If you were to do an Internet search on the phrase "sad lottery winner stories," the slew of horror tales populating the screen would surely make you think twice before ever anteing up. The outcomes have often been dismal, with coveted windfalls of dough leading many a winner to destitution and isolation if not criminal status (and serious jail time). For the winners, the tantalizing sensation of cash burning a hole in their pockets has often led to the proverbial house going up in flames.
What does this have to do with Warren Buffett, you ask? Absolutely nothing--and that's the point.
The legendary investor and chairman of Berkshire Hathaway (BRK-A) is the antithesis of a lottery winner, although he is currently sitting on a stockpile of cash in the neighborhood of $100 billion. Since Buffett is generally disinclined to pay dividends or buy back shares (as he believes he can do better for shareholders by reinvesting funds or finding enticing new investments), his pockets have been left full--and decidedly cool.
At Validea, where I run a series of systematic investing models based on Wall Street greats, we refer to Buffett as the "Patient Investor," a moniker that may transcend his philosophy on making investments to his stance on finding investments. A Bloomberg article from May states, "What's possible is not necessarily probable, of course. For starters, there aren't that many companies that are worth $100 billion and fewer still that might interest Buffett," citing hostile bids as a turnoff for Buffett. The article references the Buffett-backed Kraft Heinz Co. offer for Unilever (market cap of approximately $150 billion) earlier this year that didn't make it off the ground because the Dutch consumer products behemoth characterized the offer as "unfriendly."
Another Bloomberg article, printed in the wake of the fizzled deal, suggests that the decision to back off of the offer could be viewed as illogical given Buffett's deep pockets (Berkshire reportedly had cash balances of approximately $80 billion at the time). According to the article, however, the move "illustrates one of Buffett’s favorite investing principles: There’s no need to chase deals. Buying companies, he has observed, is like hitting a baseball. Don’t swing at one that’s out of your comfort zone."
Buffett and baseball analogies are familiar friends. In this year's HBO documentary Becoming Warren Buffett, the billionaire described his philosophy: "The secret to investing," he asserts, "is to sit and watch pitch after pitch go by and wait for the one in your sweet spot. If people are yelling, 'swing, you bum!,' ignore them." He likens his investing life to being in a "no-called strike" business which, he argues, "is the best business you can be in."
Earlier this month, Berkshire made news by agreeing to making a $1.8 billion loan to (and purchase a minority stake interest in) Home Capital Group, a Canadian mortgage lender that has suffered an exodus of deposits amid concerns around overpriced Canadian real estate. Berkshire also recently announced an investment of $377 million (a 9.8% stake) in Store Capital, a real estate investment trust.
While neither of these deals will put much of a dent in Berkshire's money bucket, they do reflect the Oracle of Omaha's slow-and-steady approach to investing. He doesn't succumb to external pressures or opinions, of fans shouting for him to take a swing. Instead, Buffett sticks to fundamentals when evaluating investment opportunities, focusing on the underlying operations and whether the numbers make sense. He targets well-established companies with strong management and competitive advantage, not flashy acquisition targets that make for titillating news. So, while the world watches for a home run play, Buffett seems to be living up to his "Patient Investor" epithet by keeping his powder dry--and his pockets cool—while he hits a few singles.
Using the stock screening models I created based on the investment strategies of Warren Buffett and other market legends, I have identified the following four high-scoring stocks. I'm not citing these as acquisition targets for Berkshire, but rather stocks that pass the quantitative strategy I've implemented based on the published writing by or about a handful of great long term investors.
Credit Acceptance (CACC) offers financing programs that enable automobile dealers to sell vehicles to consumers. The company earns a perfect score under my Warren Buffett-based investment strategy due to its earnings predictability and long-term growth in earnings-per-share of 17.0% (based on 3-, 4- and 5-year averages). Average return-on-equity over the past ten years of 29.4% is more than double the minimum required under this model, and management's use of retained earnings reflects a return of 17.6%. My Martin Zweig-inspired screening model likes Credit Acceptance's price-earnings ratio of 14.94 relative to the current market P/E of 19.0.
Sherwin Williams (SHW) is engaged in the development, manufacture, distribution and sale of paint, coatings and related products, and earns high marks from my Buffett-based investment strategy due to its ability to pay off debt ($1.2 billion) with earnings (also $1.2 billion) in less than two years as well as management's use of retained earnings that reflects a favorable return of 15.3%. My Validea Momentum model favors Sherwin William's average annual earnings growth over the past five years of 23.72% as well as the stock's price performance—it is currently trading at $352.64, within 15% of the 52-week high.
NetEase (NTES) is a technology company that operates an interactive online community in China. The company earns a perfect score under my Buffett-based screening model due to earnings predictability as well as ten-year average EPS growth of 26.4%. The debt-free balance sheet adds interest, as well as ten-year average return-on-equity of 25.3%, well above the required minimum of 15%. NetEase also earns high marks from my Peter Lynch-based investment strategy due to its favorable ratio of price-earnings to growth in earnings-per-share (PEG ratio) of 0.61 (anything under 1.0 passes this test).
Banco Macro SA (BMA) is an Argentina-based financial institution that offers traditional banking products and services. The company is favored by my Lynch-based screening model given its PEG ratio of 0.30, and my Buffett-based model likes the predictable and consistently growing earnings as well as ten-year average return-on-equity of 25.2%, well above the required minimum of 15%. Management's use of retained earnings reflects a favorable return of 30.4%.
Disclosure: At the time of publication, John Reese and/or his private clients were long Credit Acceptance, Sherwin Williams, NetEase, Banco Macro and all other stocks mentioned in this article, including Berkshire Hathaway.
John P. Reese, Contributor