Warren Buffett bought Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) about 60 years ago. At the time the company was in decline and the purchase seemed foolish. But today, Berkshire Hathaway is worth more than $1 trillion. And it reached these heights thanks to the fact that Buffett has smartly reinvested the company’s cash over the decades.
Given his impressive track record, I’m steadily studying Buffett’s mindset to improve my own investing skills. My office is littered with highlighted and underlined copies of his annual letters to shareholders and well-worn books on Buffett. Suffice it to say, I’m a student and a fan.
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On November 14, Berkshire Hathaway disclosed its quarterly stock holdings. Normally I’m intrigued by the investment decisions. But this time the company was sold Ultimate beauty (NASDAQ: ULTA) And Floor & Decoration (NYSE: FND). And I think those moves are mistakes.
I have a lot of respect for Warren Buffett and Berkshire Hathaway, so I don’t say this flippantly. But I believe Ulta Beauty and Floor & Decor stock are poised to outperform Ulta Beauty and Floor & Decor stock S&P500 in the next five years. And that’s why I humbly disagree with Berkshire’s decision to sell.
With more than 1,400 locations, Ulta Beauty is a major cosmetics retail chain, suggesting that future growth opportunities are limited. This is reflected in management’s expectations for 2024, which imply a slight decline in net sales as same-store sales decline slightly. This moderate growth is causing investors to sour on the shares.
Growth is certainly important. But there are other paths to strong stock performance, and Ulta Beauty has what it takes. For starters, the company is highly profitable even during slow business times. It expects an operating margin of almost 13% this year and expects it to remain above 12% in the long term.
At a profit, Ulta Beauty is buying back stock — it just approved a $3 billion buyback plan in October. And reducing the number of shares can increase earnings per share (EPS) much faster than revenue. Management even expects double-digit earnings per share growth from now on.
Double-digit earnings per share could be enough to send Ulta Beauty stock rising faster than the S&P 500. Plus, I think there’s little risk associated with this investment. Cosmetic spending is extremely resilient. And the stock is trading at its third-lowest price-to-earnings valuation ever, limiting downside risk if earnings continue to rise.
Floor & Decor shares have fallen 30% from their all-time high. And the short story is that the home improvement market is shrinking, which is impacting the company’s revenue. Same-store sales are expected to decline approximately 8% year-on-year in 2024. But I don’t think it’s a problem to worry about right now. As the chart below shows, sales growth largely reflects existing home sales in the US.
I’m not an eternal optimist here. On the contrary, if home sales were to pick up and Floor & Decor sales were still under pressure, this would be a time for serious concerns. But I think the fear is premature. The housing market is cyclical and should eventually pick up again, which should give Floor & Decor a boost when that happens.
With only 241 locations left at the end of the third quarter of 2024, Floor & Decor has plenty of room for expansion. In fact, management is targeting 500 locations in the long term. It will open a total of 30 new stores in 2024, 20 of which had already opened before the end of the third quarter. And in 2025, the company expects to open another 25 – at a slower pace than normal, taking into account the weak housing market.
In these lean times, Floor & Decor’s management maintains profitability by cutting costs where possible. Admittedly, the profit margin over the first three quarters of 2024 is only 4.7% – in recent years it has been as high as 9%. But these gains continue to make the company financially stronger, making it well prepared for when the housing market recovers.
I’m not sure when the housing market will recover and neither does the management of Floor & Decor. But given the usual ebb and flow of the housing market, I expect a recovery within the next five years. And when that happens, I expect sales to recover and profit margins to rise to more historic levels. And this will almost certainly translate into strong performance for the stock.
Buffett’s Berkshire Hathaway sold Ulta Beauty and Floor & Decor shares, and the holding company is known for making great investment decisions. But if you want to outperform the S&P 500 over the next five years, I think both Ulta Beauty and Floor & Decor offer low-risk opportunities to do just that. For this reason, I humbly disagree with the decision to sell and believe both stocks are good to buy today.
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Jon Quast has positions in Floor & Decor. The Motley Fool holds and recommends positions in Berkshire Hathaway and Ulta Beauty. The Motley Fool has a disclosure policy.
Warren Buffett’s Berkshire Hathaway just sold shares of two companies. Here’s why I (humbly) disagree and expect both stocks to rise from here. was originally published by The Motley Fool
