2 Warren Buffett Stocks to Buy Hand Over Fist and 1 to Avoid

Berkshire Hathaway (BRK.A -0.59%) (BRK.B -0.48%) is well known for its massive stock portfolio, which has dozens of common stock positions, many of which have been hand-picked by legendary investor Warren Buffett himself.

Certainly, there is a solid investment to be made for almost all of them. Buffett tends to invest in stocks that have sustainable competitive advantage, attractive valuations and other clearly identifiable reasons why they are attractive investments. However, some are much more attractive than others now. Here are two stocks in particular from Berkshire’s portfolio that deserve a closer look, and one that I stay away from, even though it’s a Warren Buffett favorite.

A very profitable bank with interesting potential

Capital One Financial (COF -0.69%) it’s an interesting bank stock right now, and it’s one of the few big banks trading for less than its book value right now.

Although best known for its credit card business, Capital One is a full-service bank with an extensive branch network in the Washington, DC metropolitan area. Because of the high-interest nature of the credit card business, Capital One has a net interest margin of 6.7% — more than double what most other big banks make. Additionally, as one of the few banks with branches that offer savings accounts and high-yield CDs, the company grew its customer deposits by 7% year-over-year. There is certainly some downside risk in the credit card business, but Capital One’s default rate is reasonable and the bank has plenty of reserves to cover potential losses.

Perhaps most significantly, Capital One plans to acquire Discover Financial Services (DFS -0.40%) in an all stock transaction. Not only will this make Capital One’s credit card business much bigger, but it will give Capital One its own payment network, which will make the bank much less dependent on Visa and Mastercard. Management expects $2.7 billion in synergies from the deal through 2027, with most of that coming from network savings.

A leader with a superior cost structure

Financial ally (ALLY 1.29%) is a leading auto lender with a rapidly growing online banking operation. Berkshire owns 9.5% of Ally, and there are plenty of reasons why Buffett might be a fan.

First, Ally has several competitive advantages, such as relationships with over 22,000 vehicle dealers, a high level of automation, and the superior cost structure that comes with online banking versus branch banking. It’s also a high-margin business, as the average retail auto loan it originates has an interest rate of 10.6%. With a deposit cost of around 4% and a net charge rate of less than 2%, it’s easy to see why this can be such a profitable business.

Ally is also a pretty cheap bank stock, with shares trading 25% below its 52-week high and for a forward P/E multiple of just 8.8.

This Buffett favorite is not for me

It’s clear that Buffett is a fan of his Occidental Petroleum (OXY -2.44%)as it has bought the stock frequently in recent years, and Berkshire now owns more than 27% of the oil company. But it’s a stock I’m happy to watch from the sidelines.

On the one hand, the company is very sensitive to the price of oil, even relative to other major oil and has companies, because its main objective is to extract oil from the ground. That’s why Occidental has underperformed benchmarks recently as crude has fallen more than 15% since mid-year.

Debt is also an issue that makes me nervous, and while management is doing a good job of reducing debt, this could affect cash flow in the near future.

Another Buffett stock might be the better option for you

As a final thought, if you can’t decide which “Buffett stocks” are best for you, there’s nothing wrong with buying Berkshire Hathaway and getting exposure to them all. In fact, another reason I don’t want to invest in Occidental is that Berkshire is one of my largest stock investments, and so I already have significant indirect exposure to the oil company.