A Trio of Buffett Buys for Income and Value

07/06/2020 5:00 am EST

Focus: STRATEGIES

Bob Ciura

Contributing Editor, Sure Dividend

In the search for high-quality dividend stocks, investors might take their cues from legendary value investor Warren Buffett; his stocks have a number of similar qualities, including reasonable valuations, competitive advantages, and attractive dividend yields, editor of Bob Ciura, contributing editor to Sure Dividend.

We believe three stocks in Berkshire Hathaway’s investment portfolio are particularly attractive for value and income investors in a highly uncertain market.

Coca-Cola (KO) is arguably the most recession-resistant stock in Berkshire Hathaway’s entire portfolio. The reason is simple — consumption of food and beverages remains stable during economic downturns. This is how Coca-Cola has managed to increase its dividend each year for over 50 years in a row.

Warren Buffett popularized the term economic “moat” to describe a company that can resist competitive threats, just as a moat protects a castle from invasion. Coca-Cola is a great example of a company with a wide economic moat, as it commands top market share in the beverage industry due to its world-class brand.

Coca-Cola stock trades for a 2020 P/E ratio of 25, and a 2021 P/E ratio of 22 based on prevailing analyst estimates. These are higher-than-average valuation multiples, but premium companies often deserve premium valuation multiples for their relative earnings quality, and dividend safety. With a strong 3.6% dividend yield, and a long history of annual dividend increases, Coca-Cola is a top dividend growth stock.

American Express (AXP) continues to prepare for a recession by cutting costs. It also raised its provisions for loan losses from $810 million to $2.6 billion. American Express would be adversely impacted by a recession, but the company should return to growth once the coronavirus crisis is over. The company generated approximately 10% annual earnings growth over the past decade.

The stock has a reasonable valuation, trading for a price-to-earnings ratio of approximately 13.3x based on 2021 earnings estimates of $7.35 per share. Therefore, assuming the coronavirus crisis does not extend beyond 2020, shareholders buying at the current price could be getting a blue-chip dividend stock at a bargain.

The stock also has a 1.7% dividend yield, which is slightly below the S&P 500 Index average, but American Express makes up for this with steady dividend growth. With a payout ratio of just 23% based on next year’s projected earnings, the dividend appears to be highly secure.

Bank of America (BAC) is the second-largest holding of the portfolio. Net income fell to $4 billion in the first quarter, down from $7.3 billion in the same quarter a year ago, but the company remained highly profitable. The steep decline was mostly due to a $3.8 billion loan loss reserve build, directly related to the coronavirus-induced economic downturn.

However, many other metrics remained strong. Net interest income declined only slightly, from $12.4 billion to $12.1 billion. This was a very resilient performance in a highly difficult environment for banks, characterized not just by the coronavirus, but also by extremely low interest rates. Average deposits and loans both grew by 6% in the first quarter. Bank of America’s loan-to-deposit ratio was 68%, which is still quite low.

Continued growth in loans and deposits, combined with cost efficiency, means Bank of America has performed admirably to start 2020. The stock appears to be undervalued, trading for a 2020 P/E ratio of 16.5 and a 2021 P/E ratio of 11. With a nearly 3% dividend yield, the stock offers value and income.

Overall, Coca-Cola, American Express, and Bank of America are three high-quality dividend stocks that are a major part of Berkshire Hathaway’s investment portfolio. These three stocks should remain profitable and continue to pay their dividends even with the U.S. economy in recession, thanks to their competitive advantages and wide economic moats.

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