Seven 5-Star Stocks from Berkshire's Latest Portfolio

By Bill Bergman| Senior Stock Analyst

While  Berkshire Hathaway (BRK.A) (BRK.B) may have made big headlines earlier this month with its $44 billion acquisition of  Burlington Northern , the company was no slouch during the third quarter, when it was actively buying and selling securities in its equity portfolio. In fact, the latest 13-F filing by the insurer revealed more turnover than we're accustomed to seeing from the insurance company. Of the thirteen position changes in Berkshire's portfolio during the third quarter, there were four new money purchases, two outright sales, and seven holdings where the portfolio managers at Berkshire were either adding to or subtracting from existing positions. Relative to the size of the company's overall portfolio, though, none of these transactions were large enough to make a significant dent in Berkshire's top ten holdings, which remained relatively unchanged from the second quarter of 2009.

Berkshire Hathaway has long maintained a concentrated equity portfolio. Among the 43 different stock positions held by the insurer at the end of the third quarter, the top ten holdings accounted for more than 85% of the total value of the equity portfolio.  Coca-Cola (KO) (at around 19% of the portfolio) and  Wells Fargo (WFC) (accounting for close to 16%) were Berkshire's two largest holdings. The next three largest positions--Burlington Northern,  Procter & Gamble (PG), and  American Express (AXP) accounted for 30% of Berkshire's equity portfolio. Rounding out the company's top ten holdings were  Kraft Foods (KFT),  ConocoPhillips (COP),  Johnson & Johnson (JNJ),  Wal-Mart (WMT), and  Wesco Financial . The following chart demonstrates the relative contribution that Berkshire's 43 stock holdings (ranked by the size of each position) make to the insurer's equity portfolio:

At the end of the third quarter, Berkshire's equity portfolio had a total market value of $56.5 billion, up nearly 16% from $49.0 billion at the end of June, putting its performance on par with a similar gain posted by the S&P 500 Index (SPX). American Express, which was up nearly 50% during the third quarter, was Berkshire's best performing stock out of its top ten holdings. Wells Fargo also posted market beating returns during the third quarter which, based on the much larger stake it represents in Berkshire's portfolio, contributed greatly to performance during the period.

Much like the second quarter, when Berkshire's equity portfolio was up close to 20% (relative to a 15% gain for the market), we managed to find more than a handful of 5-star stocks in the company's third-quarter holdings. As you may recall, we had believed that Berkshire's portfolio was flooded with buying opportunities earlier this year when a review of the company's fourth-quarter holdings uncovered 31 5-star stocks. By the time we reviewed the firm's first-quarter holdings, the number of stocks in the portfolio that were considered buyable by our analysts had dropped to 13, and as the market rally continued, the number had fallen to eight by the end of the second quarter.

That number has since slipped to seven, with Procter & Gamble recently drifting into 4-Star territory and ConocoPhillips moving even closer to our analyst's fair value estimate. We've highlighted these seven 5-star holdings, which now includes  Home Depot (HD), in the table below:

Seven 5-Star Stocks in Berkshire Hathaway's Portfolio

Stock Price and Morningstar Rating data as of 11-19-09

 Johnson & Johnson (JNJ)
We've been recommending this wide moat consumer and healthcare products giant for much of the past four years. Our analyst Damien Conover believes J&J's ability to maintain a diverse revenue base and a robust research pipeline, generate exceptional levels of cash flow, and control the top or number-two spot in 70% of its product lines, has endowed it with a wide economic moat around its business.

 Comcast Corporation 
Besides being the largest domestic cable provider, Comcast is also a significant provider of Internet and telephone services. Our analyst Michael Hodel believes Comcast's competitive advantages stem from the fact that no other company can match it ability to offer multiple services over one connection within the territories it serves.

 Wellpoint (WLP)
As a leading health insurer, WellPoint's stock has been challenged by the uncertainty of health-care reform. Our analyst Matthew Coffina sees WellPoint's economies of scale and broad, low-cost provider network 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 health-care providers.

 Lowe's Companies (LOW)
This home improvement retailer has been markedly exposed to the macroeconomic weakness in housing prices and employment outlook in recent years, but our analyst Mike Taggart still likes the long-term prospects for what has already been a long-run success story. Lowe's provides the best combination of efficient store operations and superior customer service in the home improvement retailing business, making it extremely well-positioned when the economy rebounds. His current outlook foresees slightly higher than inflationary revenue growth in the coming years.

 UnitedHealth Group (UNH)
Much like with Wellpoint, the complete set of implications that health-care reform holds for UnitedHealth Group are difficult to anticipate, but Morningstar analyst Matthew Coffina thinks the company will continue to play an important role in financing health care services. 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.

 Becton, Dickinson and Company (BDX)
Becton Dickinson has been a favorite of our analyst Alex Morozov for some time now. The company is the world's largest manufacturer and distributor of medical surgical products, such as needles, syringes, and sharps-disposal units. It also manufactures diagnostic instruments and reagents, as well as flow cytometry and cell imaging systems. Berkshire Hathaway created some buzz around the stock when it made a new money purchase in the name during the second quarter.

 Home Depot (HD)
Much like its main competitor, Home Depot has been markedly exposed to macroeconomic headwinds in recent years. With Home Depot once again focused exclusively on its retail stores, our analyst Mike Taggart thinks that competition with Lowe's is set to intensify. Given the size and fragmentation of the home improvement market, though, he believes that the two retailers can coexist and grow profitably for years to come. Plus, Home Depot has the added benefit of being able to reap significant profitability efficiencies over the coming years (from a new distribution system, and better IT infrastructure).

Seven Recent Purchases by Managers at Berkshire Hathaway

Stock Price and Morningstar Rating data as of 11-19-09

While there were more than a handful of 5-Star stocks in Berkshire's third-quarter holdings, none of them were names where the insurer was putting money to work. The company made four new money purchases during the period in  The Travelers Companies (TRV),  ExxonMobil (XOM),  Republic Services (RSG), and  Nestle (NSRGY). Of interest to us was the purchase of Republic Services, which you may recall was one of ten high conviction purchases made by our Ultimate Stock-Pickers during the third quarter, with  Oak Value   fund being one of the other major buyers of this waste removal firm.

The purchase of Nestle also stands out, if only because of Berkshire's current 6%-plus position in Kraft, which is a major competitor for the Swiss firm (especially in Europe and North America). Nestle is also a dominant fixture in the global market for bottled water, beating off competition from  Danone (DANOY),  PepsiCo (PEP), and even top Berkshire holding Coca-Cola. Our analyst Philip Gorham believes Nestle's large global distribution network and well-known brands have generated a narrow economic moat for the firm, but thinks the firm's growth opportunities will be limited to developing and emerging markets, rather than developed countries. With emerging economies being hit particularly hard by the global recession, Berkshire could have felt that the time was ripe to start building a position in Nestle--especially as (much like Coke) it has one of the most developed global distribution networks among the packaged food and beverage firms.

Berkshire's two other third-quarter purchases involved additions to already established positions in Wells Fargo and Wal-Mart, with the insurer nearly doubling its stake in the discount retailer. Wal-Mart has long been a favorite of ours, with analyst Joel Bloomer believing the firm's unmatched scale relative to most vendors provides it with favorable terms on everything from the products on its shelves to store leases and distribution agreements. This has allowed Wal-Mart to not only dominate the U.S. retail landscape, but has set it up to grow quickly internationally. While the retail giant has benefited more than most of its peers from the economic downturn, the prospects of a mild recovery, and the fact that the retailer is still in the early stages of its international expansion, leave the firm with plenty of growth opportunities in the near term.

As for the sales Berkshire made during the quarter, Eaton Corporation (ETN) and Wabco Holdings , were some of the most economically sensitive companies in the firm's portfolio. The sales were not altogether inconsistent with some of what Buffett has been saying and doing lately. Eaton and Wabco both manufacture products used to make heavy-duty trucks, and with Berkshire citing the relative cost advantage in railroad transportation (and making such a significant bet on Burlington Northern) it was not too surprising to see the insurer move out of these stakes. Berkshire also made meaningful reductions to its holdings in Moody's (MCO) and NRG Energy (NRG) (as well as a smaller reduction in SunTrust Banks ) which, given its offer to acquire Burlington Northern earlier this month, could have been a move to build up cash.

Disclosure: Bill Bergman does not own shares in any of the securities mentioned in this article.