Warren Buffett is known for being an investor who, for decades, has consistently picked stocks that have outperformed the stock market average. Of course, he doesn't beat the market every year. His company Berkshire Hathaway barely lost to the market last year and looks like it will barely lose again this year. But Mr. Buffett's stock picks are still doing quite well.
Because of Buffett's consistent performance, it pays to consider the stocks that Berkshire Hathaway is holding. And after taking a look, I believe Floor & Decor Holdings (FND 5.93%), Amazon (AMZN 1.66%), and StoneCo (STNE 3.54%) are three underrated opportunities today. Here's why.
Image source: Getty Images.
1. Floor & Decor: A new addition to Mr. Buffett's portfolio
Floor & Decor is a home improvement retailer and the newest addition to Berkshire Hathaway's holdings. In Berkshire's most recent filings with the Securities and Exchange Commission (SEC), it showed a $99 million initial investment in Floor & Decor. Considering the entire portfolio is worth over $300 billion, this $99 million investment is relatively small. But it's still a nice vote of confidence from one of the greatest stock pickers ever.
I agree that Floor & Decor stock is a good buy. I'll start my case by stating the obvious: This is a brick-and-mortar retailer. With these businesses, it's important to consider comparable sales -- this metric looks at sales from stores open for at least 13 months and compares them to sales from these same stores one year ago. It's a good barometer for ongoing brand popularity. And Floor & Decor just seems to keep getting more popular considering its comparable sales in 2021 are on pace to go up for the 13th consecutive year.
Strong comparable sales growth suggests Floor & Decor is resonating with consumers and contractors. Consumers seem to appreciate the company's large warehouses that display more flooring options than its competitors. And CEO Tom Taylor is a former Home Depot executive who seems to be using the same playbook to attract repeat business from professional customers.
As sales per location increase, Floor & Decor gains operating leverage and becomes more profitable. Through the first three quarters of 2021, the company had an operating margin of 11%, up from 8.6% in the comparable period of 2020 and moving toward Home Depot's stellar operating margin of 15.8%. It only operates around 150 locations today but is growing quickly on a path to 400. Therefore, this is a profitable concept with room to grow, which is why I believe investors should give it a look.
Image source: Amazon.com.
2. Really? Amazon is underrated?
Yes, it might sound ridiculous to call a $1.7 trillion company underrated, but hear me out with Amazon: Everyone knows what the company has been. But I don't believe investors are on the same page when it comes to its future growth prospects. Let's look at two secular trends that could push Amazon stock to greater highs: e-commerce and cloud computing.
Despite what you might think, e-commerce isn't a played-out trend by a long shot. According to eMarketer, global retail e-commerce sales are projected to hit $7.4 trillion by 2025, up from an estimated $4.9 trillion this year. That's 51% industry growth between now and then. Moreover, even if this eye-popping number is reached, e-commerce sales would still only account for roughly 25% of total retail sales, providing yet further upside opportunity beyond 2025.
Then there's cloud computing, where Amazon Web Services (AWS) was named a leader in Gartner's Magic Quadrant for cloud infrastructure and platform services. According to International Data Corp. (IDC), whole cloud spending is expected to grow at a nearly 17% compound annual growth rate (CAGR) between now and 2025, exceeding $1.3 trillion in spending. Granted, AWS only addresses a portion of the broader cloud market. However, I believe the IDC report points to an ongoing robust growth opportunity for AWS.
Between e-commerce and cloud computing, Amazon's addressable market could expand by trillions of dollars in coming years, and there are few companies as well-positioned to profit from the opportunity. Consider the company's cash flow over the past 12 months. It's only generated free cash flow of $2.5 billion. But that's because it's spent $52 billion on property and equipment, including building new warehouses for e-commerce and new data centers in new regions around the world.
For perspective, $52 billion is the entire market capitalization of Dollar General, a company with nearly 18,000 locations. In other words, Amazon spent a Dollar General-sized amount of money this year and was still free-cash-flow positive. That's hard to outcompete.
Finally, keep in mind that 62% of Amazon's operating income so far in 2021 has come from its AWS segment. But this segment is just 13% of total net sales and only amounts to $44 billion. Considering the growth rate and size of the cloud industry, Amazon's positioning in the space, and the high-margin profile of this revenue stream, it's easy to envision this $1.7 trillion company substantially padding its bottom line in coming years, which is why I say Amazon is underrated.
Image source: Getty Images.
3. StoneCo: down but not out
Finally, I'll say Brazilian financial technology (fintech) company StoneCo is underrated, but it's not exactly thriving like Floor & Decor and Amazon. To be clear, it's struggling. But the market appears to have a worst-case scenario outlook for this company. The reality likely isn't as bad as feared, so I'd say StoneCo stock is underrated. But there are certainly some challenges you should be aware of.
First, the inflation rate in Brazil is over 10% right now, hurting consumers and contributing to the Brazilian real's decline against the U.S. dollar. Besides these macroeconomic problems, StoneCo struggled to adapt to some regulatory changes in Brazil in the second quarter, causing it to temporarily pause new loans, which is a big part of its business. Finally, the company was forced to write down the value of an investment in Banco Inter in the third quarter, leading to a net loss of almost 1.3 billion reais (over $220 million) -- StoneCo's first quarterly loss as a public company.
The decline in profitability in Q2 and the huge loss in Q3 are particularly disappointing for StoneCo investors considering how profitable this company was prior to the pandemic. The company had a net profit margin of 19% and 34% in 2018 and 2019, respectively, even while it was spending on growth. Growth and profitability is a rare combination. Is there reason to think StoneCo can get back to what it was?
While it has work to do, some important StoneCo fundamentals are still trending in the right direction. For example, its base of micro-merchants and small and medium-sized business customers more than doubled year over year in Q3. Average revenue per user is also up in its banking and insurance businesses. Moreover, total payment volume (TPV) for its entire business was up 7.6%. And when adjusting for government stimulus money last year, TPV was up almost 54%.
To summarize, StoneCo is getting more customers, making more money per customer, and processing more transactions than ever before. These factors suggest that the company still has a bright future and may someday return to its previous levels of profitability. If that happens, investors who buy StoneCo stock today are locking in an attractive valuation.
Just one?
I'm a big fan of Floor & Decor's execution up to this point. And StoneCo seems to have a lot of upside opportunities. But if I could buy only one of these three today, Amazon looks like a stock hard to pass up. Not only is there the potential reward that I outlined above, but the company is also low risk, given how important its business is. And given the recent market volatility, a low-risk stock might help calm investors' nerves.
