2014 has been another busy year for Warren Buffett. The Founder and CEO of Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) added stakes in several big name stocks, including General Motors, Verizon, and Wal-Mart, and made waves last month when he acquired Duracell from Procter & Gamble, unloading his stake in the consumer goods giant in a canny deal that saved Berkshire over $1 billion in taxes.
Despite lackluster performances by two of Buffett's favorite stocks, IBM and Coca-Cola, Berkshire shares have returned 28% this year, giving the company a market cap north of $360 billion.
Buffett's investing strategy is no secret. The Oracle of Omaha looks for companies with strong brands, economic moats (i.e. competitive advantages), stable and predictable cash flows, and an understandable business model. Coca-Cola and Heinz, companies that have been leaders in their respective categories for generations, are typical Buffett investments. He also avoids companies with businesses models he doesn't understand, often in technology.
With that in mind, let's take a look at three stocks that could make great additions to Buffett's portfolio.
1. Google (GOOG 0.69%)
Buffett has spent his career avoiding technology stocks as he claims he does not understand how they make money and does not believe they are sufficiently sustainable since the industry is so changeable. However, he broke that rule in 2011, when he bought over $10 billion of IBM stock, arguing that management had an impressive track record of setting goals and knocking them down, and that its aggressive share buyback program would ensure a return on his investment. So far, the wisdom of that decision has been dubious as IBM has been essentially flat while the S&P 500 has gained over 50%.
Buffett's decision to invest in tech, however, was long overdue as tech has become the stock market's most valuable sector in the age of the Internet. Together, Apple, Google, and Microsoft alone have a market value of nearly $1.5 trillion. Buffett's mistake wasn't investing in tech, but rather it was choosing IBM when he should have bet on Google, valuing old-school brand recognition versus new-school monopoly.
More than any tech company, Google would seem to offer what Buffett is looking for. Its economic moat is so big that often the company's only true threat is itself as it has run into antitrust concerns with regulators on several occasions. Its products are so widely adopted that competitors (Bing, Yahoo, Hotmail, etc.) are roundly mocked. Google is the Internet's utility company, and its search algorithm is the modern-day equivalent of Coca-Cola's secret recipe. With its irons in many fires, Google may seem like a difficult company to understand, but the business model is almost exclusively dependent on search, which is a simple advertising business at its core. The company's huge profit margins and expected growth rate, both near 20%, are further evidence of its dominance.
2. Nike (NKE +0.68%)
Warren Buffett is no stranger to the apparel business. In 2002, Berkshire plunked down $835 million for Fruit of the Loom, which in addition to being a leading underwear brand, owns subsidiaries including women's brands Vanity Fair, Curvation, and Best Form. In 2006, Buffett also purchased sports apparel company Russell Atheltic, which owns Brooks, one of the nation's biggest running-shoe brands, and Berkshire also owns Spalding, the maker of sports equipment.
Given that history, Nike figures to fit right into Warren's wheelhouse. The sports apparel and equipment maker has been the leading brand in its industry for a generation, since Michael Jordan came to prominence. The company has proven itself to be a master of both marketing -- its Air Jordan sneakers are among the most coveted products on the secondary market -- and product, with recent innovations such as the Fuelband and Flyknit. And that success has paid off handsomely for investors as the stock has jumped 2,000% in the last 20 years.
Though its brand is popular around the world, Nike may not have the economic moat that Google does, considering upstarts such as Under Armour, which could pose a legitimate threat down the road. Still, Under Armour's sales are not even 10% of Nike's, and Nike's growth has hardly slowed despite Under Armour's insurgence as sales grew 15% in its most recent quarter. If anything, the rise of Under Armour and companies like lululemon are a testament to the growth of the industry as a whole, growing the pie for everyone rather than fighting over market share. In fact, athletic apparel seems to be stealing share from other casualwear as jeans sales fell 6% domestically last year. Finally, with its bold plan to reach $36 billion in revenue by 2017, investors can be assured that Nike won't take its eye off the ball over the next few years.
3. Starbucks (SBUX 0.33%)
Like apparel, fast food is also one of Buffett's favorite industries. In 1997, Berkshire purchased Dairy Queen for $585 million. The conglomerate also previously owned shares of McDonald's, and earlier this year took a preferred equity stake for $3 billion in Burger King to fuel its acquisition of Tim Horton.
Though Starbucks may like to think of itself as of a different class than Burger King and its ilk, the business model is the same, just with coffee instead of burgers. Starbucks has come to dominate the global coffee market, and its brand strength has not only allowed it to open over 21,000 outlets around the world, but also branch out into packaged goods, a higher-margin opportunity for the company. With over $2 billion in profits, Starbucks trounces the #2 coffee slinger, Dunkin' Brands, which brings in less than $150 million on the bottom line annually, and like Nike, the company just announced an ambitious plan for the future, which aims to nearly double revenue to $30 billion by 2019. That would make it the largest restaurant business in the world, surpassing McDonald's. To make it happen, Starbucks will introduce Mobile Order & Pay and delivery, expand and enhance its food offerings, and double its store count in China, among other initiatives. For an investor like Buffett, Starbucks would seem to be this generation's McDonald's -- a giant, hugely profitable restaurant chain with growth rates that indicate it's still far from maturity.
So will he buy any of them?
In short, probably not. Buffett is a value investor above all else. He'll only pounce if the price is right, and all three of these stocks carry weighty multiples, with P/E's near 30. Buffett also tends to favor older companies with long-standing reputations -- part of the reason he chose IBM -- and Nike is the oldest of the three, at 50.
That doesn't mean individual investors shouldn't take a piece though. All three of these companies are industry leaders with strong growth opportunities, a rare combination. I'd expect all three to continue to outperform the market over the long-run. A dip in the price would make them all the more appealing, but their track record and future growth justify the premium.
