(By The Morningstar Ultimate Stock-Pickers Team) As many of you already know, The Morningstar Ultimate Stock-Pickers Team regularly reviews the investment choices of managers we admire in light of the independent research done by our own equity analysts. Stock picks of managers we like will often overlap with the views of our equity research department, providing us with investment ideas we can pursue further.
Like many of the analysts here at Morningstar, we have a high regard for Berkshire Hathaway (BRK.A) / (BRK.B), regularly sifting through the holdings, purchases and sales of the iconic managers--Warren Buffett, Charles Munger, and Lou Simpson--behind the investment choices at the firm. Buffett has been involved in Berkshire's investment portfolio for much of the last forty years, while Munger has been contributing to investment decisions at the firm for nearly as long. Simpson, who has announced he is retiring at the end of the year, has managed Geico's investment portfolio for decades. This type of longevity is rare among asset managers.
We also note that Berkshire is one of four insurance companies we have included in our list of top managers. When we relaunched Ultimate Stock-Pickers last year, we made a point of including a few insurance firms because, unlike their peers in the mutual fund business, the portfolio managers at insurance companies are not impacted by investor redemptions during poor market environments. They also tend to be a bit more long-term oriented than fund managers, investing their portfolios according to the time horizons and payout profiles inherent in their companies' product lines rather than worrying about near-term benchmarks and investor outflows. While fixed income tends to dominate the investment portfolios of most insurance companies, as the asset class provides a steady stream of cash flows and (in most markets) less risk than equities, there is always room for stock holdings, which provide the potential for capital appreciation.
Berkshire Hathaway's Top 10 Stock Holdings (as of 06/30/10)
| ||Star Rating||Size of Moat||Current Price ($)||Price/Fair Value||Fair Value Uncertainty||% of Stock Portfolio|
|Coca-Cola (KO) ||3||Wide||55.16||0.97||Low||21.6|
|Wells Fargo (WFC) ||5||Narrow||23.49||0.57||Medium||17.6|
|American Exp (AXP) ||3||Wide||39.73||0.74||High||13.0|
|P&G (PG) ||5||Wide||59.54||0.77||Low||10.1|
|Kraft (KFT) ||3||Narrow||29.42||0.87||High||6.3|
|Jhnsn & Jhnsn (JNJ) ||5||Wide||57.80||0.72||Low||5.3|
|Wal-Mart (WMT) ||4||Wide||50.97||0.85||Low||4.0|
|Wesco Fin (WSC) ||3||Narrow||363.00||0.97||Medium||4.0|
|U.S. Bancorp (USB) ||4||Wide||20.97||0.72||Medium||3.3|
|ConocoPhillips (COP) ||3||Narrow||52.41||0.85||Medium||3.1|
Stock Price and Morningstar Rating data as of 08-26-10
Looking at Berkshire's stock portfolio at the end of the second quarter, the insurer had more than $46 billion under management, spread out over 37 different equity positions. The portfolio is concentrated among the top ten holdings, though, which accounted for close to 90% of the total dollar value of Berkshire's stock holdings at the end of the second quarter. This has a big influence on the insurer's sector allocation, as top ten holdings Wells Fargo (WFC), American Express (AXP), Wesco Financial (WSC), and U.S. Bancorp (USB) lift financials to more than 40% of the total portfolio. Large stakes in Coca-Cola (KO), Procter & Gamble (PG), and Kraft Foods (KFT) have also helped make consumer goods as big of a sector bet for Berkshire. The insurer's next largest sector allocations are in health care (6%) and consumer services (5%). These figures do not include foreign investments held abroad, such as BYD Corporation, Tesco PLC (TSCDY), and POSCO.
Berkshire Puts More Money into the Tapeworm
In terms of significant position increases during the second quarter, Berkshire added more than 17 million shares to its 24 million share stake in Johnson & Johnson (JNJ
). In noting that the insurer purchased nearly $1 billion of additional stock in the health care company, we were reminded of comments that Warren Buffett recently made about health care costs being a major drain on U.S. businesses, acting like an "economic tapeworm" that sucks resources out of the overall economy given the high costs and low productivity in the system. While we were quick to wonder if Buffett was somehow being inconsistent or socially irresponsible by investing in the industry, we don't think this is necessarily the case. Looking at the concept of economic moats, we note that companies with the most significant competitive advantages tending to be our most productive enterprises, driving down costs, improving efficiency, and adding value for their customers as well as shareholders in the long run. Johnson & Johnson certainly has these characteristics.
Berkshire also made meaningful purchases in two other health care names, Becton Dickinson (BDX) and Sanofi-Aventis (SNY), during the second quarter. Becton Dickinson is one of Berkshire's relatively smaller holdings, but the 8% increase in shares held since the end of the first quarter was, next to Johnson & Johnson, the largest addition (in percentage terms) in the portfolio. The insurer first started buying shares in medical products firm Becton Dickinson during the second quarter of 2009, and has added to its stake in each of the last three calendar quarters. After not making any meaningful changes to its stake in Sanofi-Aventis in close to two years, Berkshire added to its holdings in the French pharmaceutical firm. Both stocks were trading in 5-Star territory during the second quarter, and continue to trade at prices where our analysts would consider them for purchase, further increasing our interest in them. When sifting through our analysts' current thinking on these names, we came away with the following conclusions...
Johnson & Johnson (JNJ)
Morningstar analyst Damien Conover thinks that Johnson & Johnson stands alone as a leader across the major health-care industries, having cultivated compelling competitive advantages. The company maintains a diverse revenue base, a robust research pipeline, and exceptional cash-flow generation that helps sustain its wide economic moat. While Damien believes patent losses on the firm's antipsychotic drug Risperdal, as well as its neuroscience drug Topamax, along with product recalls in Johnson & Johnson's over-the-counter business, will weigh on near-term performance, he remains confident that the company's product breadth can overcome these issues. While many of its competitors are approaching a major patent cliff, Johnson & Johnson is past its own hurdles, and is on the verge of returning to growth with several new potential blockbusters. The company has survived the loss of patent protection on Risperdal and Topamax by bringing forward a robust set of replacement drugs. Within this group of new drugs, rivaroxaban (for cardiovascular disease) and bapineuzumab (for Alzheimer's) offer the potential to revolutionize treatment. Damien expects the company to deploy its enormous cash flow to fund small acquisitions, and augment its internal development efforts.
Becton Dickinson (BDX)
Becton Dickinson is a leading manufacturer of medical supplies, designing and manufacturing health care products ranging from needles to sophisticated diagnostic equipment. Morningstar analyst Alex Morozov cites the firm's defensible competitive position, manufacturing scale, technological prowess, and competent management team as factors that make this health-care bellwether one of his favorite names in the medical products industry. Alex likes the company's robust and predictable cash flows and durably strong returns on capital, which together with a squeaky-clean balance sheet and wise capital allocation policy make the firm a relatively safe choice for risk-averse investors. While Becton Dickinson's fiscal third-quarter results generally met his expectations, he felt that the firm's revenue growth fell a bit short (noting, though, that the company's medical and diagnostic businesses were both negatively affected by tough flu-related comparisons). Despite these issues, Becton Dickinson maintained its earnings per share outlook for the year. Alex also noted that the firm boosted its share repurchase program, continuing its trend of returning a greater percentage of the company's cash flows to shareholders via share buybacks.
With close to one third of Sanofi-Aventis's current sales at risk for generic competition by 2013, the French firm faces an extremely challenging patent cliff. Morningstar analyst Damien Conover believes the company will meet its 2013 revenue goal (equivalent to 2008 revenue) largely as a result of the firm's strategy of expanding into emerging markets, building out its consumer health-care platform, expanding its diabetes franchise, and developing new drugs for largely unmet medical needs. Sanofi-Aventis currently holds the number-one position in emerging markets among large pharmaceutical firms, which should bode well for its long-term prospects, as by 2013 the majority of worldwide pharmaceutical growth is expected to come from emerging markets. Damien thinks the company will have trouble meeting its 2013 operating margin target, though, which is comparable to 2008 levels as well, believing that current cost-cutting efforts may not completely offset patent losses on its high-margin drugs. He's also concerned about the company's recent offer to buy Genzyme (GENZ), a deal where he sees few synergies between the two firms, and where Sanofi-Aventis may eventually be forced to up the ante in order to take control of the biotech firm.
New Money Purchases Always Spark Our Interest
Believing that portfolio managers send signals about how they feel about a particular stock by the amount of money they're willing to commit to it at any given time, we focus on both the purchases and the sales made by our top managers. While we tend to assess the relative attractiveness of an individual security by how many managers hold it, whether or not they've been adding to or subtracting from that position, and the percentage that each security makes up of a total portfolio, we will put a bit more weight behind new money purchases and outright sales when looking at transactions in any given quarter. We believe that it takes a slightly higher level of conviction to buy a stock that isn't in a portfolio already (or to completely blow out a holding) than it does to put additional money to work in (or trim away at) an existing position.
Berkshire Hathaway made one new money purchase during the second quarter, the first time it had put new money to work since the third quarter of last year when the insurer established stakes in ExxonMobil (XOM), Nestle (NSRGY), and Republic Services (RSG). This time around Berkshire put about $200 million to work in Fiserv (FISV), a leading provider of core processing and complementary services (such as electronic funds transfer and loan processing) for U.S. banks and credit unions. Morningstar analyst Brett Horn notes that the bedrock of Fiserv's business is core processing, which is the nuts-and-bolts system that banks need to maintain their deposit and loan accounts and post daily transactions. Given the integral nature of core processing to their operations, banks rarely switch systems. Fiserv leverages its essentially captive core processing relationships to cross-sell other products and services. While Brett admits that the company's top line will be stalled until banks finish putting their houses in order, he notes that a fair chunk of Fiserv's revenue recurs under long-term contracts, and that the firm has been good about cost controls, two things he thinks the market fails to fully appreciate. Brett believes that Fiserv is well-positioned for the long haul, with the firm's recent acquisition of CheckFree further improving its competitive position.
While there were no outright sales in the second quarter, Berkshire once again pared back positions in Procter & Gamble, Kraft Foods, ConocoPhillips (COP), and M&T Bank (MTB). Berkshire had previously trimmed stakes in Procter & Gamble, Kraft Foods, and M&T Bank to help fund its purchase of Burlington Northern (which closed during the first quarter of 2010). While the insurer likely used the proceeds from sales of ConocoPhillips to help fund the Burlington Northern deal as well, Berkshire has been unwinding its position in the energy company for the better part of the last two years. Buffet has acknowledged that the timing of Berkshire's initial purchase, which was made when oil and gas prices were near their peak in 2008, was a major mistake. Despite selling off close to 55 million shares over the last seven calendar quarters, Berkshire still held a 3% position in ConocoPhillips, worth around $1.4 billion at the end of June.