You can always tell when Warren Buffett gets anxious.
At the end of 2007, his firm,
Berkshire Hathaway (NYSE:
, was sitting on $44 billion in cash and investments. And that
was too much money lying around, as far as he was concerned. So
in 2008, he spent billions to acquire partial stakes in several
blue chips firms such as General Electric and Goldman Sachs.
Those buys pushed Berkshire's cash balance down to a more
reasonable $25 billion by the end of 2008. As
Bloomberg News noted in October 2013
, Buffett "likes to keep $20 billion on hand should the
reinsurance operations need to pay large claims."
If Buffett thought he was sitting on too much cash seven years
ago, his troubles have grown larger. At the end of Q2 2014,
Berkshire Hathaway held $55 billion in cash and investments -- a
Now, chatter is rising that Buffett is ready to plow that cash
into another major acquisition.
At the end of the day, the main point is not which companies
Buffett buys. Instead, it's what constitutes a great acquisition.
In effect, if such companies are good enough for Buffett, then
they are good enough for the rest of us.
Chewing gum, Railroads, Lubricant and Ketchup
Buffett got his start
buying insurance companies
. However, he has since shown a willingness to venture into many
kinds of industries -- technology is the one sector he avoided,
Over the past six years, in addition to making quarterly
investments in a range of publicly-traded companies, Berkshire
has also swallowed up entire companies, including:
- Wrigley (in tandem with Mars) in 2008 for $23 billion
- Burlington Northern Santa Fe Corp for $26 billion in
- Lubrizol for $9 billion in 2011
- H.J. Heinz (in tandem with 3G Capital) for $28 billion
All of these assets share the same traits. Wrigley and Heinz
have strong brands. Burlington Northern and Lubrizol built wide
moats around their business. And they all have a history of
generating strong and growing free cash flow.
Buffett realizes that billions in cash parked in the bank
yields minimal returns these days. So he needs to pursue
deal-making if his firm is to keep garnering solid returns.
It's notable that Berkshire is increasingly working with other
investment firms to jointly acquire their prey. For example,
Buffett's firm announced plans this week for a $3 billion
investment that will help Burger King (NYSE:
) acquire Canadian fast casual eatery Tim Horton's. Even after
that move, Berkshire Hathaway still has a war chest exceeding $50
To identify Buffett's next acquisition target, I screened for
U.S. companies that meet his criteria. Buffett rarely ventures
outside the United States, perhaps for reasons of management
For starters, we can assume that Buffett likes to target
companies that can be acquired for $5 to $25 billion. Around 400
companies in the S&P 400, 500 and 600 meet that
Second, these companies must have a history of strong free
cash flow. From that universe of stocks, 166 companies generated
positive free cash flow in 2013.
Lastly, Buffett likes bargains. He'll likely only consider
companies trading for less than ten times trailing free cash
The results yield a group of stocks that Buffett was once
known for: Financial services firms.
In light of Berkshire's recent acquisition history, one might
think that Buffett lost his appetite for financial services
stocks. Buffett's stakes in Wells Fargo and American Express are
worth a combined $40 billion, and make up two of Berkshire's top
three public holdings, according to GuruFocus.com. The fact that
these two firms sport a combined market value of $358 billion
means that they are too large to own outright. But these other
And the reason to own banks and insurers is about to get a lot
more compelling. These firms hold considerable cash balances.
That means an eventual uptick in interest rates will cause their
interest income to soar.
(Click here to read about other companies with
massive cash balances.)
Let's assume for a moment that Buffett believes that Berkshire
already has ample exposure to the financial sector through its
portfolio of privately-held and publicly-held stakes.
There are a handful of other companies in his preferred market
value range, all of which trade at reasonable prices in relation
to free cash flow. But with these companies you get what you pay
for. All of them face growth headwinds, and Buffett's team would
need to find ways to invigorate sales or squeeze out costs to
meet his goal of rising free cash flow.
Frankly, Buffett doesn't like to fix other company's messes.
He prefers to buy companies with proven strong management teams,
and the standout name in this group is Xerox Corporation (NYSE:
). CEO Ursula Burns was dealt a tough hand when she took the
reins of this photo-copy and fax machine firm in 2009. And in the
face of clear headwinds, she has done an admirable job of
transforming Xerox into a broader outsourcing and consulting
firm. All the while, Xerox has generated at least $1.5 billion in
free cash flow in three of the past four years.
To be sure, the kind of companies that Buffett really loves --
those with strong brands or robust moats -- can't be had for
attractive prices. The five-year bull market has led to a sharp
increase in value for most of these firms. So if Buffett instead
looks at high-quality companies worth less than 12 times trailing
free cash flow, then you could include:
- Cardinal Health, Inc. (NYSE:
- C.R. Bard, Inc. (NYSE:
- Omnicom Group (NYSE:
- Rock-Tenn Company (NYSE:
Lastly, a pair of obvious choices already sits in Buffett's
portfolio. His firm has a $1.2 billion stake in building
materials firm USG Corporation (NYSE:
) and a $2.7 billion stake in dialysis firm DaVita HealthCare
Partners, Inc. (NYSE:
), which means that Berkshire already owns 28% and 18% of those
firms, respectively. The problem with acquiring companies in this
fashion is that once Buffett starts to nibble, other investors
bid up shares. DaVita, for example, has more than doubled in
value since he began acquiring shares in late 2011.
Risks to Consider:
Virtually every type of company that Buffett would seem
likely to acquire has seen its value rise sharply in recent
years, thanks to the extended bull market. Buffett, like
Baupost Group's legendary Seth Klarman, may choose to wait this
market out and sit on cash until the next window of opportunity
Action to Take -->
Buffett has handily outperformed the broader market over the past
30 years by acquiring assets capable of generating robust and
growing cash flow. Banks and insurers have economic tailwinds at
their back for that to happen and, in relation to the rest of the
market, appear reasonably priced. Don't be surprised if Warren
Buffett announces a major deal in this sector in coming
It's safe to say, anything that Buffett buys, the average
investor should also buy.
But that's easier said than done. How about a group of stocks
that are so stable and profitable that you can buy them now,
forget about them and reap the benefits forever. At
StreetAuthority, we call them "Forever" stocks and we've found a
treasure trove of them. To learn the name and ticker symbols of
our Forever stocks,
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