This Is the Opportunity Warren Buffett Has Been Waiting For

Key Points

• Buffett's favorite trade is in an industry giant whose stock has become a bargain.

• These are rare opportunities, and Buffett recently found one in UnitedHealth Group.

• Despite short-term pressures, it remains one of the largest companies in the country.

• 10 stocks we like better than UnitedHealth Group ›

Warren Buffett's investing method is often touted as being in the value camp, but he credits Charlie Munger for changing his tune, from looking for deep-value stocks to finding great companies at fair prices. However, when a deep-value opportunity presents itself, Buffett is quick on the uptake. He's really the ultimate contrarian investor, buying stocks that have strong fundamentals that are on the outs with the market.

He made a splash last week with the news that Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) took a position in UnitedHealth Group (NYSE: UNH). Let's take a look at what attracted his attention and dollars, and why this is the ultimate Buffett play.

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Waiting for this moment

Warren Buffett and his team have built up an equity portfolio worth nearly $295 billion at today's prices. It's chock-full of value stocks, but Buffett's focus when buying stocks is investing in great companies. In other words, it's only a real value if the stock is underpinned by a top industry player.

Today's market looks inflated, with stocks trading near record highs. The S&P 500 Shiller CAPE ratio, which is the P/E ratio cyclically adjusted for inflation, is close to 38, or right below its 10-year high. That was right before the market plunged in 2022.

That explains, at least in part, why Buffett's been holding onto record levels of cash. Berkshire's cash and Treasury bill holdings sit at $344 billion as of the second quarter, slightly below the first-quarter amount, and it was the 11th straight quarter of net selling. "If we've got $335 billion now in Treasuries, we would rather have conditions that are developed where we would have, like, $50 billion or something like that," he said at the recent shareholders' meeting. "But that just isn't the way the business works. And we have made a lot of money by not wanting to be fully invested at all times."

Still, Berkshire Hathaway took six new positions in the second quarter, in addition to increasing six others. But UnitedHealth Group stands out because it took a huge position, worth $1.6 billion.

The contrarian play

Buffett explained pretty clearly how his model works in the most recent shareholders' letter:

We own a small percentage of a dozen or so very large and highly profitable businesses with household names such as Apple, American Express, Coca-Cola, and Moody's. Many of these companies earn very high returns on the net tangible equity required for their operations...very occasionally, they sell at bargain prices...Often, nothing looks compelling; very infrequently, we find ourselves knee-deep in opportunities.

He has also praised incoming CEO Greg Abel several times for acting decisively at such times. Buffett has done this many times successfully in the past. One excellent, recent example is when Berkshire Hathaway bought Kroger stock in late 2019. It's the industry leader in a space with high barriers to entry that will always be in demand, and it had fallen to a P/E ratio of around 6. Today, that's 19, and the stock has almost tripled.

Great stock, deep value

UnitedHealth is a healthcare giant. It's one of the top-five companies in the U.S. by sales, behind Amazon. That already put it in Buffett's wheelhouse.

He's also a fan of financial and insurance companies, since in general, the model brings in a lot of money that doesn't necessarily get spent -- for financial companies like banks, that's in the form of deposits, while for insurers, that's in the form of premiums. The insurance company can invest its premiums and make high profits on whatever isn't getting paid out as claims, and it fits Buffett's interest in companies that don't have to spend a lot of money to make a lot of money.

There have been a number of issues plaguing UnitedHealth recently, including a CEO switch and profits not keeping up with analyst expectations. However, insurance companies sometimes fall behind the curve as costs rise before they can raise premiums. It's doing that now. But revenue is growing at a healthy rate, up 13% year over year in the second quarter. It's also highly profitable, expecting $16 in full-year earnings per share (EPS).

UnitedHealth stock has plunged 47% over the past year and trades at a P/E ratio of 13, its lowest levels in a decade. As the price has plummeted, the dividend yield has rocketed to heights not usually seen for this stock. Today it sits at 2.8%, and getting it at this higher yield will bring cash benefits for Berkshire Hathaway for years.

In other words, this is the rare opportunity Buffett saves his cash to buy when he can quickly pounce.

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American Express is an advertising partner of Motley Fool Money. Jennifer Saibil has positions in American Express and Apple. The Motley Fool has positions in and recommends Amazon, Apple, Berkshire Hathaway, and Moody's. The Motley Fool recommends Kroger and UnitedHealth Group. The Motley Fool has a disclosure policy.