After 10 years of a strong bull market, it's getting tough to find good deals on quality stocks. You won't find many high-flying tech stocks among Berkshire Hathaway's holdings, which reflects legendary investor Warren Buffett's long practice of avoiding industries he doesn't understand.
Two of the industries that fit Buffett's circle of competence and where he has been finding deals lately are banking and airlines. At the end of the first quarter, Berkshire owned significant stakes in Goldman Sachs (GS -0.58%), Bank of America (BAC 0.37%), and Delta Air Lines (DAL -0.30%). Here's why these stocks might be some of the best bargains in the market right now.
A sleeping giant in consumer credit
Shares of the world's largest financial institutions have been left out to dry in recent years as investors chase the exciting growth stories in other industries. Valuations for the big banks have become incredibly cheap.
Buffett has taken notice. Berkshire holds several bank stocks, including 18,353,635 shares of Goldman Sachs at the end of the first quarter. That's 5% of one of the most prestigious financial institutions in the world.
Goldman Sachs hasn't grown the top line much over the last decade, but it's been consistently profitable, and management is beginning to target new products and services to expand its addressable market. One of those is the effort to get into consumer banking, with Goldman recently partnering with Apple to launch a consumer credit card.
Goldman Sachs has enormous growth opportunities across different areas. The company has less than $50 billion in online retail deposits, but there are trillions worth of deposits in the U.S. that Goldman could tap into to grow its deposit total. A similar opportunity exists in investment management and investment banking.
Given these opportunities, the stock looks like a bargain, trading for 1x tangible book value. What's more, management plans to repurchase nearly 10% of the company's shares outstanding over the next year -- a signal to investors that the stock is undervalued. Plus, a dividend increase to $1.25 per share starting in Q3 of this year was recently approved, bringing the forward yield to 2.4% based on the current stock price.
Buffett's favorite bank is a steal
Berkshire's largest bank holding, and second largest equity holding overall, is Bank of America. Berkshire owns $26.3 billion worth of the stock, which is nearly 10% of the total outstanding shares of Bank of America -- a big vote of confidence by the Oracle of Omaha.
His confidence starts at the top. CEO Brian Moynihan took over the reins following the financial crisis in 2008 and has spent his tenure lowering the company's risk profile, at the same time cutting expenses to make it one of the most profitable banks in the industry.
It holds the No. 1 market share spot in consumer deposits, and the company has experienced robust growth in digital banking, which accounts for 27% of total sales.
It earned a 16% return on tangible equity in the first quarter, which makes the stock's price-to-tangible-book-value ratio of 1.60 look cheap. On a forward P/E basis, the stock trades at 10.4 times this year's consensus earnings estimate.
As with Goldman Sachs, Bank of America's management clearly sees the stock as undervalued and wants to do something about it. The company's capital return program calls for the repurchase of more than 10% of the shares outstanding, and the dividend payout is getting a boost of 20%, which brings the forward dividend yield to 2.45%.
Refueling the tank
Excluding his admitted mistake by investing in USAirways in 1989, Warren Buffett has long shunned airline stocks due to cutthroat competition and low profitability. All the major airlines, except Southwest, have filed for bankruptcy in the last 20 years, but the times are changing.
The airline industry is much more focused on profitability today than years ago. A better focus on profitability combined with growing consumer expenditures going toward air travel is leading to good times for the industry, particularly Delta -- Berkshire's largest airline holding at the end of the first quarter.
Between 2014 and 2018, Delta saw revenue increase by 10%, or by $4 billion in total. Meanwhile, operating expenses increased by only $1 billion. This left most of the incremental increase in revenue dropping straight to the bottom line, with net income improving from $659 million in 2014 to $3.9 billion last year.
Delta expects 2019 to be the fifth year in a row of $5 billion or more in pre-tax profits. The company expects to generate $3 billion to $4 billion in free cash flow, and management plans to return about 70% of that to shareholders in the form of dividends and share repurchases.
Wall Street is currently worried about rising fuel costs and the impact of the grounding of the Boeing 737 MAX, but these are short-term problems that shouldn't affect Delta's business over the long term. Because of these near-term headwinds, investors can currently buy Delta stock for just 8.5 times this year's earnings estimates, and the stock has a dividend yield of 2.44%.