Under the direction of Warren Buffett and Charlie Munger, Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) has progressed from its roots as a textile manufacturer into the largest investment holdings company in the world. The company's investment portfolio is currently valued at a staggering $349 billion.
Berkshire Hathaway's knack for picking great stocks that perform is precisely why investors should at least consider its investments for their own portfolios. With a 7% stake in Kroger (KR -0.75%) worth $2.3 billion, the grocery retailer is the 16th-largest position within Berkshire's portfolio of approximately four dozen stocks. Clearly, Berkshire and Buffett see something they like about his stock.
Here are three reasons why value investors may want to think about buying Kroger stock for their portfolios.
1. Private-label brands and brand variety drive robust results
Since its founding and first store opening in downtown Cincinnati in 1883, founder Barney Kroger's straightforward motto has guided Kroger to immense success: "Be particular. Never sell anything you would not want yourself."
The company sells fresh food at low prices to customers: It does so through a variety of store banners such as supermarket brands like the eponymous Kroger, Pick 'n Save, and Metro Market, as well as warehouse stores including Food 4 Less and Foods Co. Kroger's approach has allowed it to grow to around 2,800 stores under store brand names like Kroger, Harris Teeter, Fry's, Fred Meyer, and Ralph's, serving more than 11 million customers each day. The company's vast reach makes it a formidable grocery retailer, which is probably one reason why Berkshire Hathaway has probably built up a meaningful position in the company.
Not to mention that Kroger's private label brands (i.e., generic), such as Heritage Farm and Simple Truth, are growing in terms of U.S. consumer spending share, exceeding national brands' growth. This is because, unlike in the past, the packaging and quality of these products are more on par with the likes of national brands. These products are also more profitable than their national brand counterparts, with private-label grocery brands boasting 35% profit margins compared to the national brands average of just 26%. And since these products are estimated to make up one-quarter (and counting) of the company's total sales, this should help the retailer to become more profitable over time. Berkshire Hathaway prefers businesses that grow in profitability because this serves as a litmus test as to their competitive positioning relative to industry peers. Thanks to these factors, Kroger's sales grew by 7.5% to $148.3 billion in the fiscal year 2022 (ended Jan. 28, 2023). The company's non-GAAP (adjusted) diluted earnings per share (EPS) also roared 14.9% higher to $4.23 for the fiscal year.
Looking forward, the future should be just as bright for Kroger. As the retailer opens more locations and its private label brands grow in popularity, analysts expect its adjusted diluted EPS to compound by 8% annually through the next five years. This is in line with the grocery stores industry average annual earnings growth outlook of 8.5%.
2. Kroger has a quickly growing dividend
Compared to the S&P 500 index's 1.6% dividend yield, Kroger's 2.3% yield is certainly enticing to a dividend investor. But with the quarterly dividend per share having more than tripled over the past 10 years, the company also comes with attractive growth prospects.
KR Dividend data by YCharts.
While Berkshire Hathaway doesn't exclusively invest in dividend growth companies, a consistently growing payout does demonstrate that a business is also steadily growing. This is a good sign that also often leads to outperformance versus the broader markets.
And fortunately, it doesn't appear as though Kroger's tremendous dividend growth pace will end anytime soon. That's because the company's dividend payout ratio came in at just 22.2% in its previous fiscal year. Such a manageable dividend obligation leaves Kroger with plenty of capital for future growth opportunities, debt repayment, and share repurchases.
3. Kroger's valuation multiple is low
Kroger's shares have edged 3% higher so far in 2023. But even with this modest gain, the stock looks to be undervalued. Kroger's forward price-to-earnings (P/E) ratio of 10.2 is a tad less than the grocery stores industry average forward P/E ratio of 11. Considering its quality, the stock arguably deserves a higher valuation multiple. By insisting upon not overpaying for ownership in businesses, Berkshire Hathaway and Warren Buffett often protect themselves from downside risk with their investments. Limited downside risk and the potential for future upside in the valuation multiple is why I believe Kroger is a no-brainer buy for dividend growth investors at the current $46 share price.
