The period from 2010 to 2021 saw many growth stocks deliver mind-boggling gains, fueled by the availability of cheap capital. However, the landscape changed in 2022 with soaring inflation forcing the Federal Reserve to push up interest rates, which in turn increased the cost of capital. In response to this tough macro environment, investors are now increasingly prioritizing return-on-capital metrics and are shifting to Warren Buffett's time-tested investment strategy of buying high-quality stocks at an attractive price (value investing).
Class A and B shares of Buffett's conglomerate Berkshire Hathaway have gained 24.1% and 22.3%, respectively, in the past year. This is significantly more than the 15% rise recorded by the benchmark S&P 500 index in the same time frame. Given this backdrop, let's assess whether Buffett's top two investments can prove to be good picks now.
Apple
Tech giant Apple (AAPL 0.10%) accounts for 46.7% of Berkshire Hathaway's investment portfolio. This is not surprising considering Buffett and the vice chairman of Berkshire Hathaway, Charlie Munger, have a penchant for picking up stocks with a strong management and competitive advantage.
Apple has managed to cultivate impressive customer loyalty and brand authority for its products (iPhone, iPad, and Mac). That's despite the ongoing contraction in the global smartphone market (which has lasted for two years. According to Counterpoint Research, Apple's iPhone ended the second quarter with a 17% share.
Shipments of the iPhone have proven quite resilient, dropping by only 2% on a year-over-year basis, far lower than the 8% year-over-year drop in global smartphone shipments in the second quarter (due to a longer consumer replacement cycle and increasing demand for refurbished phones).
While smartphone demand in lower and mid-tier segments has suffered, the premium segment has continued to grow. With iPhone firmly placed in the premium segment (smartphones costing $600 or more at wholesale), Apple has remained relatively immune to the headwinds in the broader smartphone market.
Besides launching several generations of the iPhone, Apple has been committed to innovation in other products such as the iPad, Apple Watch, and MacBook.
To further leverage its installed base of over 2 billion active devices, the company has also introduced a range of services such as iCloud storage, Apple Pay, Apple Music, Apple TV+, and the App Store. While these services do not bring high upfront payments (like devices do), they are helping the company build secure and recurring revenue streams with higher margins. This, in turn, is expected to make Apple less vulnerable to consumer slowdowns, while also increasing its bottom line.
As per a Bloomberg report, Apple is also said to be making artificial intelligence tools to compete with OpenAI and Microsoft's ChatGPT, Alphabet's Google, and several others. In case these tools materialize, they will further contribute to the company's top line.
The recent run-up in prices has made Apple's shares pretty expensive. The stock trades at a price-to-earnings ratio of 33, significantly higher than the hardware industry median of 20.6.
However, considering the company's solid long-term growth prospects, its share prices can continue to grow in the coming months. Hence, it makes sense for retail investors to pick up a small position in this stock even at current elevated levels.
Bank of America
The second-largest bank in the U.S. (by total assets), Bank of America (BAC 0.91%) accounts for 8.7% of Berkshire Hathaway's investment portfolio. Despite the regional banking crisis, this Charlotte-based bank managed to surpass both consensus revenue and earnings estimates in the second quarter. In fact, CEO Brian Moynihan considers the second quarter to be one of the strongest quarters in the company's history.
Bank of America reported an $18 billion drop in average deposits since the first quarter. While this may seem daunting, Bank of America's stellar balance sheet has helped build confidence among investors. The bank's common equity Tier 1 ratio (a risk-adjusted measure of financial strength) improved by 110 basis points year over year to 11.6%. The bank also has ample liquidity, as is evident from $867 billion in global liquidity sources.
Thanks to the soaring inflation and subsequent interest rate hikes, Bank of America has seen impressive growth in net interest income (NII). With the Federal Reserve continuing its interest rate hike in July 2023, Bank of America may see even further growth in NII in the coming quarters. The bank also has managed to maintain the credit quality of its consumer and commercial portfolios despite the tough environment -- as is evident from the nearly stable and low percentage of nonperforming loans and leases in the second quarter.
Bank of America has been long known for its solid dividend yield -- currently 2.96%. With that, plus its interest rate-sensitive business model, this banking giant may prove to be an attractive pick in the current macroeconomic environment.
