Berkshire Hathaway (BRK.A -0.78%) (BRK.B -0.62%) CEO Warren Buffett is a legend on Wall Street. In roughly six-and-a-half decades, the Oracle of Omaha grew his net worth from $10,000 to more than $81 billion. And, may I add, Berkshire Hathaway's share price appreciation over the years has created more than $400 billion in value for shareholders.
Buffett's investing style is unique on Wall Street for its relative simplicity. Rather than try to use fancy charting software, Buffett simply focuses his attention on a handful of sectors and industries within the market, learns the ins and outs of these sectors and industries, and purchases companies that he believes offer excellent value and competitive advantages. It may sound boring, but the data doesn't lie: Buy-and-hold investing can work wonders.
Although not all of Buffett's 47 currently held securities in Berkshire Hathaway's portfolio could be accurately described as "value stocks," many of them are. In fact, three Buffett stocks that can be rightly called his cheapest are currently valued at less than six times next year's projected earnings per share (EPS).
Berkshire Hathaway CEO Warren Buffett at his company's annual shareholder meeting. Image source: The Motley Fool.
Teva Pharmaceutical Industries: 2.8 times next year's EPS
When it comes to cheap Buffett stocks, nothing tops brand-name and generic-drug producer Teva Pharmaceutical Industries (TEVA 3.13%). Following a more than 90% decline from its all-time highs set in the summer of 2016, Teva now trades at a mere 2.8 times Wall Street's consensus EPS forecast for 2020.
On the one hand, there's a very good reason Teva Pharmaceutical is so inexpensive. Namely, it's faced a veritable laundry list of problems over the past two years. In no particular order:
- The company's debt levels ballooned following its acquisition of generic drugmaker Actavis;
- Teva settled a bribery lawsuit with the U.S. Justice Department;
- The company shelved its dividend and has reduced its adjusted EPS forecasts multiple times;
- It's faced generic-drug pricing weakness; and
- As the icing on the cake, it's being sued by 44 U.S. states over its role in supplying opioids to the marketplace.
In fact, Buffett himself didn't pick out Teva to add to Berkshire's portfolio. Buffett has a history of avoiding drug stocks because of the effort needed to stay abreast on clinical trial data. Rather, it was one of his trusted investment managers who made the purchase.
However, Teva may still surprise the naysayers. Turnaround specialist CEO Kare Schultz has reduced Teva's net debt by $8 billion in two years, and the company is on track to have lowered its full-year operating expenses by $3 billion. All the while, Teva has remained very profitable on an adjusted basis and expects operating cash flow to improve after a trough year in 2019.
Teva is also a generic-drug giant, which should favor the company over the long run. Since brand-name drugs have a finite period of patent protection, Teva's generic reach and portfolio breadth continue to grow.
Image source: American Airlines.
American Airlines Group: 5.2 times next year's EPS
Another exceptionally cheap stock that Buffett owns is American Airlines Group (AAL -2.87%) at just over five times next year's EPS, according to Wall Street's consensus. Unlike Teva, American Airlines is a company picked out by Buffett.
Buffett first began adding shares of airlines, including American Airlines, to Berkshire's portfolio during the third quarter of 2016. The logic here is that West Texas Intermediate crude prices had briefly crashed below $30 a barrel earlier in 2016. With fuel expenses being the biggest single cost for airlines, this opened the door for significant margin expansion.
Additionally, a number of airlines have faded away in recent decades due to bankruptcy. As the field of competitors has shrunk, it's arguably helped to bolster the pricing power of the remaining major airlines. And since this is a cyclical industry, the longest economic expansion in U.S. history has allowed companies like American Airlines to fly high.
But there are reasons American Airlines is valued at only 5.2 times next year's EPS. For starters, it's lugging around more net debt than any other airline at $29.3 billion. This gives the company far less financial flexibility than its peers.
Airlines like American also have a very poor track record when recessions strike. It's a business that requires a lot of capital to operate, but that often returns very low margins. When coupled with high debt levels, American Airlines may very well be a value trap.
The 2019 Chevrolet LT Trail Boss. Image source: General Motors.
General Motors: 5.6 times next year's EPS
A third incredibly cheap stock in Buffett's portfolio is Detroit automaker General Motors (GM 0.53%). Automakers have, historically, traded at single-digit forward price-to-earnings ratios. However, General Motors' forward P/E ratio of 5.6 is modestly below its five-year average forward P/E ratio of 6.1.
Like American Airlines, General Motors is a cyclical company, meaning it tends to do well when the U.S. and global economy are expanding. Therefore GM has been able to take advantage of the longest expansion in U.S. history, as well as historically low lending rates, to grow its business. These lending rates not only mean paying less on the company's existing debt, but it's allowed consumers to finance new vehicles, rather than buying used cars, without draining their pocketbooks.
Furthermore, GM has benefited from more moderate crude prices, just as airlines have. Lower prices at the pump, along with innovative and more fuel-efficient engines, have encouraged consumers to purchase trucks and SUVs instead of sedans. That's great news for GM considering that trucks and SUVs bear juicier margins than smaller sedans. Perhaps unsurprisingly, GM is also one of Buffett's top high-yield dividend stocks.
But, once again, there are reasons General Motors is so relatively inexpensive. For one, it's contending with the longest labor strike in roughly two decades with the United Auto Workers. Through the first 30 days of the strike, it's cost the company about $2 billion. Thankfully, these aren't recurring costs and should make for some delectable year-over-year comparisons next year.
The bigger worry might be that GM's sales in China are floundering. Once viewed as the perfect hedge to a peak in auto sales in the U.S. market, General Motors has seen its China sales decline in five consecutive quarters, including a 17.5% drop in the third quarter of 2019 when compared to the prior-year quarter. Without this high-growth safety valve, GM's near-term growth prospects have hit the skids.
