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The Dow Jones Industrial Average recently eclipsed 25,000 for the first time, and the stock market as a whole is looking rather expensive. Berkshire Hathaway (NYSE:BRK-B)(NYSE:BRK-A) is no exception, with many stocks in the famous portfolio trading at sky-high valuations.
However, there are some exceptions. Here are two stocks from Warren Buffett’s portfolio that are reasonably priced and could do very well in 2018.
|Company (stock symbol)||Recent Stock Price||Sector/Industry|
|Synchrony Financial(NYSE:SYF)||$39.54||Financials — Credit cards|
|Goldman Sachs (NYSE:GS)||$254.61||Financials — Investment banking|
Great margins and growing revenue
Synchrony Financial is one of the more recent additions to Berkshire’s portfolio, first appearing on the company’s second-quarter 2017 13-F filing.
If you’re not familiar with Synchrony, the company is the largest issuer of private-label credit cards in the U.S. and was formerly part of General Electric‘s consumer finance division. If you have a store credit card with Wal-Mart, Lowe’s, T.J. Maxx, or Gap, just to name a few, you are a Synchrony customer.
On the surface, Synchrony may seem like a more risky credit card play than Buffett would like. Store card default rates are rather high, in comparison to traditional credit cards, and Synchrony currently has a net charge-off rate of 4.95%. In other words, roughly 5% of purchases charged on Synchrony’s credit cards don’t get paid back.
However, keep in mind that store credit cards tend to have significantly higher interest rates, which more than makes up for this risk. Synchrony’s loan receivables yield an average of 21.78%, and its net interest income is 16.74% of its interest-earning assets. For context, the average credit card interest rate in the United States is currently around 16%. This means that Synchrony’s net profit margin is more than most credit card companies collect in interest, before charge-offs are taken into account. Furthermore, Synchrony currently holds about 7% of its loan portfolio in loss reserves, so even if the default rate ticks up, the company is well-covered.
In addition, Synchrony’s business is a highly efficient one, with an efficiency ratio of 30.4%. Simply put, this means that Synchrony only spends about $0.30 to generate each dollar of revenue. Compare this with traditional banks, which generally run at efficiency ratios of 60% or more.
Synchrony’s business grew nicely in 2017, and with the Fed expected to continue to raise interest rates several more times over the next couple of years, Synchrony could be a big beneficiary.
The smartest guys on Wall Street
When Warren Buffett first invested in Goldman Sachs in the wake of the financial crisis, he called it a “bet on brains.” And its not too hard to see why — not only does Goldman have a well-deserved reputation for recruiting the best and brightest talent, but the company’s track record of profitability in a variety of market environments speaks for itself.
First, the bad. Goldman Sachs’ trading revenue fell sharply in 2017. Trading revenue was down across the industry, mainly due to the low-volatility environment, but with a 26% year-over-year drop, Goldman’s fell more sharply than most.
Aside from the drop in trading revenue, 2017 was a solid year for Goldman. Net revenue grew by 8% year over year through the first three quarters, and pre-tax margins grew by 230 basis points, the combination of which produced a 26% increase in earnings.
And its also worth pointing out that although trading is a big part of Goldman’s business, the bank’s revenue stream is more diverse than you might think. Equity and fixed-income, currency, and commodity (FICC) trading make up a combined 40% of Goldman’s revenue, and 60% comes from fee-based recurring revenues, such as investment banking and investment management.
Despite the strong 2017 performance, Goldman has lagged the rest of the banking sector and trades for one of the lowest price-to-book valuations of the big U.S. banks. With the recently passed tax reform bill and an administration that favors bank deregulation, now could be a smart time to pick up shares of this investment banking giant.
Matthew Frankel owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Lowe’s, Synchrony Financial, and The TJX Companies. The Motley Fool has a disclosure policy.