Warren Buffett is among the most popular investors in the world. Also called the Oracle of Omaha, Buffett - the chairman of Berkshire Hathaway (BRK.B) - is best known as a value investor. In the simplest terms, this means he hunts for fundamentally strong stocks trading well below their intrinsic value to benefit from outsized gains when the market sentiment improves.
The ongoing volatility in the equity markets amid a challenging macro backdrop has driven valuations of stocks across sectors significantly lower in recent months, making them attractive to value investors. And when it comes to bank stocks in particular, investors have been pricing in concerns over the Fed's steep interest rate hikes, which could negatively impact demand for loans across verticals.
Moreover, the rising cost of debt is bound to result in higher default rates, especially if the economy enters a recession. So, banks also need to allocate additional capital to account for a surge in delinquency rates, driving earnings lower. A portion of this decline might, however, be offset by higher profits due to higher interest rates.
For investors looking to scoop up some Berkshire-approved financial picks on the cheap in this environment, here are three undervalued stocks that are part of Warren Buffett’s portfolio.
Bank of America
Down 46% from all-time highs, Bank of America (BAC) stock is valued at a market cap of $206 billion.
However, the drawdown in share prices has increased Bank of America’s dividend yield to a healthy 3.47%. These payouts have risen by 19% annually in the last nine years, which is exceptional for a bank stock.
Despite the recent pullback, BAC has more than doubled investors' returns in the last 10 years, after adjusting for dividends. Priced at 7.6x forward earnings, BAC is very cheap, given revenue grew by 11% year over year in Q2 while earnings increased by 19%.
Out of the 19 analysts covering BAC, nine recommend “strong buy,” one recommends “moderate buy,” seven recommend “hold,” one recommends “moderate sell,” and one recommends “strong sell.” The average price target for Bank of America stock is $35.26, indicating an upside potential of 37.5% from current levels.
Ally Financial
Ally Financial (ALLY) is a direct-to-consumer bank that provides traditional banking services such as checking and savings accounts, personal loans, mortgage loans, auto loans, and certificates of deposits.
Shares of Ally Financial are down 53% from record highs, valuing the company at a market cap of $7.5 billion. It currently offers shareholders an annual dividend of $1.20 per share, indicating a yield of 4.83%.
Due to an asset-light model and a lower cost base, Ally Financial enjoys certain advantages over legacy banks. For instance, it can offer higher interest rates on customer deposits compared to its brick-and-mortar peers. It also has strong customer retention rates, allowing it to end Q2 with $159 billion in total assets and customer deposits of $139 billion.
Notably, Ally Financial has significant exposure to the auto loan business. In recent months, vehicle manufacturers are slashing prices on their inventory to boost customer demand, making investors nervous.
Priced at 7.7x forward earnings, Ally Financial stock now trades at a discount of about 24% to Wall Street's consensus price target. Out of the 16 analysts covering Ally Financial, four recommend “strong buy,” one recommends “moderate buy,” nine recommend “hold,” and two recommend “strong sell.”
Capital One Financial
The final Warren Buffett stock on my list is Capital One Financial (COF), which is down 46% from record levels.
In the last 30 days of Q2, Capital One’s delinquencies on credit cards surged to 3.77% from 2.42% in the year-ago period. Comparatively, charge-offs almost tripled from $835 million to $2.2 billion in the period.
Additionally, as per stress test requirements, Capital One has to raise “stress capital” to 4.8% of total assets, up from 3.1%, which will negatively impact profit margins in the near term.
However, Capital One is forecast to increase adjusted earnings from $11.69 per share in 2023 to $13.47 per share in 2024. Priced at 7.9x forward earnings, COF stock trades at a discount of 21% to analysts' consensus price target of $116.31.
Out of the 17 analysts covering Capital One Financial stock, five recommend “strong buy,” one recommends “moderate buy,” nine recommend “hold,” and two recommend “strong sell.”
