Many of the best investors in the world were actively buying stocks during the first quarter. Fund managers that oversee a minimum of $100 million are required to disclose their holdings with the Securities Exchange Commission (SEC) within 45 days of the end of every quarter. These holdings are known as 13F filings and can provide a treasure trove of investment ideas.
The 13Fs for the second quarter won't be released until the middle of August, but there are a few top stocks that were purchased by notable fund managers during the first quarter that are still trading at discounts.
In the first quarter, Bill Ackman's Pershing Square Capital added to stakes in Starbucks (SBUX -0.96%) and Hilton Worldwide Holdings (HLT -0.73%). Ruane Cunniff & Goldfarb, manager of the Sequoia Fund, recently disclosed a new position in Walt Disney (DIS 1.50%) that it acquired during the second quarter. Here's why these stocks could be good buys right now.
1. Starbucks: Still finding growth opportunities
Bill Ackman at Pershing Square Capital Management nearly doubled his firm's stake in Starbucks during the first quarter. During the market plunge in March, the stock price fell to a low of $50.02. The stock quote now sits around $75. Even at that higher price, the stock is still below its 52-week high of $98.94.
Starbucks revenue declined 5% year over year in the fiscal second quarter, with comparable store sales down 10% globally. The near term will remain challenging, but management expects sales to recover heading into the fiscal fourth quarter ending in September and into next year.
Starbucks might look like a mature restaurant chain with more than 32,000 stores globally, but management continues to identify ways to keep revenue growth going. It is successfully expanding to non-retail channels, such as the Starbucks by Nespresso line in partnership with Nestle. The current environment has made this strategy even more beneficial for Starbucks, given the lower traffic at stores.
Sales from these branded products, including whole bean and ground coffees, ready-to-drink beverages, and other branded products that are included in the channel development segment, saw an increase of 16% year over year, reaching $519 million in the fiscal second quarter.
Traditional valuation metrics are not very helpful in gauging the stock's value right now, given that earnings will drop in fiscal 2020 over the pandemic. But the stock is currently trading in the middle of its historical range based on the price-to-sales (P/S) ratio, currently at 3.42, showing that investors are getting a fair price for one of the top consumer brands in the world at current price levels.
2. Hilton Hotels: A world-class hotel operator
One of the hardest-hit industries during the pandemic has been the travel industry, but that could present an ideal time to scoop up the leaders at a discount. Hilton has been one of Bill Ackman's top ideas, and he added to his firm's stake in the first quarter. Lone Pine Capital is another notable hedge fund that started a new position in the stock during the first quarter.
What makes Hilton a good pick? For starters, it has a diversified group of hotel brands that offer something for everyone at various price points. On the low end are midscale to upscale chains like Hampton and Doubletree. On the luxurious end is the iconic Waldorf Astoria, LXR, and Conrad hotels and resorts.
Hilton also has an award-winning loyalty program with 106 million members, in which membership increased by 21% in 2019. This provides Hilton with a large customer base that drives repeat business.
Hilton has an attractive business model where it mainly makes money through management and franchise fees. It takes on very minimal capital commitments and generates revenue primarily by charging fees to the hotel owners. In return, the owners can opt in to Hilton's loyalty program, marketing, and other services.
Hilton's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) was $2.3 billion in 2019. A pipeline of approximately 405,000 new rooms under development could add about $800 million to adjusted EBITDA, according to company estimates. To put that expansion in perspective, Hilton Hotels had approximately 977,000 available rooms across all hotel brands at the end of the first quarter.
From 2016 through 2019, Hilton delivered cumulative revenue growth of 43% and growth in free cash flow per share of 47%. That pushed the stock up 92% over that same period. The stock is down 31% year to date, but the current price could be a bargain as time goes by. This is a top tier hotel stock that can deliver good returns for investors once the economy recovers.
3. Walt Disney: An undervalued streaming stock
Disney is down 19% year to date as it begins to reopen theme parks, which along with consumer products comprised 38% of its revenue in fiscal 2019 ending in September. All four Walt Disney World parks and Disney Springs are currently open, and that has caused analysts to turn more bullish on the stock recently.
Ruane Cunniff & Goldfarb's Sequoia Fund has delivered 13.4% annualized returns since inception in 1970, beating the S&P 500 index by more than two percentage points per year. Ruane Cunniff is known for doing exhaustive research on companies before investing, so it's meaningful that Walt Disney made the cut.
Disney's most recent quarter was terrible, as expected, with profits plunging following the closure of its theme parks. The recently ended fiscal third quarter will likely be another weak earnings report, but Ruane Cunniff is looking beyond the current crisis to what Disney will be worth down the road in a normal economic environment. Disney is in a good position to capitalize on a future where more people are watching its content digitally.
On that note, a Goldman Sachs analyst believes the market is undervaluing Disney's direct-to-consumer business by at least 50%. The analyst believes Disney's theme parks will fully recover once COVID-19 has faded away, and that Disney+ will reach 150 million subscribers by 2025. Other analysts have been even more bullish on Disney's streaming prospects.
At the beginning of 2020, the share price was hovering over $140 -- nearly 20% above the current quote -- and it didn't look expensive with a P/S ratio of about 3.0, which is within Disney's historical trading range.
Like Starbucks, investors are getting a top brand at a fair price at the least. If new CEO Bob Chapek can lead Disney to better profit margins over time, as he did as head of the parks segment before taking over the reins as CEO, the stock could be undervalued from current price levels.