Investors can learn some valuable lessons from Warren Buffett. The so-called Oracle of Omaha has built a legendary career of sustained success by focusing on companies with strong fundamentals and reasonable valuations. These two stocks are among the best buys in the portfolio of his holding company, Berkshire Hathaway.
Coca Cola continues to succeed
Coca-Cola (KO 0.68%) is one of the most reliable consumer staples stocks. It maintains a portfolio of more than 200 brands that are sold in nearly every country around the globe. Coke itself is consistently ranked among the strongest brands in the world, and the company complements its flagship soda products with a range of coffee, tea, water, sports drinks, juices, dairy products, and alcoholic beverages.
The company's brand strength, scale, and diversity create a wide economic moat protecting it from challengers. The company's competitive position could change as consumer tastes evolve, but it's nearly impossible for such a shift to happen quickly. People all over the world would need to completely change consumption patterns across numerous beverages simultaneously. That's not realistic, so Coca-Cola is likely to continue generating strong cash flow for the foreseeable future.
The company is in a great position to slowly and steadily build. Analysts only expect it to average low-single-digit growth annually, but it's also resistant to economic cycles and competitive pressures so they estimates seem reliable.
Those dynamics have been clear over the past few decades, during which Coca-Cola slowly expanded while delivering reliable profits. That historical performance doesn't guarantee anything about the future, but the same catalysts are still at play.
KO free cash flow data by YCharts.
The reliability allows Coca-Cola to return cash to shareholders. The stock currently pays a nearly 3% dividend yield. Its payout ratio is under 80%, so the business is generating enough profit to sustain and grow its dividend. That should allow Coca-Cola to maintain its Dividend King status, extending its 61-year streak of dividend growth.
Visa has a winning business model
Visa (V -0.48%) operates the world's largest payments transfer network. The company holds more than 40% global market share, and its annual revenue is expected to exceed $30 billion this year.
Buffett was drawn to Visa's wide economic moat and exceptional ability to generate cash flow. The company's operational results are dependent on cyclical consumer spending trends, but its free cash flow has marched steadily upward over the years.
It has also delivered consistently high return on invested capital (ROIC), which has trended upward over time. This indicates that the company maintains an efficient operating model, with management exhibiting fantastic capital stewardship.
V free cash flow data by YCharts.
Visa's economic moat is supported by its enormous scale, brand recognition among consumers and vendors, and entrenched relationships with financial institutions. It's not easy to build a payments network, because it requires acceptance by all parties -- there's not much use for a credit card that isn't accepted as payment anywhere. That's why there are only a small number of major payment processors, and Visa holds a major advantage over its primary rivals.
Visa doesn't necessarily come to mind for most people when they think about fintech stocks, but a digital payment-processing network is absolutely financial technology -- even if the service has been around for decades.
Financial services have experienced significant disruption in recent years, with automation and the blockchain promising to improve efficiency and reduce the costs. This could represent a threat to Visa, but it has wisely positioned itself as an innovator that's willing to evolve. If Visa is committed to updating its own technology and capabilities, then it can use its enormous scale and massive budget to answer competitive pressures.
The most glaring issue with Visa stock is its valuation. The company's forward price-to-earnings (P/E) ratio is nearly 30, which is significantly higher than most of its peers. Its 0.77% dividend yield is also lower than some of its direct competitors. Wall Street forecasts indicate that Visa is likely to grow in the 10% to 15% range on average for the next few years, which would justify the valuation premium.
But that creates downside risk if the company falls short of expectations due to macroeconomic factors or a shifting competitive landscape. Visa's investment narrative is still a strong one, but investors should be aware of the risk associated with the stock.
