3 Top-Ranked Value Stocks Warren Buffett Should Buy Next

Warren Buffett, the proverbial king of value investing, who has beefed up his conglomerate from ice-cream to insurance, is eyeing an attractive opportunity. Berkshire Hathaway Inc. (BRK.B), of which Buffett is the chairman and CEO, revealed a huge cash hoard of $55.5 billion as of Jun 30, in its second-quarter earnings release. Of the total, almost 90% came from the company's insurance operations, which are traditionally the most profitable. This wide moat gives Buffett ample fund for acquisitions, capital expenditures and most of the company's operations.

Buffet's investment choice is quite clear. He believes, “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price” and is willing to wait for one. With enough dry power $35 billion ($20 billion to be kept in cash coffers) Buffett is just ready to pull the trigger.

Buffett Waiting for Right Entry Point?

But the improving mood of financial markets in recent years has made it tougher for Buffett to lock in investments which befit his value style investing.

The markets have been bullish for over 5 years and the equities have shown a remarkable rise since the last recession. Even after losing last month, the S&P 500 Index stands at a level which is nearly 3 times higher than its 2009 low. Equity benchmarks are advancing, ignoring the troubles created by the annexation of Crimea by Russia; slowing growth and credit concerns in China; mixed U.S. economic data; and sectarian tensions in Iraq.

Buffett has always had an eagle's eye for those stocks that have generally have been side-lined in the marketplace but have good fundamentals and can be purchased at a bargain, compared with book value, replacement value or liquidation value.

Some of the big purchases made by Buffett included railroad Burlington Northern Santa Fe for $26.5 billion in 2009, chemicals giant Lubrizol for $10 billion a year later and H.J. Heinz for $28 billion in 2013.

Buffett's unprecedented investments in Berkshire have driven growth for the company.  The company's latest annual filing shows that Berkshire's book value has grown at a compounded annual gain of 19.7% compared with 9.8% gain for S&P 500 from 1964 to 2013.

Market Correction Anytime Soon?

A significant market correction would present a buying opportunity for Buffett. Last week former Federal Reserve chairman Alan Greenspan said that he expects market to see a significant correction after having recovered for so long.

Most of the S&P 500 companies have reported second-quarter results and the season has been positive, with company managements generally reporting upbeat outlooks for the rest of 2014. Strong corporate fundamentals should therefore provide good support for share prices going forward and further propel the rally in the equity markets.

Moreover, a nod from the Fed about the rebound in economic activity and an improvement in labor market conditions in its latest meeting also signal that equities will gain.

3 Stocks Buffett Might Be Interested In

Buffett's acquisition choices have changed over time. While at the start of his career he would look for lesser-known companies trading at bargain prices, more recently he has been favoring larger, higher quality names at reasonable prices. We believe the change is just appropriate since he now manages many billions of dollars at Berkshire Hathaway, and therefore buying small firms would be like bolt on acquisitions and not make much difference to the company's overall results.

Below we point out some promising stocks which have the capacity to deliver. Needless to mention that looking out for value stocks amid the bull-run is a challenging task, since valuations are stretched across the markets. The primary measures used to define value stocks are price-to-earnings ratio (the price of a stock divided by the current year's earnings per share) and price-to-book ratio (share price divided by book value per share). Value stocks have relatively low price-to-earnings and price-to-book ratios.

We have listed three stocks with a forward PE ratio below 15 and Price/Book Value (P/B) less than 2.5. with a debt-to-equity ratio of less than 1.

These stocks have trailed the S&P 500 in terms of year-to-date price returns, and thus possess attractive valuations. In addition, these stocks with a favorable Zacks Rank have posted positive earnings surprise over the past four quarters and have are witnessing upward estimate revisions.

Capital One Financial Corp. COF

With $45.5 billion of market capital, this is a diversified banking company focusing on consumer and commercial lending as well as deposit origination. The company's steady capital deployment activities make it an attractive pick for investors. Capital One continues to witness a rise in net revenues.

In 2012, the company acquired ING Direct USA, which boosted the top line significantly. The company also has a strong Credit Card business and maintains a geographically diversified loan and deposit portfolio.

The stock has gained 4.7% year-to-date.

Forward P/E = 10.4x.
P/B Ratio = 1.04
Debt to Equity Ratio of 0.85
Zacks Rank #2 (Buy)

Principal Financial Group Inc.  PFG

Ranked among the Fortune 500 companies and with a market capitalization of $14.6 billion, it provides an expansive range of retirement savings, investment and insurance products and services through its various subsidiaries. The company's Asset Under Management shows a steadily increasing trend. Several recent acquisitions are also expected to increase its asset under management

Moreover, Principal Financial's capital deployment through share buybacks and dividend payment looks impressive, making it an attractive pick for investors.

The stock has gained 3.3% year-to-date. It has a PEG Ratio of 1.

Forward P/E = 11.7x.
P/B Ratio = 1.44
Debt to Equity Ratio =0.24
Zacks Rank #2 (Buy)

Lincoln National Corp. LNC

With market capitalization of $13.6 billion, it is a diversified life insurance and investment management company that is structured to suit the needs of all economic strata, adding value to client-investments and mitigating risks related to retirement planning. Higher asset-based fee revenues, improved spread income from interest-sensitive products and lower amortization of intangibles, have driven Lincoln National's earnings over the past few years.

Lincoln National has taken steps to protect and build its capital base and mitigate balance sheet risks. The company adopts strong asset and liability management practices from time to time, including equity and interest rate hedging programs, which partially mitigate risk exposure. The company is focused on product development to increase its competitive position among small to mid-sized corporates and employee benefit markets as well as to capitalize on opportunities from regulatory changes effective in 2009.

The stock has gained 3.5% year-to-date. It has PEG Ratio = 0.90, which indicates future growth.

Forward P/E = 10.4x.
P/B Ratio = 0.93
Debt to Equity Ratio =0.33
Zacks Rank #2 (Buy)

Bottom Line

Will these stocks live up to the expectations of The Oracle of Omaha? Though these metrics help in picking the right stocks, fundamentals and other qualitative aspects of a company also play important roles.

PE ratio and PB ratio combined with a solid Zacks Rank, rising earnings estimate revisions as well as and a moderate debt position are nonetheless solid indicators of lucrative stocks in an overvalued market.

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CAPITAL ONE FIN COF: Free Stock Analysis Report
 
BERKSHIRE HTH-B (BRK.B): Free Stock Analysis Report
 
LINCOLN NATL-IN LNC: Free Stock Analysis Report
 
PRINCIPAL FINL PFG: Free Stock Analysis Report
 
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