns about the television business as factors weighing on the stock, but he believes the firm is well positioned with alternative technologies and that it can continue to generate significant cash flow.

 ConocoPhillips (COP)
ConocoPhillips has been one of the weaker elements in Berkshire's equity portfolio of late, with the stock recently trading at about half its 2008 peak. This energy giant made significant acquisitions at relatively high resource prices before the recession kicked in. While it has battened down the hatches on the acquisition front, ConocoPhillips still faces significant project development challenges due in part to those acquisitions. At current market prices, though, we feel that the firm's fundamental strengths and cash flow potential make it a compelling buy.

 Johnson & Johnson (JNJ)
We've been recommending this wide-moat consumer and health-care products giant for much of the past four years. Johnson & Johnson is certainly well known for the strength of its branded consumer products, but the company also has one of the strongest research and marketing programs in health-care products and services. Analyst Damien Conover cites some risk from patent expirations in a small portion of the firm's product mix, but he sees significant product development potential augmenting its already solid revenue base.

 Lowe's Companies (LOW)
This home improvement retailer has been markedly exposed to the macroeconomic weakness in housing and consumer confidence in recent years, but analyst Brady Lemos still likes the long-term prospects for what has already been a long-run success story. Lowe's provides perhaps the best combination of efficient store operations and good customer service in the home improvement retailing business, making it extremely well-positioned in the event of an upturn in housing activity.

 Procter & Gamble (PG)
Procter & Gamble is another wide-moat company that has become an outsized position in Berkshire's relatively concentrated equity portfolio. Analyst Lauren DeSanto has labeled Procter & Gamble a consumer product Goliath. The depth and breadth of the latest consumer-driven recession has provided a few Davids, to be sure, but Lauren feels that Procter & Gamble will take full advantage of the slowdown to not only improve the productivity of its operations but also take share from competitors.

 UnitedHealth Group (UNH)
UnitedHealth faces its own unique challenges. The implications that health-care reform holds for this managed-care organization are difficult to anticipate, but Morningstar analyst Matthew Coffina thinks UnitedHealth will continue to play an important role in financing health-care services. Size doesn't always lead to economies of scale in this business, but Matthew likes how UnitedHealth has been able to leverage its 33 million medical members to negotiate large discounts with health-care providers that want to be part of the company's network.

 Wellpoint (WLP)
WellPoint is another health-care services firm challenged by the uncertainty of health-care reform. Much like UnitedHealth, our analyst Matthew Coffina sees WellPoint's economies of scale and productivity of service delivery as distinct advantages. Wellpoint is the largest managed care organization in the United States, by medical membership, and enjoys a particularly strong bargaining position when dealing with service providers. While he can't rule out a worst-case single-payer outcome from yet-to-be-formulated health-care reforms, he thinks the final product will most likely not involve scenarios as drastic as that.

Disclosure: Bill Bergman does not own shares in any of the companies mentioned above.