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Wonderful Companies at Fair Prices
Posted by: dhennessy1 (IP Logged)
Date: November 21, 2011 11:54AM

Value Investor Warren Buffet famously remarked that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” This statement has guided his stock research and stock picking strategy for decades. Gurufocus posted a nice article on Buffet’s recent disclosure of buying more than 5% of IBM that underscores this theme. We conducted a thorough screen of companies with strong balance sheets, strong overall financial health and solid credit ratings, high predictability of earnings and, based upon our valuation models, that are trading at 20-30% discounts to intrinsic value. Our results are as follows:

St Jude Medical (STJ), is a medical device manufacturer that develops and markets cardiovascular medical devices for the management of arrhythmias, cardiac surgery and has recently diversified into implantable neuromodulation devices. Like several other large-cap device-makers, St Jude enjoys both barriers to entry and high switching costs for its products. It also faces formidable competition from companies such as Boston Scientific (BSX) and Medtronic (MDT), in addition to headwinds related to healthcare expenditures, PPACA “fees”, and margin pressure from third-party payers. The company has posted solid earnings and book value growth for the last 3-5 years and has a forward P/E less than 50% of its 5-year average. ROE for the past 5-years approaches 20%, indicating a durable competitive advantage. St Jude stock currently has a 2.3% dividend yield.

Becton Dickinson & Co (BDX) operates in medical devices, biosciences, and diagnostics. Most healthcare professionals worldwide come across Becton’s core single-use medical products of needles and syringes multiple times per day. Similar to Gilette’s (formerly G, now PG) disposable razors, these recurring use products are manufactured by the billions annually and provide the Company with scale economy that makes entry of competitors unlikely. This is truly a consistent earner with solid geographic reach (55% of sales are international) and its diagnostics and biosciences segments offer diversification from its core segment, which accounts for more than 50% of revenues. The Company has exhibited strong earnings and book value/share growth through the last 3-5 years. Forward PE of 10.2 is less than 50% of its 5-year average and the dividend yield stands at 2.2%.

Novartis (NVS) is a global drug manufacturer with an impressive late-stage pipeline across multiple therapeutic areas, along with generic and vaccine segments. The Company faces the same pressures as its peers; generic competition, cutbacks by government and private payers, and challenges related to healthcare reform legislation. While much of the industry has suffered from stagnant growth over the past several years, the Company has posted solid earnings and book value growth. With a rock-solid balance sheet, despite $20 billion in additional debt from the Alcon acquisition still on the books, and strong cash flow generation, the Company’s 3.7% dividend it quite safe.

We’ve written about Exxon Mobil (XOM) here. Our fair value estimate for XOM is ~$99/share; giving investors strong upside capital appreciation potential. While we would prefer that the Company utilize its strong cash flow generating capability and rock-solid balnce sheet to boost the dividend payout, the modest dividend yield of 2.4% adds to the returns for XOM.

We wrote an investment thesis for Abbott (ABT) here at Gurufocus. Although we are critical of the planned break-up of the Company, we still see this as a strong and undervalued company.

As a diversified industrial, 3M Co. (MMM) is coupled to the global economy. Despite the cyclicality of this industry and the global economic downturn, 3M has demonstrated remarkable stability in operational performance, as shown by the following table of 10-year operation results and the chart of 10-year earnings and book value.

The impressive 5-year average ROE of 33% underscores the company’s durable competitive advantage born out of its industry-leading technological innovation and economies of scale. Relative valuation metric indicate a modest discount to intrinsic value and, along with a dividend yield of 2.7%, these shares would make a nice core holding in a value-investor’s portfolio.

Rounding out the wonderful companies at a fair price, Proctor and Gamble (PG), was highlighted here in the article titled, “Highest Yield Stocks of Most Predictable Companies of Donald Yacktman: AVP, SYY, CLX, JNJ, PG.” With an unmatched portfolio of billion-dollar consumer brands, PG is another solid core holding with an impressive 3.3% yield and a modest discount to intrinsic value.

One of the risks that we have found with value investors and, admittedly, with our own stock selection process is focusing too much on the “cheapest” stocks (even in a wide-moat universe). We therefore assign a lower “Margin of Safety” requirement for the truly wonderful companies that we cover. Warren Buffet’s simple statement that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price” was the culmination of a remarkable evolution from Benjamin Graham’s net-net and “Cigar Butt” strategies. Wonderful companies at a fair price should form the core of a value investing portfolio. Luckily, these opportunity exist on the US exchanges.



Stocks Discussed: AVP, SYY, CLX, JNJ, PG, STJ, MMM, XOM, ABT, MDT, BDX, NVS,
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