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My Top Buffett Stock to Buy for 2018

By Matthew Frankel, CFP® – Updated Jan 22, 2018 at 2:09PM

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It’s one of Buffett’s bank stocks, but probably not one you're thinking of.

If you look at the massive stock portfolio of Warren Buffett-led conglomerate Berkshire Hathaway (BRK.A -1.05%) (BRK.B -1.36%), you'll find a disproportionately high amount of bank stocks. In addition to major positions in Wells Fargo, Bank of America, and American Express, Berkshire also owns substantial stakes in Bank of New York Mellon, M&T Bank, U.S. Bancorp, and more. It's fair to say that Buffett and his team are fans of the financial sector.

While I think all of these stocks could benefit tremendously from rising interest rates, the one financial stock in Berkshire's portfolio that I'm keeping a close eye on is Synchrony Financial (SYF -3.21%).

Warren Buffett speaking to the media.

Image Source: The Motley Fool.

What does Synchrony Financial do?

I often say that Synchrony is the largest credit card company that many people have never heard of. The company primarily issues store credit cards, and just to name a few, it issues credit cards for, Wal-Mart, Lowe's, Gap, J.C. Penney, and TJ Maxx. In addition, Synchrony is the company behind the CareCredit healthcare credit card that allows consumers to finance medical expenses.

In addition to its credit card business, Synchrony also operates an online bank that offers consumer deposit products with competitive interest rates. Because of the high interest margins it earns from credit cards, and lack of physical banking branches, Synchrony can afford to pay more than its competitors to attract deposits. As I write this, Synchrony is offering savings yields of up to 1.45% and CDs with interest rates as high as 2.4%. Compare these with your bank -- most brick-and-mortar banks aren't even close.

Strong growth and an ultra-efficient business

Synchrony has been growing nicely in recent years. Over the past year alone, the company's net interest income grew by 8%, its loan portfolio has risen by 7%, and the company added $4 billion of deposits on the banking side of its business.

These are pretty impressive growth metrics, especially considering that Synchrony trades for just 14.2 times earnings.

In addition, Synchrony runs a remarkably efficient operation. For 2017, Synchrony's efficiency ratio was 30.3%, meaning that the bank spent just over $0.30 for every dollar in revenue in generated. Most banks would be happy to run at twice that level.

One thing to keep an eye on

Store credit cards tend to have higher default rates than other types of credit, and Synchrony's numbers confirm this point. The company's net charge-off rate of 5.78% is high -- 113 basis points higher than it was a year ago.

Now, Synchrony more than makes up for this matter with credit cards that have generally higher than average interest rates. Aside from their promotional financing periods, store credit cards often have interest rates in the upper-20% range. In fact, the average credit card interest rate is around 16%, and Synchrony's margin, even after accounting for charge-offs, is 16.24%.

In other words, Synchrony's high charge off ratio isn't a problem, business-wise. However, if the charge-off rate continues to rise, it could be a sign of trouble.

Looking ahead to 2018

One particularly exciting development as we head into 2018 is Synchrony's acquisition of PayPal Holdings' U.S. consumer credit receivables portfolio, and its agreement to become the exclusive issuer of the PayPal Credit program. The deal is expected to close in the third quarter of 2018, and should have a major impact on the company's revenue. In fact, the company projects that its loan receivables will grow by as much as 15% in 2018, with the PayPal acquisition being the main growth driver.

In a nutshell, Synchrony Financial is a highly profitable and growing company that trades for a cheap valuation in an otherwise expensive market. It's easy to see why it became a part of Berkshire Hathaway's portfolio in 2017, and I wouldn't be surprised if Buffett and his team decide to add to their position this year.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Matthew Frankel owns shares of American Express, Bank of America, Berkshire Hathaway (B shares), and PayPal Holdings. The Motley Fool owns shares of and recommends Amazon, Berkshire Hathaway (B shares). and PayPal Holdings. The Motley Fool recommends American Express, Lowe's, Synchrony Financial, and The TJX Companies. The Motley Fool has a disclosure policy.

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