The chairman and chief executive officer of Berkshire Hathaway (BRK.A -0.44%) (BRK.B -0.35%), Warren Buffett, is one of the greatest investors around. His company has a compounded average annual gain of 19.8% over the past five-plus decades. Knowing what stocks Buffett and Berkshire are investing in can be worthwhile for those looking to give their portfolio a boost.
Berkshire Hathaway currently holds just over $900 million in stock (roughly 1.7% of shares outstanding) in the medical products distributor McKesson (MCK 0.76%). The company started buying McKesson stock in early 2022 and built up to its current position.
But just because Berkshire bought it, is the stock right for your portfolio? Let's take a closer look at McKesson's business model and fundamentals to see what prompted Berkshire Hathaway to invest.
McKesson has nearly insurmountable competitive advantages
In business, size often matters. Sure, this may not always be the case. Companies can achieve success by differentiating themselves from the competition with an out-of-the-box business model like Floor & Decor, another holding of Berkshire Hathaway.
MCK Profit Margin data by YCharts.
But in the medical distribution industry, there are no exceptions to this rule from my vantage point. And that is arguably what Buffett and company appreciate about McKesson. As the largest player in its industry, the company holds unrivaled bargaining power over its hundreds of thousands of pharmacy and hospital customers throughout the world. That is how McKesson's net profit margin is far superior to the profit margins of its much smaller competitors, AmerisourceBergen and Cardinal Health.
McKesson's profits soared in the fourth quarter
The Irving, Texas-based company reported $68.9 billion in total revenue for the fiscal fourth quarter ended March 31. For context, that represents a 4.2% year-over-year growth rate. The primary driving factor for this top-line growth was a 14.9% growth rate over the year-ago period in the U.S. pharmaceutical segment to $61.7 billion in revenue. This growth was fueled by general growth in the market and higher specialty pharmaceutical product volume (i.e., costlier and higher margin products). But much of this top-line growth in the U.S. pharmaceutical segment was canceled out by a 57.6% decline in currency-neutral international segment revenue to $3.4 billion. That was due to the divestiture of the company's European businesses.
A more focused approach to its business helped McKesson's non-GAAP (adjusted) diluted earnings per share (EPS) to climb 23.3% year over year to $7.19 in the fiscal fourth quarter. The company's net margin expanded by over 10 basis points due to improved operating efficiency, which explains how adjusted diluted EPS grew ahead of revenue during the quarter.
Thanks to McKesson's wide moat and the need for its services, analysts anticipate that the company's adjusted diluted EPS will compound by 11.2% annually over the next five years. Putting that into context, this is slightly better than the medical distribution industry's average annual earnings growth outlook of 10.1%.
McKesson has a payout with double-digit annual growth potential
McKesson's 0.5% dividend yield appears to be quite paltry in comparison to the S&P 500 index's 1.6% yield. But considering that the per-share quarterly dividend has grown by 170% in the past 10 years to $0.54, the stock is less of an income play and more of a growth play.
McKesson should also continue to hand out strong payout boosts in the future. This is because, with the dividend payout ratio coming in at less than 8% in the previous fiscal year, the company has plenty of capital available to grow the dividend while also funding growth opportunities and debt repayment.
McKesson stock is reasonably valued
Even after gaining 24% in the past 12 months, the share prices of McKesson look to be fairly valued. The stock's forward price-to-earnings (P/E) ratio of 13.2 is on par with the medical distribution industry's average forward P/E ratio of 13.3. Put another way, McKesson is an above-average dividend growth stock priced at an average valuation -- an uncommon combination in the investing universe.
