"I'm on the prowl."
Those four words were tucked in to Warren Buffett's just-released
2011 annual letter to shareholders
And the mad dash begins to figure out what company may be in his
Such an exercise might preoccupy the financial media simply for the
sake of covering Buffett (which always attracts an audience), but
if done right, it can actually lead to uncovering compelling stocks
that might be worth buying -- even if Buffett doesn't buy himself.
First, it's worth noting that in recent years, he's picked up the
pace of major investments:
Berkshire Hathaway (NYSE:
completed a $34 billion
of railroad Burlington Northern in early 2010, and then picked up
lubricant maker Lubrizol for a cool $9 billion in the spring of
So what will he do in 2012?
Well, those recent deals give a clue. On the surface, railroads and
lubricants appear to have little in common. But those two firms are
known for robust recurring
--, in almost any economic environment.
The questions for investors are now:
• How much would he be willing to spend for his next blockbuster
• And what companies have the makings of a perfect Buffett stock?
First off, another $34 billion purchase would be a stretch. During
the past seven years, Buffett has never let Berkshire's cash
balance slip below $25 billion. (He says he believes in saving
"rainy-day money" for crazy bargain opportunities, like he did on
Aug. 8, 2011 when he spent billions on plunging stocks.)
Berkshire had $35 billion in the bank as of Sept.30, 2011. That
figure now likely approaches $40 billion. By that math, Buffett
might like to spend up to $15 billion on any deal, perhaps $20
billion as an absolute maximum. Considering he'd have to pay a
premium to receive acceptance of a
, then we're talking about companies that are currently valued at
less than $15 billion. He probably wouldn't waste his time looking
for small deals, so the minimum value of any target would likely be
around $5 billion.
Of course, for Buffett, it's all about the cash flow. I've compiled
a table of U.S.-based companies with a
in the $5 billion to $15 billion range, all of which currently
free cash flow
yields in excess of 5%. I've weeded out any stocks that have seen
free cash flow turn negative at any point in the past eight years.
(That knocked out Alcoa, Avnet, Bunge, CNA Financial, Crown
Holding, Electronic Arts, HCA Holdings, HollyFrontier, Interpublic,
JC Penney, KBR, Vertex Pharmaceuticals, and Whirlpool if you are
looking for solid investment ideas that didn't make the cut).
What's left is an impressive list of solid, stable, high cash-flow
We can quickly rule out the companies that Buffett would NOT seek
to buy. Retailers such as
Best Buy (NYSE:
face a real risk that retail titans such as
will cause even further
Buffett would also likely shun advertising giant
because that entire industry is too exposed to economic cycles.
Defense industry firm
L-3 Communications (NYSE:
faces the risk of revenue declines as defense budgets shrink.
That's not Buffett's ideal backdrop.
He does have a predilection for insurers and the stable cash flow
they generate, so
Principal Financial (NYSE:
may fit the bill.
may seem like a dinosaur to some, but the company has a set of
solid long-term contracts in place that are generating steady
annual free cash flow. Buffett would see this as more of a "
" than a growth platform.
Yet there are two companies on the list that have the makings of
the perfect Buffett acquisition.
1. TRW Automotive Holdings. (NYSE:
The fact that this auto-parts supplier has managed to generate
positive free cash flow throughout the last decade is very
impressive, considering how poorly the industry fared a few years
back. Of perhaps greater appeal to Buffett is that TRW is working
on the two most important areas of auto technology -- safety and
The company has always been a leading supplier of air bags, but it
is now playing a key role in many new safety features found on
today's cars, such as pedestrian avoidance sensors. Also, TRW's
fuel injection technology helps explain why a number of new cars
are getting close to 40 miles per gallon on the highway.
currently sit at $45. Merrill Lynch analysts think shares are worth
roughly $72. Buffet could offer to acquire the company for $55 a
share, and still give current shareholders a nice 20% premium.
[block:block=16]2. Agco (Nasdaq:
Buffett would love to own a company like
, which is perfectly positioned for the ongoing global agricultural
boom. But Deere's $33 billion current market value and $17 billion
make this too big a fish for him to swallow.
Instead, Buffett could reap similar exposure by acquiring Agco, the
world's third-largest maker of agricultural equipment. Agco is
currently valued at about $5 billion (and less than $6 billion when
the assumption of debt is included in the purchase price). On the
downside, Agco is heavily exposed to Europe. On the plus side, the
company has strong market share throughout Latin America. The
company's sales base has risen from $6.9 billion in 2010 to a
projected $10 billion in 2012. That's just the right size for
Buffett to work his magic, extending that sales base onto a higher
plane by giving Agco the resources it may lack as a
Risks to Consider:
Buffett is looking at dozens of opportunities, so the odds that
any one of these stocks gets acquired by him are fairly small. Any
purchase of these stocks should be based on their own merits, first
Action to Take -->
Buyout or not, these stocks are appealing on their own merits,
thanks to robust free cash flow yields. If you want to mimic
Buffett's investment style, then either of these stocks could help
you score solid gains.
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of AA in one or more if its "real money" portfolios.
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