Personal Finance

Is This the Best Warren Buffett Stock to Buy Now?

Warren Buffett at an investors conference

Warren Buffett's legendary stock-picking approach has turned him into one of the best investors of all time. While there's no telling how long stocks will remain in Berkshire Hathaway 's (NYSE: BRK-A) (NYSE: BRK-B) portfolio, following in the Oracle of Omaha's footsteps can be profit-friendly.

Unfortunately, Berkshire only reports its holdings once per quarter, and it does so weeks after the prior quarter has ended. As a result, it's rare that investors get an opportunity to buy shares at the same price Berkshire Hathaway did. One exception, however, could be Synchrony Financial (NYSE: SYF) . After losing the contract to run Walmart 's (NYSE: WMT) private-label credit card in July, Synchrony Financial's price-to-book level has retreated to levels last seen in the second quarter of 2017, when it first showed up in Berkshire's portfolio. Is this lender worth buying now?

What it does

Synchrony Financial is a consumer credit company that was spun off from General Electric in 2015. It manages private-label credit cards for various retailers, including and until recently, Walmart.

Warren Buffett at an investors conference


The private-label credit card business historically offers more attractive business margins, but it's riskier because applicants tend to have lower credit scores and cardholders tend to fall delinquent more frequently.

Berkshire buys in

Synchrony Financial showed up as a holding in Berkshire Hathaway's portfolio in Q2 2017, following a 30% sell-off in shares caused by the company reporting a larger than expected rate of loan-loss provisions in Q1 2017. Specifically, Synchrony set aside $1.3 billion in provisions that quarter, which was about $400 million more than anticipated. The increase was caused by net charge-offs as a percentage of total loans increasing to 5.33% from 4.74% in the same quarter of 2016.

The challenges resulted in Synchrony's Q1 2017 EPS of $0.61 falling $0.12 shy of what Wall Street's industry watchers were modeling.

After the Q1 results were reported, Synchrony's shares tumbled, and by June 2017, they were trading at about $27, which translated into a price-to-book-value ratio of about 1.5 and a trailing 12-month price-to-earnings ratio of about 10.

SYF PE Ratio (TTM) data by YCharts .

Berkshire hasn't specifically said why it bought Synchrony Financial's shares. However, it's a good bet it concluded that the increase in charge-offs would prove temporary; if so, then the company's discount rack valuation presented an opportunity too good to pass up.

Another opportunity to buy presents itself

Berkshire Hathaway didn't buy or sell any shares of Synchrony Financial in Q2 2018, so it currently owns 20.8 million shares worth $659 million. That's an ant-sized position for Berkshire given that its portfolio is worth over $200 billion, but it's a large enough stake to make Berkshire the sixth-largest institutional owner of Synchrony Financial shares.

There's no telling if Berkshire is interested in buying more shares in Synchrony. But the revelation that Synchrony and Walmart couldn't come to terms on a contract renewal has resulted in another swoon in the lender's share price. As a result, its price-to-book and price-to-earnings ratios have both retreated back to levels similar to where they were when Berkshire bought shares last year.

There's no denying that losing a big retailer like Walmart is a negative to Synchrony's bottom line. However, management told investors during its second-quarter conference call that it thinks it has two options for its legacy Walmart business: It can sell the portfolio, or it can convert accounts to a Synchrony-branded credit card. According to the company, both scenarios replace any lost earnings per share because of losing Walmart. Also, both are accretive to earnings, relative to what would have happened if Synchrony had agreed to renew with Walmart on less-attractive terms.

Selling the portfolio would free up $2.5 billion in capital Synchrony could use for acquisitions, buybacks, and dividends. Furthermore, a sale would result in up to $350 million in cost savings and, because of lower credit quality, up to a 70-basis-point improvement in the company's net charge-off rate, which was 5.97% in Q2.

If management keeps the portfolio, then converting accounts to its own branded card would provide it with more cross-marketing options for its direct-to-consumer business, while also reducing costs. Synchrony plans to decide which path to take no later than Q1 2019.

What to watch next

The Walmart contract expires next summer. Until then, investors will want to keep watch on delinquency rates to see if recent improvements continue. Last year, the company got more selective with approvals; as a result, only 4.17% of receivables were more than 30 days past due in Q2, down from 4.52% in Q1 and 4.25% the year prior. Only 1.98% of receivables were more than 90 days past due, down from 2.28% in Q1, and that was the lowest reading since Q2 2017.

Investors will also want to see how smoothly Synchrony's recent $6.9 billion acquisition of PayPal 's credit financing business goes. That deal, which closed in July, gave Synchrony a $7.6 billion portfolio of receivables that historically has grown faster than the Walmart business.

Is it a buy?

There are question marks because we don't yet know what management will do with the legacy Walmart business. However, the economy remains strong, and that's supporting wages; in combination with its stricter underwriting, that should help the company keep a lid on delinquency and charge-off rates.

If so, then I think Synchrony is an attractive value stock to buy now. The company is increasingly getting more of its funding through lower-cost deposits at its direct-to-consumer bank, which should help support its profitability. And last quarter it announced a new $2.2 billion buyback program, which should help put a floor under the share price.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Todd Campbell owns shares of, and The Motley Fool owns shares of and recommends, AMZN and PYPL. The Motley Fool recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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