Investing in 2022 has been a challenge in every sense of the word. The three major US stock market indices – the Dow Jones Industrial Average, S&P500and Nasdaq Compound – have fallen into a bear market, with maximum losses ranging from 22% to 38% since hitting their respective highs. There was also no solace in the bond market, with bonds producing their worst annual return already!
However, the Oracle of Omaha has been through some tough times before.
Since becoming CEO of the conglomerate Berkshire Hathaway (BRK.A 3.20%) (BRK.B 3.36%) in 1965, Warren Buffett oversaw his fair share of economic downturns, recessions, stock market corrections, crashes and bear markets. Although each event represented a short-term struggle, Buffett’s company emerged stronger each time. In 57 years, Warren Buffett has led his company’s Class A shares (BRK.A) to a torrid average annual return of 20.1%.
The Oracle of Omaha’s ability to significantly outperform the long-term performance of the S&P 500 is the result of many factors, including its unwavering determination to stick with its investments for long periods of time, its love of cyclical stocks and the fact that Berkshire Hathaway’s portfolio is full of dividend-paying stocks. Buffett’s affinity for investing in highly profitable and proven companies has helped his company and its shareholders through periods of instability.
But not all Warren Buffett actions are created equal — at least in the eyes of Wall Street analysts.
At this time last week, Berkshire Hathaway had nearly four dozen stocks in its investment portfolio. Two of those holdings have been tagged with aggressive price targets by Wall Street that suggest they could rise in value by 95% and 157%, respectively, over the next 12 months.
General Motors: implicit increase of 157%
If there’s one price target on Wall Street on a Warren Buffett stock that’s sure to leave investors stunned, it has to be the sky-high $90 price target that analyst John Murphy of Bank of America Set of car manufacturer titles General Engines (GM 1.81%). Should this price target materialize, GM shareholders would enjoy a 157% gain from where the company’s stock ended last week.
Murphy’s price target for General Motors, which was actually lowered from $5 to $95 in September, is supported by the belief that GM will become a global leader in electric vehicles (EVs). While Murphy acknowledges that supply chain issues are likely to hamper U.S. auto inventory production through 2023, he also expects the demand cycle for U.S. autos to miss its peak. peak before 2028.
For its part, General Motors is investing heavily in the development of electric and autonomous vehicles, as well as in battery research. The company has earmarked a total of $35 billion through the middle of the decade, which is intended to cover a number of bases.
By the end of 2025, CEO Mary Barra expects her company to produce more than one million electric vehicles per year in North America (a significant percentage of these electric vehicles will be high-margin trucks) and launched a total of 30 new electric vehicles globally. By the end of next year, GM is expected to have two facilities dedicated to battery production.
The initial request was intriguing, though it’s important to remember that electric vehicles represent a small portion of GM’s revenue, for now. For example, the Chevy Silverado EV was introduced by Barra earlier this year. Through the end of July, the company has secured over 150,000 reservations for the 2024 model.
The economics of transitioning to an EV-driven future are also compelling. As the company ramps up production of electric vehicles and batteries, margins in this “new” segment are expected to exceed 20% and GM’s total margin, including internal combustion engine vehicles , rises 200 basis points to 14% by 2030. Based on revenue, General Motors may double sales by the turn of the decade.
Historically, auto stocks have received little premium from investors, due to their strong cyclical ties and often overleveraged balance sheets. But with GM’s long-awaited organic catalyst finally here, Murphy’s $90 price target seems tenable this decade, but not over the next 12 months.
Amazon: 95% implied benefit
The other Warren Buffett stock that commands a high price target on Wall Street is none other than the FAANG stock. Amazon (AMZN -6.80%). Tigress Financial analyst Ivan Feinseth set a price target of $4,655 for the company earlier this year. But following its 20-to-1 futures stock split, Feinseth’s adjusted price target of $232.75 implies a roughly 95% upside from its close last week.
If you’re wondering why Feinseth thinks Amazon can add more than $1.1 trillion in market value over the next year, look no further than its key growth drivers.
Believe it or not, the company’s dominant online marketplace is not among these engines of growth. Even though online sales represent the majority of Amazon’s revenue, online retail sales produce very thin margins. In theory, the company’s online market could stagnate for years, but Amazon’s operating cash flow could double every two to four years, thanks to the rapid growth of its ancillary operating segments.
One growth engine highlighted by Feinseth is Amazon Prime. By April 2021, the company had surpassed 200 million Prime subscribers worldwide. However, that number is likely much higher now, especially with Amazon holding the exclusive rights to Thursday night football. Subscription revenue tends to be recurring and generates much higher margins than online retail sales.
The other central enabler cited by Feinseth is Amazon Web Services (AWS). Research firm Canalys estimates that AWS generated 31% of global cloud services spend during the second quarter. With the exception of Microsoft Azure, no other cloud infrastructure service provider is within 23 percentage points of AWS.
The beauty of cloud computing is that it is still in its infancy. Thanks to the juicy margins associated with cloud services, AWS regularly accounts for more than half of Amazon’s operating profit, despite generating only a sixth of the company’s net sales.
Perhaps the toughest challenge for Amazon will be convincing investors that it’s a good deal in a bear market. It is not uncommon for Wall Street and investors to avoid companies trading at a higher valuation when stocks fall. From a traditional fundamental standpoint, Amazon is not cheap.
However, valuing Amazon with traditional metrics has never worked well. Since the company tends to reinvest most/all of its operating cash flow, it makes more sense to look at its valuation versus its cash flow. After spending the 2010s at a median year-end multiple of 30 times cash flow, Amazon shares can now be bought for around nine times Wall Street’s projected cash flow in 2025. That’s a good deal.
As with GM, Amazon’s high price is feasible. Don’t expect that to happen in the next 12 months.
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