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Buffett's Favorite Dow Stocks: Earnings Preview

Earnings of Dow stocks Procter & Gamble, Kraft and Johnson & Johnson will be scoured the most by billionaire investor Warren Buffett, whose Berkshire Hathaway is among the top four shareholders of each.

Warren Buffett
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Warren Buffett

Those three companies, and the other Dow consumer-goods stock McDonald's, will start reporting earnings Jan. 24.

Procter & Gamble, Kraft, Johnson & Johnson and McDonald's had virtually flat earnings last year, according to analysts' estimates.

Nevertheless, Buffett has made a fortune by buying large and steady companies. (He also owns Coca-Cola .) As the economy rebounds this year, not only growth stocks such as Apple and Netflix may outpace the S&P 500 Index, but also laggards including Dow Jones Industrial Average stocks.

The 2010 share-price returns of the four Dow consumer stocks are led by McDonald's, at 27%, and bracketed by Johnson & Johnson, with a decline of 0.7%. Dow stocks gained 11% last year, while the S&P 500 rose 15%. The Dow industrials have advanced a mere 7% over the past decade, trailing small- and mid-cap stocks.

But large-cap stocks are considered undervalued, based on current price-to-earnings ratios versus historical norms, and are overdue for a breakout, according to fund managers including Bruce Berkowitz of the Fairholme Fund and Donald Yacktman of the Yacktman Fund. So these companies could soon shine, especially as inflation quickens when they can pass on rising costs to customers.

Among the challenges faced by food-industry firms McDonald's and Kraft is rising agricultural commodity prices, which put pressure on profits in the fourth quarter. They are expected to bump up prices because of that.

Another common issue is the push for a bigger geographic footprint. Johnson & Johnson and Procter & Gamble are long-standing international forces. Kraft bought the U.K.'s Cadbury, a candy maker, about a year ago to boost its international business. And McDonald's is pinning much of its growth prospects on China, where business is booming.

Buffett's investing philosophy includes buying high-dividend-paying stocks with strong fundamentals and some sort of "moat" such as a strong brand name, market dominance and industry leadership.

And each of those companies has those characteristics.

Buffett is also known as a buy-and-hold investor. As evidence of that, the three companies were also among the top seven holdings of Berkshire Hathaway at the end of 2008.

McDonald's
AP
McDonald's

What follows are the fourth-quarter earnings expectations of four companies in the Dow's consumer-products sector, arranged by reporting dates, starting with McDonald's.

McDonald's , the fast-food giant, reports earnings Jan. 24. Wall Street analysts surveyed by Thomson Reuters expect earnings of $1.16 per share on revenue of $6.2 billion. For the same period a year earlier, profit was $1.11 per share on $6 billion in revenue.

Business from China was a big contributor to fourth-quarter earnings, and the earnings outlook from analysts increased 3.5% over the period because of that. China is expected to be the growth driver in coming years, and the company plans to boost capital spending there by 40% this year.

The consensus analysts' estimate from Thomson Reuters calls for 2010 earnings of $4.60 per share, rising to $5.02 in 2011. It said analysts' consensus price target over the next 12 months is $85.40, a 15% premium to its current price.

Shares of McDonald’s gained 27% in 2010 versus the 35% increase of the restaurant sector tracked by Morningstar. Its shares are down 2% this year. They have a dividend yield of 3.3%.

At the end of the third quarter, Capital World Investors was the largest shareholder, with a 6% stake, despite selling 7 million shares in the period. Fidelity was the second-largest shareholder, and bought 3 million shares to grow its stake to 4% in the third quarter.

Analysts have eight "strong buy" ratings, seven "buy" ratings, 10 "holds," and one "reduce" on its shares, according to Thomson Reuters.

Johnson & Johnson will release its fourth-quarter earnings Jan. 25. Analysts expect it to report $1.03 per share, versus $1.02 last year, according to Thomson Reuters. In the third quarter it earned $1.23. That would bring 2010 earnings to $4.75. It earned $4.63 in 2009.

The company's quarterly earnings have been relatively flat over the past three years. Analysts expect its earnings to grow 5% to $4.97 per share in 2011. Projected 2010 revenue is $62 billion, flat to 2009.

Johnson & Johnson is one of the world's largest and most diverse health-care companies, with three divisions: pharmaceutical, medical devices and diagnostics, and consumer products.

Johnson & Johnson also has been one of the most respected brands in its various fields, but that is being undermined by a series of recalls, the most recent about a week ago.

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CNBC.com

On Jan. 14, it announced the recall of nearly 47 million units of over-the-counter medicines including bottles of certain Tylenol, Benadryl, Sudafed and Sinutab products distributed in the U.S., the Caribbean and Brazil.

The company faces challenges on other fronts as well. The patent rights of two of its big sellers — the antipsychotic Risperdal and the neuroscience drug Topamax — expired recently, which will hurt revenue.

But its fundamentals are solid, including a diverse revenue base (each business represents about a third of annual revenue), protected markets, because of its many patents and huge cash flow that it uses to fund its research pipeline and make acquisitions.

Johnson & Johnson's shares gained 11% in 2009, lost 0.7% in 2010 and are up 1% this year. It shares have a dividend yield of 3.49%. The company announced a $10 billion share-repurchase program late last year, which should help boost prices.

A poll of 17 analysts by Thomson Reuters gives it a 12-month price target of $67.70, or an 8.2% premium to the current price. Those same analysts give its shares three "buy" ratings, 10 "buy," and 11 "hold."

At the end of the third quarter, State Street was the biggest shareholder, with 5% of outstanding shares, about the same as over the course of the previous year. Berkshire Hathaway is the fourth-largest shareholder, at 1.6%, and the number of shares owned was up by over 30% in the first three quarters of 2010.

Procter & Gamble , the international household-products conglomerate, is expected to report earnings of $1.10 per share on Jan. 27 for its second fiscal quarter, down from last year's $1.49 per share. In the previous quarter, its first fiscal quarter, which ended Sept. 30, it earned $1.02 per share. Analysts expect 2010 earnings of $3.98 per share down from $4.11 in 2010.

Among P&G's well-known branded products are Tide detergent, Dawn dishwashing liquid, Bounty paper towels, Pringles snack chips, Gillette shavers and Duracell batteries. The firm offers multiple products in a category and often more than one brand and regularly comes out with improvements to retain customers.

The mean consensus 12-month share-price target of 18 analysts is $71.60, a 9.3% premium to the current price, according to Thomson Reuters. It has a dividend yield of 2.9%. A healthy 9.5% dividend increase in fiscal 2010 and planned share buybacks of $6 billion help make its share s more attractive.

The stock has underperformed the broader market over the past two years, gaining 9% in 2010 and about 1% in 2009. Shares are up 1.6% this year and hit a 52-week high Jan. 18. Berkshire Hathaway is third-largest shareholder, at 2.7%. Its share holdings were down slightly in the third quarter, the latest period for which such information is available.

Kraft Foods will release its fourth-quarter results Feb. 10. Analysts expect earnings, on average, of 46.5 cents per share, versus 48 cents last year. In the third quarter, it reported 47 cents per share. Kraft's quarterly earnings have hovered around 50 cents per share for the past four years. Earnings for 2010 are pegged at $2.03 per share on revenue of $49 billion, and are seen rising to $2.32 per share in 2011.

Kraft acquired U.K. candy company Cadbury early last year in a $19 billion deal and is still in the process of restructuring to integrate it into its other businesses. Cadbury's brands and distribution capabilities worldwide are expected to leverage sales of Kraft's products. The company manufactures and markets packaged food products, including snacks, beverages and packaged grocery products.

Kraft has operations in more than 70 countries. Its brands include Oscar Mayer meats, Philadelphia cream cheese, Maxwell House coffee and Nabisco cookies and crackers.

Shares gained 20% last year and 5.6% in 2009. They are down 1% this year. They have a dividend yield of 3.7%. Kraft's shares are seen as cheap, given its 14.1 forward price-to-earnings ratio.

According to Thomson Reuters, analysts give Kraft shares seven "strong buy" ratings, eight "buys" and six "holds." Their current 12-month share-price target is $35.10, a 2.3% premium to the current price. Berkshire Hathaway is the largest shareholder in Kraft, at 6% of outstanding shares, which is almost 7% of Berkshire Hathaway's assets. That stake is down about 24% from the beginning of 2010. Kraft shares were up 20% in 2010 and are down 1% this year.

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