Considering what a crazy year it's been, you might be surprised to learn that Warren Buffett's Berkshire Hathaway (BRK.A 0.64%) (BRK.B 0.54%) is wrapping up 2020 right about where it started. The price of the company's B shares -- $226.19 per share as of this writing -- is nearly identical to its $226.50 per share close on Dec. 31, 2019. Meanwhile, Buffett is sitting on a huge cash hoard.
We asked three of our Motley Fool contributors what stocks Buffett should spend that cash on in 2021. They came back with McCormick (MKC 0.59%), Dover (DOV -0.53%), and 3M (MMM 0.57%). Here's why they'd recommend them to the Oracle of Omaha himself.
Image source: Getty Images.
Put some zest in your portfolio
John Bromels (McCormick): Honestly, I don't know why Buffett hasn't taken a big position in herbs, spices, and condiments manufacturer McCormick before now. Berkshire already owns a 26.7% stake in Kraft Heinz (KHC 0.57%). Buying McCormick would get Buffett some French's mustard to go with his Heinz ketchup, as well as two of my favorite hot sauce brands, Frank's RedHot and Cholula. Not to mention, of course, the company's dominant share of the supermarket spice rack.
Buffett's reluctance may be due to the underperformance of his Kraft Heinz investment. While its share price has outperformed Berkshire's so far in 2020 -- up 6.3% year to date -- it's underwhelmed investors with its failure to capitalize on the strength of its brands. McCormick, on the other hand, has seen its shares rise by 10.2% so far in 2020. That's still losing to the S&P 500's 13.4% return, but over the last five years, McCormick's shares have easily beaten the S&P 500, paying a small dividend to boot.
Of course, Buffett may think that McCormick's relative success has left it overpriced. While its current price-to-earnings ratio of 33 is high for the company, CEO Lawrence Kurzius sees opportunity for more growth ahead. He stated on the Q3 earnings call that McCormick expects more consumers to continue cooking from home even after pandemic restrictions on dining out are lifted. And while sales to restaurants -- which comprise about 20% of the company's business -- have declined, those sales should begin to recover in 2021.
All told, 2021 looks like a good time for Buffett to spice up his holdings with this king of spices.
A manufacturing maven from the Land of Lincoln
Scott Levine (Dover): Follow the world of investing for even a short while, and you'll find that a common topic among investors is discussing which stocks would be good fits for the Berkshire Hathaway portfolio. While the Oracle of Omaha has shown the willingness to make investments that he had once avoided -- I'm thinking of you, Barrick Gold -- Dover is a company that has many of the hallmarks of the typical Warren Buffett investment.
One of the metrics that Buffett favors over earnings per share in evaluating a potential investment is a high return on equity. In his first letter to shareholders, Buffett stated, " ... we believe a more appropriate measure of managerial economic performance to be return on equity capital." In this regard, Dover, a manufacturer and solutions provider to a variety of industries, warrants recognition. In 2019, for example, the company had a return on equity (ROE) of 23.4%. However, relative to its closest peers by market cap, Trane Technologies and Xylem, Dover's ability to turn shareholders' investments into profits shines even brighter.
DOV Return on Equity data by YCharts.
In terms of generating a high ROE, Dover consistently outperforms its peers, and it's worth noting the company's superior performance during the challenges presented by COVID-19. On a trailing-12-month basis, Dover's ROE is 21.4%, considerably better than Xylem's 7.8% and Ingersoll Rand's negative 3%.
While Berkshire Hathaway doesn't reward its own shareholders by way of a dividend, Buffett is certainly a fan of owning stocks that offer him a dividend -- another way in which Dover fits the bill. Raising its dividend for more than 50 consecutive years, Dover is in rarefied air as a Dividend King. But its track record of returning capital to shareholders is even more impressive than its Dividend King status implies; the company has raised its dividend for an impressive 65 years in a row! And it's not as if management is jeopardizing the company's financial health through the dividend. Over the past 10 years, the company's payout ratio has averaged 35.5%.
Lastly, Buffett is well-known to be an advocate of companies that don't rely too heavily on debt, relying on a weighed-down balance sheet to finance future growth. While Dover isn't debt free, it certainly doesn't rely inordinately on debt for growth. Over the past 10 years, it has averaged an annual debt-to-equity ratio of 0.67. Further illustrating Dover's financial health, investors can consider the company's conservative approach to leverage. As of the end of Q3 2020, Dover's net debt-to-EBITDA ratio is 2.2.
3M, a Buffett style investment
Lee Samaha (3M): If Warren Buffett is known for one thing, it's buying businesses that are capable of generating earnings and cash flow by using less invested capital. That can be achieved without necessarily improving the company's growth rate; all that needs to be done is to improve the rate at which it makes money from its debt and equity.
That's where 3M comes in. The multi-industry industrial giant isn't going to become a high-growth company overnight, but it does have a significant opportunity to improve its return on capital and its earnings margin in the coming years. As you can see below, 3M has fallen behind with these metrics in recent years.
Data by YCharts
However, the good news is that 3M continues to generate bundles of free cash flow (FCF) -- the current FCF of $6.32 billion represents 6.3% of the company's market cap. That will give CEO Mike Roman ample firepower to carry out his ongoing restructuring plans.
Indeed, Roman launched a new operating model in January and recently announced actions to streamline the company's operations with 2,900 positions being "impacted." Meanwhile, he continues to restructure the portfolio of businesses by selling less profitable ones and acquiring new ones, notably in healthcare.
The FCF to engineer an improvement is there, the will is there, and 3M has a portfolio of leading businesses from which it can improve margin and return on assets. Trading on just 16.4 times current FCF and with a dividend yield of 3.4%, the stock is the sort of opportunity that Buffett, and Buffet-like investors, should be looking at.
