3 Underrated Warren Buffett Stocks That Are Smart Buys Right Now | The Motley Fool (2024)

While 2023 was a great year for stocks, remember that last year's gains came on the heels of a horrid 2022. So even after the past year's good news, with inflation coming down and unemployment remaining low, many stocks still look undervalued even after strong one-year runs.

So where to put new money into your portfolio, IRA, or 401(k) today? Warren Buffett's Berkshire Hathaway (BRK.A 1.06%) (BRK.B 1.20%) portfolio is always a good place to look for rock-solid stocks with staying power.

Heading into 2024, the following three Buffett holdings look undervalued.

Amazon

Amazon (AMZN 0.87%) stock was up a whopping 81% in 2023, but is almost 20% below its all-time high. Moreover, the company's price-to-sales ratio is actually at a relative low compared with the past five years.

Why hasn't Amazon appreciated to all-time highs, as some other Magnificent Seven stocks have? Probably because the company hasn't been perceived as a leader in the artificial-intelligence race.

But that could be short-sighted. The recent turmoil at OpenAI, which has exclusivity with Amazon rival Microsoft, has spurred large enterprises to diversify their artificial-intelligence application providers, according to a recent article in The Wall Street Journal. Amazon Web Services should be a key beneficiary, as the largest cloud platform out there with the most diverse selection of large language models and partners through its new Amazon Bedrock service.

It's hard to say which large language model will be the most used, or which AI chipset will dominate the industry. There will probably be multiple successful AI models and a variety of semiconductors that may be optimized for certain applications.

Amazon has a long tradition of taking on competitive industries and then using its scale and innovation to increase choice and drive down costs. After doing that across various retail categories and consumer services, Amazon looks to do the same with AI. As with e-commerce, Amazon is also developing its own lower-cost "private label" products and services, with its Graviton, Inferentia, and Trainium in-house-designed semiconductors, and even its own in-house large language model, called Titan.

Basically, I don't believe Amazon has lost any of its competitive fervor or ability to innovate in the age of AI. At a relatively low valuation relative to history, it's a great buy to start the new year.

American Express

The economy has proved more resilient than many expected, and it's shown up in the results of credit card issuer and card network American Express (AXP 7.10%). The curious thing about American Express stock is that it garners a majority of its business from payment volumes and card fees, which are not dependent on underwriting loans. Yet at 16.9 times trailing earnings, the stock trades more like other large banks, and not card network rivals Visa (V -1.71%) and Mastercard (MA 0.40%), which trade at 32 and 37 times earnings, respectively.

But only 22% of American Express' revenues come from net interest income on loans and card receivables. Therefore, one might think AmEx would trade at a higher multiple than it does. This is especially true as the company's lending book has also shown very strong results.

Last quarter, American Express' net write-off rate remained at 1.8%, consistent with the prior quarter and still below the 2.2% write-off rate of the fourth quarter 2019 before the pandemic, when interest rates were much lower. Meanwhile, the company's payments volume continues to grow faster than GDP at 7%, thanks to inflation-protected spending and increasing card use. And AmEx has showcased its pricing power too, with card fees up 20% year-over-year-last quarter.

American Express has done a great job of pivoting its classic premium brand to suit the needs of millennial and Gen Z customers, with over 60% of new accounts coming from these demographics. That has come from understanding what perks these age cohorts want, and delivering it. As further evidence, J.D. Power just selected American Express as the No. 1 credit card company for the fourth year in a row.

D.R. Horton

In the second quarter of 2023, Buffett or his lieutenants made a big bet on three different U.S. homebuilders, but the vast majority of the investment went to just one of those names: D.R. Horton (DHI -0.76%). That may be because D.R. Horton is the largest homebuilder in the country and Buffett needs to buy large stocks to make a dent in Berkshire's portfolio. But there's also a compelling case for D.R. Horton specifically in today's industry climate.

First on the investing thesis behind homebuilders generally. One, these stocks tend to trade at low multiples. Even after rising over 70% in 2023, D.R. Horton only trades at 11.2 times earnings today.

Homebuilders have tended to trade at low valuations, because of their perceived cyclicality and sensitivity to interest rates, as well as their traditional capital intensity with having to buy land up front. But Buffett seems to be making a bet that those multiples will rise.

There are a few good reasons for this. First, the homebuilding industry has become more concentrated, with the top 10 builders making up about 50% of all new homes built today. Moreover, top builders are using options to buy land these days, rather than outright purchases, decreasing the need for up-front capital investment and allowing for greater returns on equity.

And conditions may be especially favorable for homebuilders today within the housing market. There has been an undersupply of new homes built over the past 10 years, putting a floor under prices. Meanwhile, since mortgage rates have gone up so much from the pandemic and pre-pandemic low-rate era, homeowners with existing fixed rates aren't moving very much. The lack of existing homes for sale are tightening the market even further, leaving more and more of available supply coming from newly built homes.

That leaves conditions very favorable for homebuilders, provided, of course, buyers can still afford homes. Many buyers, especially first-timers, have been priced out of markets. But that's also why D.R. Horton specifically may find itself in a favorable position, with its focus on affordable and quick move-in homes, with more than half its customers in the form of first-time buyers. And because of Horton's scale, it can probably out-price smaller homebuilders with perks such as mortgage rate buy-downs.

That's why D.R. Horton has posted a string of earning beats over the past year, increased its dividend by 20% last quarter, and upped guidance for share repurchases in the upcoming year. Expect more good things from this new Buffett stock in 2024.