Kraft Heinz (KHC 3.47%) is one of Berkshire Hathaway's most significant holdings, with a current value of $9.1 billion, representing 3.3% of its equity portfolio. However, with a 67% decline over the last decade, it's not one of Warren Buffett's most successful holdings, and it remains to be seen whether there will be any changes in it when Greg Abel takes over the reins at Berkshire Hathaway.
There's a strong case for avoiding this stock, and looking at it may reveal some useful considerations that value-oriented investors can take away.
A value opportunity in a Warren Buffett stock?
Buy low and sell high is not the only investing strategy in town, but it is the most popular. It might also lead you to buy Kraft Heinz stock, because there's little doubt that the maker of condiments, ready meals, snacks, and other foods seems like a good value on a cursory look.
Here's a summation of how one type of investor might look at matters:
- Kraft's current share price is $28.07, and its expected earnings in 2025 are $2.61 per share, putting it on a forward price-to-earnings ratio (PE) of just 10.5.
- Kraft's current dividend of $1.60 gives it a yield of 5.7%.
- Its book value (assets minus liabilities, or net assets) is $49.3 billion, and with average shares in issue of 1.215 billion in 2024, book value per share is $40.60, implying that its share price of $28.07 represents a substantial discount to its book value.
So Investor A's viewpoint is: This is an attractive consumer staples company with a host of well-known brand names (including Kraft, Heinz, Oscar Mayer, Philadelphia cream cheese, Kool-Aid, Jell-O, et cetera) trading on a very low PE, with a hefty dividend yield. It trades at a marked discount to its net assets, and it's a terrific value stock opportunity.
Introducing Investor B
Alternatively, another investor might see things differently, even by focusing on the same data.
I'll get to the rationale in a moment, but first, here's Investor B's summary: Just by looking at the numbers, there's a high chance that this is a low-growth company with little opportunity to increase its growth rate and, therefore, a doubtful opportunity to increase its dividend. Avoid the stock.
Image source: Getty Images.
How can all of this be deduced simply by looking at the numbers above? I'll explain.
First, let's start with definitions:
- The PE ratio, as above, P/E=10.5.
- The dividend yield, as above, D/P=.057.
- The price-to-book-value (net assets), as above ($28.07/40.6) or P/A=0.69.
Regarding growth, looking at how a company generates earnings (E) from its assets (A) is a good idea. We can work that out with some simple math using the equations above. The key point is that when you buy a low P/E stock with a low price-to-book-value or price-to-net-assets ratio, you get a stock that's not generating a lot of earnings from its assets.
NASDAQ: KHC
Key Data Points
So, for example, as above, earnings (E) are $2.61, and book value (net assets) per share is $40.60, so E/A=2.61/40.6=.064, or 6.4%
This company does not generate a large amount of earnings from its assets, and it will struggle to do so given its payout. The dividend is $1.60, and its earnings are $2.61, implying it only has $1.01 per share left to consider reinvesting in the business. This represents 0.389, or 38.9%, of its earnings, sometimes called the plowback ratio.
Now, if its return on assets is just 6.4%, and it can only plow back 38.9% of its earnings on investing for growth, it follows that its sustainable growth rate of earnings (meaning without financing) is equal to 6.4%*38.9%=2.5%
In other words, Kraft can grow earnings and dividends at a 2.5% annual rate. That's fair enough, but it's not a rate that currently outstrips inflation by much. Moreover, it's hard to see how Kraft can increase its return on assets over the long term; it isn't a technology company with a scalable business model.
In fact, Kraft is a business that needs investment or restructuring. It struggles to grow revenue as consumer preferences change, and profit margins are flat.
KHC Operating Margin (TTM) data by YCharts; TTM = trailing 12 months; YoY = year over year.
A Warren Buffett stock to buy?
Kraft might suit some investors, but you will have to invest assuming that it can maintain its return on assets when finding revenue growth and margin expansion hard to come by. The answer is to do the same with less (finding ways to generate the same income with fewer assets), but until Kraft demonstrates it can do that, the stock won't be attractive to many, let alone folks like Investor B above.
