Pretty much all Warren Buffett has done is win since becoming CEO of Berkshire Hathaway (BRK.A -0.23%) (BRK.B -0.45%) in 1965. Including the 4% gain for Berkshire’s Class A shares (BRK.A) in 2022, the Oracle of Omaha has overseen a greater than 3,700,000% aggregate return for his shareholders since taking the reins.
However, Buffett isn’t infallible. Even the greatest investors in the world are going to be wrong from time to time. With approximately four dozen securities in Berkshire Hathaway’s investment portfolio, some are bound to underperform.
As investors continue to steam ahead into the new year, three Warren Buffett stocks stand out as potential underperformers that can be avoided like the plague.
To be perfectly clear, Buffett and his investment team don’t pile into train wrecks. They tend to buy businesses that offer a long history of profitability and/or present with clear-cut competitive advantages. Cloud data-warehousing company Snowflake (SNOW 1.74%) falls into the latter camp, with easily identifiable competitive edges.
Snowflake built its solutions atop the most popular cloud infrastructure services. While it can be difficult to share data across competing cloud infrastructure platforms without Snowflake, data-sharing is seamless for the company’s customers.
Further, Snowflake has shunned cloud-based subscriptions in favor of a pay-as-you-go model. Customers are charged based on the amount of data stored and Snowflake Compute Credits used. This considerably more transparent payment approach is well liked, as evidenced by Snowflake’s net revenue retention rate of 165% in the October-ended fiscal quarter. This retention rate means existing customers are spending 65% more on a year-over-year basis.
Despite these advantages, I fully expect Snowflake to underperform the broader market in 2023. With the Federal Reserve rapidly raising interest rates to tame historically high inflation, it’s growth-oriented companies that’ll be hit hardest. If the tea leaves are correct and the U.S. falls into a recession at some point this year, new customer generation and net revenue retention rate would both be expected to slow.
The other issue that can’t be ignored is its premium valuation. Despite Snowflake stock losing in the neighborhood of 70% since hitting an all-time high of $405 in November 2021, it’s still, arguably, the most expensive cloud stock relative to sales. Even if the company manages the 46% sales growth Wall Street’s consensus is calling for in fiscal 2024 (which covers a good portion of the 2023 calendar year), it’ll still be valued at more than 13 times the $3 billion in revenue analysts expect.
To add, Snowflake is nowhere close to generating a profit based on generally accepted accounting principles (GAAP). In fact, the company’s GAAP net loss through the first nine months of fiscal 2023 widened to nearly $590 million from $546 million in the comparable period last fiscal year. Value investors aren’t going to want anything to do with Snowflake during a bear market.
The second Buffett stock to avoid like the plague in 2023 may very well be the worst investment in Berkshire Hathaway’s entire portfolio: Kraft Heinz (KHC -0.30%).
On one hand, Kraft Heinz is doling out an inflation-fighting 3.8% yield, and it owns a vast portfolio of well-known and beloved prepackaged food brands. This includes Kraft and Heinz, as well as Oscar Mayer, Ore-Ida, Velveeta, and Jell-O, among others.
Kraft Heinz has also been a clear beneficiary of the COVID-19 pandemic. With consumers choosing to eat at home more often, the company’s prepackaged and easy-to-make meals, snacks, and condiments have received a boost. Through the first nine months of 2022, its organic growth rate clocked in at a blistering 9.5%.
However, there are a number of red flags to suggest that Kraft Heinz is in for a rough year. For instance, even though organic growth surged 9.5% through the first nine months of 2022, it’s been a function of higher price points and not volume. As a whole, price is up 12.3% and volume is down 2.8%. In my view, this leaves the company exposed to substitution bias from consumers with inflation well above average and the U.S. economy weakening. In other words, consumers could start trading down to store/generic brands that don’t cost as much as the brand-name products Kraft Heinz sells.
Perhaps the most glaring problem with Kraft Heinz can be found on its balance sheet. Thanks to acquisitions, the company is sitting on $30.6 billion in goodwill — effectively the premium Kraft Heinz paid above the tangible value of the businesses it’s purchased — and close to $20.1 billion in long-term debt. What Kraft Heinz really needs is cash to reignite interest in its brands. Unfortunately, the company is constrained by its balance sheet.
Normally, a consumer staples company with a forward-year price-to-earnings ratio of 15 would be viewed as a safe-haven investment during a bear market. But with virtually no sales growth on the docket for 2023, and the company’s balance sheet still a mess, it stands out as an easy stock to avoid.
To reiterate, once again, Buffett and his team invest in high-quality businesses. But even top-notch companies can have bad years.
On the plus side, Apple has led with innovation. The company’s iPhone accounts for approximately half of all U.S. smartphone market share. What’s more, Apple’s ongoing shift to subscription services should provide a sustained lift on its operating margin and help to reduce the revenue ebbs and flows associated with physical product replacement cycles.
Apple also has the most impressive capital-return program on the planet. Since the beginning of 2013, Apple has repurchased an almost unfathomable $554 billion worth of its common stock. Not including itself, that’s more than the market cap of all but four other S&P 500 companies.
On the other side of the coin, Apple’s iPhone 14 failed to provide a lot of differentiation from its preceding model. As a result, Apple ramped down plans to boost iPhone production this past September. Since the iPhone is its top-selling product, this bodes poorly for revenue growth over the next couple of quarters.
The other issue for Apple is that rapidly rising interest rates have walled off its access to cheap capital. Even though Apple generates plenty of operating cash flow, it had previously turned to the debt market to raise money for share repurchases. With rates rapidly rising, it wouldn’t be a surprise to see Apple’s share repurchases tail off in 2023.
As I stated earlier this week, Apple trading at a price-to-earnings multiple of 21 for the current year isn’t egregious. But with the company only slated to grow sales by 2% or 3% this year, it simply isn’t a good value. I fully expect Apple stock to fall below $100 this year, which makes it a Buffett stock to avoid.