Berkshire Hathaway (BRK.A 2.63%) (BRK.B 2.82%) CEO Warren Buffett is something of a legend on Wall Street. That's because his company's stock has averaged an annual return of 20% over a 55-year stretch, and shares are up in excess of 2,800,000% since he took the helm. For comparison, the S&P 500 has returned 23,454%, including dividend payouts, since 1964.
The vast majority of stocks Buffett and his team add to Berkshire Hathaway's portfolio are moneymakers. That's because the Oracle of Omaha and his investment team typically focus on companies that have sustainable competitive advantages and time-tested operating models.
But not every one of the four-dozen securities held by Berkshire Hathaway is currently in the green. For the time being, the following three stocks are all costing Buffett money.
Pharmaceutical stock Merck (MRK 0.96%) is a relatively new addition to the Oracle of Omaha's portfolio. Added initially in the third quarter of 2020, Berkshire owned almost 28.7 million shares, as of Dec. 31. According to Berkshire Hathaway's shareholder letter, its cost basis on Merck is $2.39 billion, equating to $83.28 a share. On May 12, this Big Pharma stock closed at $78 on the nose.
If I had to guess why Merck has underperformed since Buffett and his team became shareholders, I'd point to its lack of success in developing a coronavirus disease 2019 (COVID-19) vaccine. In late January, Merck announced that it would discontinue its research of V590 and V591 after inferior immune responses relative to what was observed after natural infection of the SARS-CoV-2 virus or from other vaccine candidates. Considering how much revenue a vaccine could generate, this was a modest disappointment.
However, any significant weakness in shares of Merck should be viewed as an opportunity for long-term investors. This is a company whose oncology segment has been thriving, primarily because of cancer immunotherapy Keytruda. Merck's lead drug is approved to treat around two-dozen indications and it's being studied as a monotherapy or combination therapy in dozens of other clinical trials. It was responsible for bringing in $14.4 billion for Merck last year, and it looks to be well on its way to eventually becoming the world's top-selling drug.
Furthermore, Merck's animal health division has been a source of steady growth. In the first quarter, animal health sales moved higher by 17% to $1.42 billion from the prior-year period. Farmers are paying more to keep their livestock healthy, but the biggest increase was seen from companion animal revenue (up 26%). It's been more than a quarter of a century since U.S. spending on companion pets has declined year-over-year. This makes animal health one of Merck's foundational catalysts.
Another holding where Warren Buffett currently finds himself underwater is telecom giant Verizon (VZ 1.66%). Berkshire Hathaway's seventh-largest holding was added in its entirety during the fourth quarter at an average share price of $59.24. With Verizon closing at $58.41 on May 12, the Oracle of Omaha is staring down an unrealized loss of less than 2%.
Then again, Buffett and his team probably didn't invest $8.691 billion into Verizon because they expected its share price to moonshot higher. Rather, with Treasury yields so low, Buffett was likely looking for a way to generate inflation-topping interest income. Verizon is one of the least-volatile megacap stocks, and it's currently paying out a hearty 4.3% annual yield.
Beyond its income potential, Verizon does offer two organic growth catalysts. First, there's the rollout of 5G infrastructure upgrades. It's been a decade since businesses and consumers benefited from an upgrade to wireless download speeds. Verizon will be spending big to make these infrastructure improvements a reality, but should be handsomely rewarded for its efforts. Since data is a high-margin driver for its wireless segment, Verizon could see a multiyear uptick in topline growth as enterprises and consumers trade their devices in for ones capable of 5G download speeds.
The other catalyst looks to be the company's fixed broadband services. The company added 102,000 net Fios internet customers during the first quarter, which marked its best Q1 for net Fios additions in six years. Internet service might not seem all that exciting, but it can provide substantial cash flow.
Teva Pharmaceutical Industries
However, one of the worst-performing stocks in recent memory in Buffett's investment portfolio is brand-name and generic-drug developer Teva Pharmaceutical Industries (TEVA 7.29%).
Since Berkshire Hathaway's annual shareholder letter only breaks down the cost basis for the company's 15-largest holdings, we don't know the exact cost basis for Teva. But we do know that Berkshire's initial buy and subsequent addition to Teva occurred in Q4 2017 and Q1 2018. Its share price then was noticeably higher than it is now. Take note that Teva was almost certainly a stock added by one of Buffett's investment lieutenants, Todd Combs or Ted Weschler, and not the Oracle of Omaha himself.
It's no secret that Teva has faced a slew of issues. It's contending with a mountain of litigation concerning its role in the opioid crisis, and is facing allegations of generic-drug price-fixing. It also grossly overpaid for generic-drug producer Actavis and has been dealing with high levels of debt ever since.
Nevertheless, Teva offers an intriguing turnaround story for those who are patient. Since turnaround specialist CEO Kare Schultz took over in late 2017, Teva has slashed its net debt levels by more than $10 billion. By the end of 2023, Schultz could oversee a net debt reduction from over $34 billion to about $15 billion. Schultz has reduced annual operating expenses by around $3 billion, sold off a handful of non-core assets, and looks to use operating cash flow to chip away at the company's debt.
The real catalyst here -- aside from a microscopic forward price-to-earnings ratio of 4 -- might just be Schultz's success in brokering a settlement with regulators. Teva can ill afford to pay huge cash fines. If the company can come to agreement with regulators whereby it provides discounted or free generics, Teva's gray cloud could potential lift overnight.