On Wall Street, Berkshire Hathaway (BRK.A) (BRK.B) CEO Warren Buffett is truly in a class of his own. Since ascending to the lead role in 1965, he’s overseen an aggregate return of 4,302,180% for his company’s Class A shares (BRK.A), as of the closing bell on July 26. Berkshire’s stock has also doubled up the benchmark S&P 500, on an annualized total return basis, including dividends, since Buffett became CEO (19.8% vs. 9.9%, through the end of 2022).
Mirroring the Oracle of Omaha’s buying and selling activity has been a popular, and often profitable, strategy for decades.
However, not all Warren Buffett stocks are created equally. Among the roughly 50 holdings currently overseen in Berkshire Hathaway’s $382 billion portfolio, two stand out as screaming buys in August, while another ultra-popular holding would be best avoided.
Warren Buffett stock No. 1 that’s a screaming buy in August: Amazon
The first Buffett stock that looks like a scorching-hot buy in the month of August is e-commerce company Amazon (AMZN).
Perhaps the biggest headwind Amazon is facing is a slowdown in retail spending. Since Amazon generates a significant percentage of its revenue from its online marketplace, there’s the belief that slowing or declining e-commerce sales will hurt the company’s key performance metrics. However, this couldn’t be further from the truth.
While it’s absolutely true that Amazon is the dominant player in e-commerce — eMarketer forecast Amazon would account for 39.5% of all U.S. online retail sales in 2022 — the operating margin associated with online retail sales is rather low. In other words, e-commerce brings in a lot of revenue for Amazon and generates a lot of interest in the company, but it’s not lining the company’s pockets with much in the way of cash flow. What’s far more important for Amazon is that its three ancillary segments are firing on all cylinders (and hint, hint… they are!).
The most important operating segment for Amazon is, arguably, Amazon Web Services (AWS). Based on estimates from tech analysis company Canalys, AWS gobbled up a 32% share of global cloud infrastructure service spending in the March-ended quarter. Not only is enterprise cloud spending still in its early innings, but cloud-based margins run circles around the razor-thin margins associated with online retail sales. AWS accounts for around a sixth of Amazon’s net sales, but is responsible for the lion’s share of its operating income.
The second segment of importance is advertising services, which has grown by no less than 21% on a currency-neutral year-over-year basis since the fourth quarter of 2021. Amazon consistently attracts north of 2 billion web visits each month, making it a popular site for businesses to put their ad dollars to work.
The third ancillary segment of importance is subscription services. Amazon topped 200 million worldwide Prime subscribers in April 2021, and has likely added to this total since securing the exclusive rights to Thursday Night Football.
All three of these segments are growing currency-neutral year-over-year sales by a double-digit percentage. This should provide a hearty lift to Amazon’s operating cash flow, regardless of how well or poorly the online marketplace performs.
Between 2022 and 2026, Amazon looks to be on track to more than triple its cash flow per share ($4.59/share reported in 2022 vs. $13.88/share estimated in 2026). This means it’s cheaper now, relative to its future cash flow, than it’s ever been as a publicly traded company.
Warren Buffett stock No. 2 that’s a screaming buy in August: Bank of America
The other Warren Buffett stock that stands out as a screaming buy in August is none other than Berkshire Hathaway’s second-largest holding by market cap, Bank of America (BAC), which is commonly known as “BofA.”
Bank stocks big and small have dealt with two tangible concerns this year. The first has been persistent recessionary fears. A multitude of predictive tools and economic datapoints point to a weakening U.S. economy in the second half of this year. Since banks are highly cyclical, the expectation would be for higher loan losses and credit delinquencies to weigh on their bottom line.
The other worry for banks is the short-lived regional banking crisis that saw SVB Financial‘s Silicon Valley Bank, Signature Bank, and First Republic Bank, all get seized by regulators. Even though it’s been three months since the last bank failure, there’s still some hesitation from Wall Street and investors to give the industry a clean bill of health.
But whereas regional bank balance sheets have been put through the ringer, Bank of America is well-capitalized and in a better position than it’s been in a long time.
Perhaps the top reason to buy Bank of America right now is the company’s interest rate sensitivity. With the Federal Reserve raising interest rates at the steepest pace in four decades, banks are generating more net-interest income from their variable-rate loans. It just so happens that BofA is the most interest-sensitive of the money-center banks in the United States. It’s bringing in billions in added net-interest income each quarter thanks to the hawkish central bank.
Bank of America’s steady investments in digitization are paying off, too. Though it’s not exactly the first bank you think of when it comes to technological advancements, an impressive 74% of households have adopted digital banking. Online and mobile transactions/loans are substantially cheaper for banks than in-person interactions. As a result, BofA’s operating efficiency has been improving over time.
Best of all, bank stocks are winning a numbers game that Warren Buffett loves to play. Despite economic downturns being perfectly normal, the Oracle of Omaha understands that most recessions are short-lived. By comparison, economic expansions often last for years. This means Bank of America disproportionately benefits from periods of expansion.
Bank of America looks like an amazing deal at less than 10 times Wall Street’s forecast earnings per share in 2023.
The Warren Buffett stock to avoid in August: Snowflake
However, not all Warren Buffett stocks are worth buying in August. Among the roughly 50 securities held in Berkshire Hathaway’s portfolio, cloud data-warehousing company Snowflake (SNOW) tops the list of those to avoid.
Let me make clear that Snowflake isn’t a bad company or a broken operating model. In fact, the company offers its shareholders a couple of well-defined competitive advantages that have helped push its market cap to a hearty $55 billion.
For example, Snowflake breaks down the hurdles often associated with sharing data across competing cloud infrastructure service platforms. Since the company’s infrastructure is built atop the most-popular cloud infrastructure services, members can share and move data seamlessly.
Additionally, Snowflake’s pricing strategy is clearly resonating with its customers. Instead of following in the footsteps of other cloud platforms and requiring subscriptions, it charges based on data stored and Snowflake Compute Credits used. This exceptionally transparent pricing strategy is saving businesses money and encouraging them to stick around. Snowflake’s fiscal first quarter (ended April 30, 2023) net revenue retention rate of 151% shows that existing clients spent 51% more with the company on a year-over-year basis.
The problem with Snowflake is twofold: slowing growth and its otherworldly valuation.
Last week, Microsoft (MSFT) reported another relatively stellar quarter of growth. The one “blemish” was that sales growth for cloud infrastructure service Azure slowed to 27% on a constant-currency basis from the previous year. Azure’s currency-neutral sales growth was 31% in the sequential quarter and 46% in the comparable quarter last year. If Azure’s growth is slowing down, it’s very likely we’ll see Snowflake’s topline growth follow suit.
To build on this point, Snowflake’s annual sales growth has slowed from 106% in fiscal 2022 and 70% in fiscal 2023, to an estimated 34% in fiscal 2024, according to consensus estimates from Wall Street and guidance from the company.
The other issue is Snowflake’s valuation amid the slowdown in the company’s growth rate. Although it’s profitable on an adjusted basis, Snowflake might be the priciest cloud stock at more than 100 times Wall Street’s forecast cash-flow-per-share. While the company’s competitive edges have earned it a premium, a price-to-earnings multiple of 279 in fiscal 2024, based on Wall Street’s consensus estimate, makes little sense in such an uncertain economic environment.
— Sean Williams
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Source: The Motley Fool