Over his legendary career as CEO of Berkshire Hathaway, Warren Buffett has favored investing in strong brands that can remain strong for many years. He's content to hold the shares regardless of how the stock performs in the near term because he knows over a long period of time, a stock's return tends to mirror a company's return on invested capital (ROIC) -- an alternate measure of return on equity. These are useful metrics in determining how well a company can turn capital employed into profits over the long term.
Kraft Heinz (KHC 0.21%) and Apple (AAPL 0.40%) are two of Buffett's top equity investments at Berkshire. Whether you are looking for dividend income or capital appreciation, both stocks have something to offer.
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Kraft Heinz
Berkshire Hathaway acquired a 27% stake in Kraft Heinz in 2015 through the merger of Kraft Foods and H.J. Heinz. Before the merger, Berkshire owned about 53% of Heinz through a partnership with 3G Capital whose co-founder Jorge Paulo Lemann has been a longtime friend of Buffett. As of March 2021, 3G Capital and Berkshire Hathaway owned a combined 44% of the company.
The investment in Kraft Heinz hasn't worked out yet. Over the last five years, the food giant has dealt with a Securities and Exchange Commission (SEC) investigation into accounting practices, a high debt burden, and weak revenue growth. The stock is down 59% over that time, significantly underperforming the broader market. But through all that, Buffett hasn't sold Berkshire's shares, and there are a few reasons for his extreme patience.
Above all, Buffett is in partnership with people with whom he likes doing business -- the managers at 3G Capital. Second, Kraft Heinz is producing a lot of free cash flow relative to its tangible equity employed in the business. Last year, the company generated $4.5 billion in free cash flow on just $5.9 billion in tangible equity. Kraft Heinz is a highly profitable business that reflects the advantage it has with top brands, including Oscar Meyer, Philadelphia, Velveeta, to go alongside the famous ketchup brand.
Additionally, Kraft Heinz has strengthened its financial position. Total long-term debt has declined from over $30 billion in 2018 to $22 billion, which is saving the company interest expense that it can redirect toward dividend payments.
The company paid out 44% of its free cash flow in dividends last year, bringing the quarterly dividend payment to $0.40. That brings the dividend yield to an attractive 4.27%.
What's more, the whole company sells for just over 10 times free cash flow, which could be a steal. If investors can remain as patient as Buffett -- and why shouldn't we? -- this value stock could be a rewarding investment.
Apple
Sticking with the theme of doing business with people you trust, Buffett has called Apple CEO Tim Cook "one of the best managers in the world." Buffett has evaluated quite a few CEOs over the years, so it pays to listen to the Oracle of Omaha.
The iPhone maker may not be introducing as many breakthrough new products as it did under Steve Jobs, but under Tim Cook, Apple has performed brilliantly for shareholders. Revenue and free cash flow have more than doubled over the last 10 years, and the stock price has returned a market-thumping 654%.
Buffett originally invested $36 billion in the stock between 2016 and 2018. He sold a small portion of those shares over the last few years, but Berkshire is currently one of Apple's largest shareholders, owning 5.6% of the shares outstanding.
Apple checks all the boxes that attracted Buffett to Kraft Heinz. It is an iconic brand with an installed base of over 1.8 billion devices around the world. What's more, the installed base could reach 2 billion, depending on the sales of the new iPhone SE.
Moreover, Apple is extremely efficient at converting capital employed in the business into profits, earning a return on invested capital of 54%, and that metric has steadily improved under Cook.
Even though the stock trades at a higher price-to-free cash flow multiple of 26, the business has been more consistent in delivering revenue growth than Kraft Heinz. Most importantly, higher-margin revenue from services (Apple Music, Apple TV+, apps, etc.) is continuing to grow at double-digit rates. The spending on ancillary services and apps reflects a tight ecosystem of hardware and software that customers enjoy using, which is likely the key factor that gives Buffett a high degree of confidence that Apple's brand will remain great for many years.
Which stock is right for you?
Kraft Heinz may or may not turn itself around, but because of its high yield and low valuation, there is the potential for a high return over the next five years if the business improves its revenue growth.
As for Apple, it's a product that people always keep on their desk or in their pocket. For that reason, it might have one of the strongest competitive advantages of any company in the world. Apple pays a smaller dividend yield, so investors looking for income may want to go with Kraft Heinz. But if you're more interested in total returns, Apple is a top growth stock to consider in 2022.
