Warren Buffett and company Berkshire Hathaway (BRK.A -0.80%)(BRK.B -0.63%) have a long track record of beating broader market indices such as the Dow Jones Industrial Average. Between 1965 and 2020, Berkshire stock has had an average annual return of around 20%, while the Dow has had an average annual return of around 7.75% between 1921 and 2019.
Much of this is due to Buffett and Berkshire’s more than $350 billion stock portfolio. While some actions like Apple and Bank of America make up a huge percentage of the portfolio and are likely the ones that Buffett and Berkshire consider safer, there are other smaller picks in the portfolio that Buffett and Berkshire may deem riskier but also have much more upside potential. Here are three riskier Buffett stocks that can beat the Dow over the long term.
As a shareholder, I was delighted to see Buffett and Berkshire take ownership of shares of Citigroup (VS -1.03%) in the first quarter of this year. The bank has struggled for years to generate the same kind of return as its big bank counterparts, leading many to believe it is a value trap. Citigroup has repeatedly traded below its tangible book value (TBV), or net worth, over the past decade. But it’s the first time Berkshire has bought shares since 2001, according to documents filed by the Securities and Exchange Commission.
In my opinion, it looks like this time may indeed be different with CEO Jane Fraser, who took the reins of the bank about a year ago, planning major strategic changes, including the sale of most banking divisions. international banking, doubling areas of strength, and finally investing what is needed to resolve regulatory issues.
The big risk here is that the transformation could still be a multi-year journey and investors will run out of patience so there is very little room for error and this is a stock that could continue to be a value trap. . But trading just 67% off its TBV, the stock has around 47% upside just to get back to TBV, which wouldn’t even be considered good valuation in today’s banking industry.
Citigroup’s investment banking unit, large US deposit market share, and extremely global presence are some characteristics that would be hard to replicate. The bank also has a dividend yield of around 3.8%, which will compensate investors well while they wait for the transformation plan to materialize.
2. Allied Financial
The big digital bank and car lender Allied Financial (ALLY 0.05%) is another stock that Berkshire picked up earlier this year that has many of the attributes of a classic Buffett stock. Not only is Ally trading at a cheap valuation, but it’s also returning a fair amount of capital to shareholders. Although it generated strong returns in 2021 and guided lower but still impressive returns going forward, Ally only trades at around 116% TBV and 5.6x earnings at term.
Ally faces some big risks. There could be a recession in the near future that would result in consumers not repaying their loans at higher rates than management currently anticipates. There are also concerns about what will happen to used car prices, which have been high, although Ally’s management team expects prices to eventually come down. Higher interest rates could also increase Ally’s deposit costs and reduce margins, although the bank has significantly increased its retail deposit base in recent years.
Still, if Ally can ride out some of these near-term headwinds and still generate good returns, the stock will likely be repriced. Ally is also returning a lot of capital to shareholders and plans to execute a $2 billion share buyback plan this year alone.
3. Nu Holdings
Berkshire has clearly been interested in Latin America’s growing financial sector, and with good reason given the huge potential. Last year, Berkshire invested in the Brazilian challenger bank Nu Holdings (NAKED 9.03%), which has made tremendous strides with its frictionless, low-fee banking experience. Nu has acquired nearly 60 million customers with an industry-leading low customer acquisition cost. Nu currently has 33% of Brazil’s adult population and has provided millions of its customers with their first bank account or credit card. Nu is also growing in Mexico and Colombia.
The risk here is that the Latin American market can be challenging, given high levels of inflation and volatile economic conditions. Additionally, Nu is not yet profitable and will likely face stiff competition. But the company is increasing its earnings significantly and after the huge sell-off in growth stocks this year, investors have the rare opportunity to buy Nu shares at a much cheaper valuation than when Buffett or Berkshire entered. Nu is a leading digital disruptor in one of the fastest growing banking regions in the world.