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Warren Buffett's Portfolio: Pharmaceutical Companies the Oracle of Omaha Should Love

By Sean Williams - Updated Sep 28, 2018 at 2:38PM

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Healthcare may not be a big ingredient in Warren Buffett's portfolio, but the Oracle of Omaha would be wise to consider these three pharmaceutical companies as potential investments.

When it comes to the world's top investors, perhaps none is more respected and emulated than Berkshire Hathaway (BRK.A -1.32%) (BRK.B -1.63%) CEO Warren Buffett.

Buffett himself began with less than $10,000 more than six decades ago, and has since built Berkshire Hathaway into one of the largest and most successful conglomerates today. Buffett isn't doing too shabby, either, with a net worth of nearly $71 billion, according to Forbes.  

Many different types of pills and capsules, some crushed, laid out in a neat pattern

Image source: Getty Images.

What makes Buffett so unique is that the vast majority of his wealth comes from personal investments and his belief in buying great businesses and holding them over the very long term. By focusing on profitable business models that can stand the test of time, and which often pay dividends, Buffett is counting on relatively steady annual returns that can outpace inflation and pad both his own pocketbook and those of Berkshire Hathaway's investors.

One sector missing from Warren Buffett's portfolio
However, one area that has been generally absent from Warren Buffett's portfolio has been healthcare -- at least relative to other sectors.

The reasoning is that Buffett likes "boring" business concepts that require minimal upkeep. He doesn't have the time or energy to sift through clinical pipeline data to see if a drug met its primary endpoint or not, so he tends to avoid a number of healthcare companies. Among the 47 companies in Berkshire Hathaway's portfolio as of its latest 13-F filing with the Securities and Exchange Commission, just three were healthcare stocks.

But just because Buffett doesn't own more healthcare companies doesn't mean there aren't healthcare companies suited for his company's portfolio.

Within the healthcare sector, the cream of the crop in terms of margins and cash flow are pharmaceutical companies. Often sporting diverse product portfolios and pipelines, brand-name drug developers can sometimes maintain gross margins in excess of 70%, 80%, and in rare cases even 90%. The end result tends to be generous shareholder returns in the form of share buybacks and healthy dividends, which are exactly what the Oracle of Omaha usually seeks.

The way I view it, there are three pharmaceutical companies the Oracle of Omaha should love.

Johnson & Johnson (JNJ -2.84%)
Healthcare conglomerate Johnson & Johnson is one of the three healthcare companies already in Warren Buffett's portfolio, though Buffett owns just 327,100 shares, or 0.01%, of J&J, for a $32.8 million stake as of Friday's closing price. At one time Warren Buffett's company owned 61 million shares of Johnson & Johnson.

What makes J&J so attractive for Buffett are its hedged business operations. Johnson & Johnson, or J&J for short, has a consumer goods division that's generally low growth but generates steady pricing power and cash flow, a medical device segment with long-term growth potential that's in a highly competitive industry, and a high-margin pharmaceutical business that's providing the bulk of its current growth. Because J&J has the ability to fall back on its slower-growth operations for stability and take chances with its higher-growth pharmaceuticals, it has a nice balance that Buffett can appreciate.

J&J also has a strong history of returning money to shareholders. Johnson & Johnson announced its 53rd consecutive dividend increase last month, boosting its quarterly payout 7% to $0.75, which I predicted with a bit of luck a week before it made the announcement. The new projected yield of 3% handily trumps the average yield of the S&P 500.

It's unclear if Buffett will again rebuild Berkshire's position in J&J anytime soon, but it remains a typical Warren Buffett stock regardless.

Pfizer (PFE -2.35%)
I know what you're thinking, and no, I'm not clinically insane. Yes, Pfizer has had its issues with patent exclusivity losses, resulting in its revenue topping out at $67.8 billion in 2010 and and then falling to a projected $45 billion at the midpoint of 2015. However, with Pfizer finally nearing the end of its patent cliff, Warren Buffett could consider dipping his toes into the water here for a five-to-10 year type of hold.

Pfizer has a number of potential blockbusters up its sleeve -- none more exciting than estrogen-positive, HER2-negative metastatic breast cancer drug Ibrance. This drug practically doubled progression-free survival in clinical studies and tacked on a better than four-month increase in median overall survival. It could easily translate into a $3 billion to $5 billion per year drug at its peak. Also, blood-thinning drug Eliquis, which was developed in collaboration with Bristol-Myers Squibb, could deliver billions of dollars when fully ramped up.

Pfizer is overflowing with clinical diversity. Despite dozens of approved products in the U.S. and around the globe, Pfizer had more than seven dozen drugs in clinical development, with another 214 discovery projects under way as of November. That's a broad portfolio that doesn't require an exceptional amount of watchfulness, which Buffett will appreciate.

Best of all, Pfizer isn't shy about returning money to shareholders. Between 2011 and 2014 Pfizer returned nearly $65 billion through share buybacks and dividends to investors. In its recently reported first-quarter results, Pfizer added $6 billion more in buybacks, and $1.8 billion in dividends. This emphasis on rewarding investors while the company enacts a turnaround could eventually sway Buffett to take a position.

Teva Pharmaceutical (TEVA -4.63%)
Lastly, I'd suggest the Oracle of Omaha might fancy a hybrid pharmaceutical company like Teva Pharmaceutical.

Like Pfizer, Teva is facing some serious loss of exclusivity challenges. Mainly, the loss of multiple sclerosis injectable Copaxone this year is going to sting. New formulations of Copaxone will help stem the tide of its declining revenue, but it's only a partial hedge. Thankfully, there are a few tricks up Teva's sleeve.

To begin with, Teva Pharmaceutical only gets about half its revenue from branded drugs -- the remainder comes from generics. Generic drugs do have smaller margins than innovator drugs, but manufacturers like Teva can make up for weaker margins through increased volume.

More importantly, because innovator drugs only have a finite patent life of 20 years, it means generic drug producers have a somewhat limitless supply of new revenue potential on the horizon. Plus investors can feel good about investing in a company that's developing drugs to help lower prescription costs.

On top of a nice mix of branded and generic drugs, Teva has also done a nice job of rewarding shareholders over the long-term. Between 2005 and 2014 Teva boosted its annual payout from $0.22 to $1.37. Although there is no rhyme or reason to its dividend payouts from one quarter to the next, Teva's dividend growth has been among the most impressive in healthcare over the past decade. These are all traits the Oracle of Omaha would like.

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Stocks Mentioned

Pfizer Inc. Stock Quote
Pfizer Inc.
$50.66 (-2.35%) $-1.22
Johnson & Johnson Stock Quote
Johnson & Johnson
$176.94 (-2.84%) $-5.18
Teva Pharmaceutical Industries Limited Stock Quote
Teva Pharmaceutical Industries Limited
$7.83 (-4.63%) $0.38
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$412,170.01 (-1.32%) $-5,529.99
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
$273.86 (-1.63%) $-4.54

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