Situation: The basic idea behind these newsletters is to highlight economically viable companies that make suitable investments for retirement savers. ”Economically viable” means the company is in a position to survive an existential calamity by further capitalizing itself: It can readily issue long-term bonds (and get short-term bank loans) at attractive rates. The recent history of Boeing (BA) is instructive in this matter.
Berkshire Hathaway is mainly an insurance company, so Warren Buffett has to set aside income from premiums (which he calls “float”) to pay future claims. That means holding a lot of cash (US Treasury Bills), owning stock in a lot of companies (the “portfolio”), and having a lot of wholly-owned subsidiaries that reliably generate income even in an economic downturn (e.g. electric utilities and a railroad). Stocks are the tricky part, given that other “property and casualty” companies invest paid-in premiums in bonds. He had to be a genius stock-picker, and he is, so you and I want to drill down on his stock picks.
Mission: From the 40+ companies in Berkshire Hathaway’s stock portfolio, select those that are suitable for retirement savers.
Execution: see Table of 13 companies.
Administration: Calamity-proof companies need to a) be in the S&P 500 Index, b) have a clean Balance Sheet, c) keep long-term debt less than 2.5 times equity, d) have a 20+ year history of trading for their common stock, and e) have at least an A- S&P rating for their bonds.
Analysis: Warren Buffett’s favorite metric is addressed in Column R of the Table: Return on Tangible Capital Employed. He thinks anything over 20% for the last fiscal year (lfy) is a good number, and 6 companies meet that standard: MMC, PG, AAPL, JNJ, UPS, ATVI. His second point (that the company is “run by able and honest managers”) is addressed in Morningstar reports (see Column AM) and is negatively impacted by the degree to which managers choose to capitalize their company by issuing long-term bonds instead of common stock (see Column V). Six companies have a BUY rating from Morningstar (AMZN, BAC, BK, USB, UPS, ATVI); 8 have a Debt:Equity ratio less than 1.0 (AMZN, PG, JNJ, GL, BK, CVX, USB, ATVI). Mr. Buffett has also stated that a high Free Cash Flow Yield (Column I) reflects good management because Retained Earnings allow the company to expand (or pay down debt) at zero cost. Ten companies (MMC, PG, AAPL, JNJ, KO, BK, CVX, USB, UPS, ATVI) have Free Cash Flow remaining after paying dividends. His third point (that the stock be available “at a sensible price”) is addressed by the 1-yr and 5-yr Forward PEG ratios (see Columns M and N): Two companies have PEGs under 2.0 at both time points (BK and UPS). BK, UPS and ATVI are each cited 4 times.
Bottom Line: In the aggregate, these 13 companies score remarkably high in our Analysis and Finance Value (Column E) sections, and are accordingly overpriced (Columns AF to AH).
Risk Rating: 7
Full Disclosure: I dollar-average into PG, JNJ, KO and UPS, and also own shares of AMZN and USB.
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