Warren Buffett studied under Benjamin Graham, the father of value investing. Even though he’s not as much a purist as he was in the past, Buffett remains a value investor at heart.
It’s not surprising, therefore, that his Berkshire Hathaway portfolio includes quite a few stocks with attractive valuations. But one of them stands out more than any. Meet the most ridiculously cheap stock in Buffett’s Berkshire Hathaway portfolio.
The cheapest of the cheap
Dialysis provider DaVita (NYSE: DVA) is the cheapest of the cheap among Buffett’s stocks on one key valuation metric. Its price-to-earnings-to-growth (PEG) ratio is only 0.45.
To be sure, Buffett owns other stocks with lower forward price-to-earnings ratios than DaVita’s multiple of nearly 12.4x. For example, Ally Financial trades at close to 8.9 times forward earnings. Hewlett Packard is even more inexpensive with its forward P/E of a little over 8x. However, the PEG ratios of these stocks are well above DaVita’s.
There are also a handful of stocks in Berkshire’s portfolio with lower forward P/E multiples than DaVita for which financial technology and data company LSEG, formerly known as Refinitiv, doesn’t currently have PEG values. I excluded those stocks from contention.
Why do I like the PEG ratio so much? It incorporates companies’ growth prospects. LSEG’s PEG ratios factor in five years of projected growth. Granted, analysts’ growth expectations could be way off. However, using the PEG ratio helps weed out stocks that have low valuations based on their near-term growth but are more expensive looking farther into the future.
Behind DaVita’s low valuation
Why is DaVita’s valuation so low? It’s not because the stock has performed poorly. DaVita’s share price has jumped more than 30% over the last 12 months. That’s well above the gains delivered by the S&P 500 during the same period.
It’s not because healthcare stocks, in general, are especially cheap, either. The average forward P/E for the healthcare sector is 19x, not much lower than the forward earnings multiple of nearly 20.8x for the overall S&P 500. (I used forward P/E values for comparison in this case, by the way, because PEGs by sector weren’t available.)
The primary reason behind DaVita’s low PEG ratio is that Wall Street expects strong average earnings growth of more than 18% annually from the company over the next five years. In the U.S., kidney disease is the fastest-growing non-infectious disease. This is driving demand for dialysis services.
But what about the potential for drugs such as Ozempic, Wegovy, Mounjaro, and Zepbound to slow the dialysis growth rate? That could perhaps occur over a long period of time — 15 to 20 years or more. However, DaVita projects a minimal impact on dialysis growth over the next 10 years.
Is DaVita a good stock to buy right now?
I think that many value investors will like DaVita. Even if analysts’ growth projections are overly optimistic, the stock does appear to be trading at a discount. Income investors will have to look elsewhere, though. DaVita doesn’t currently offer a dividend.
Some growth investors might be tempted to scoop up shares of DaVita. The overall trends related to kidney dialysis over the next decade seem to be favorable. My view, however, is that there are plenty of other stocks that offer even more compelling growth prospects.
Buffett seems to agree. He’s bought several stocks in recent years, but the last time he added to Berkshire’s stake in DaVita was way back in 2014.
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Ally is an advertising partner of The Ascent, a Motley Fool company. Keith Speights has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway and HP. The Motley Fool has a disclosure policy.
Meet the Most Ridiculously Cheap Stock in Warren Buffett’s Berkshire Hathaway Portfolio was originally published by The Motley Fool
Source: finance.yahoo.com