Warren Buffett and his longtime partner Charlie Munger have been talking for years about the need for Berkshire Hathaway, the cash-rich holding company they manage, to make larger investments.
Much like a salesperson working a territory, he would rather work on one huge deal than struggle to place many small orders. If the deal is fundamentally good, why not? Berkshire spews cash, so it's a nice, if daunting, problem to have.
Most people would think investing a billion dollars at a drop an elephantine decision. But Buffett is thinking much, much bigger — tens of billions, in fact.
He told shareholders as much in his 2006 letter:
"We continue … to need ‘elephants' in order for us to use Berkshire's flood of incoming cash. Charlie and I must therefore ignore the pursuit of mice and focus our acquisition efforts on much bigger game."
He's off to a good start of late. But even after investing nearly $6.5 billion in chewing gum giant Wrigley (done as a joint venture with privately held candy maker Mars), Berkshire Hathaway still has at least $35 billion in cash left over to invest.
Intrigued, I decided to see if there is a screen that could identify the things Buffett might be looking at for his next big move.
I recently told you about how to apply Buffett's investment ideas to small cap stocks, so here's the next big thing — very large investments, the elephants he says he wants. To create this Warren Buffett "elephant" screen, I used the following criteria:
• Market cap between $10 billion and $100 billion, large enough to be significant but small enough to ensure Buffett gains a controlling interest. (Note: Buffett did not get that control of Wrigley, an anomaly for him.)
• Industry leadership denoted by a ranking in the top 10 percent of the industry in terms of market cap.
• A P/E ratio under 25, to avoid paying too much.
• A positive dividend yield, indicating management values the participation of shareholders in the company.
• Financial indicators such as the price-to-cash-flow ratio, return on equity, profit margin, and the debt-to-equity ratio better than the industry average. These indicates that the company is well run compared to its peers.
Out of more than 8,000 publicly traded companies, just eight made our final Buffet elephant list:
One of the world's largest engineering companies, ABB is the industry leader in electrical power generation and transmission. Analysts expect earnings growth of more than 20 percent a year for the next five years. Recent price: 30.55.
This glass and ceramic company makes everything from baby bottles to fiber-optic cables. Earnings per share have grown at nearly 75 percent a year over the last five years, yet the P/E ratio is only 19 at a recent price of 25.68.
Grupo Televisa (TV)
Mexico's largest media company enjoys an operating margin of 35 percent and a return on equity of 22 percent. Recently trading at 25.22.
A healthy 3.3 percent dividend yield makes this payroll and human resources outsourcing giant appealing to income investors. The company has no debt and was recently selling for 36.29 a share.
PPL Corporation (PPL)
Buffett is already involved in utilities through Berkshire's MidAmerican Energy Holdings Company. This industry represents the second-largest operating segment within Berkshire Hathaway. PPL recently traded at 48.40.
Precision Castparts (PCP)
With a P/E ratio below its earnings growth rate, PCP is a favorite of growth investors, including managers at Janus and Fidelity mutual funds. Trading near 120 per share.
Rockwell Collins (COL)
COL specializes in cockpit and aircraft cabin electronics. Aerospace and defense have been bright spots in the economy. Return on equity of 42 percent demonstrates the quality of management Buffett likes to see. Recent price: 64.06.
The Walt Disney Company (DIS)
This former Buffett holding might be back on his evaluation screen given its recent operational track record. The question is whether Buffett would give this one-time sub-performer another chance. The recent price of 32.43 gives DIS a P/E ratio of 14 based on this year's estimated earnings.
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