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Great Businesses Selling at Fair Prices

October 24, 2011 | About:
Josh Zachariah

Josh Zachariah

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In the latter months of 1994 and early 1995, Warren Buffett significantly upped his stake in the credit card company American Express (AXP). He more than doubled his 27.7 million shares to 48.4 million shares during the period. At the time the price of the stock varied between $27 and $32 with earnings per share of $2.71 yielding a P/E just under 12.

The period was not unlike the present moment where the economy has been slowly gaining steam. In 1994, the U.S. economy started showing signs of life after a multi-year recession. Buffett, however, has not increased his stake in American Express over the past couple years despite the stock selling at exceptionally low prices.

Buffett did add to his Wells Fargo (WFC) stake and has done so of late as the stock has sold close to a P/E of 10. Although his holding in Wells Fargo is much larger, he owns a much larger share of American Express at 12.7%. It’s unclear why he chose not to add this position anytime over the past couple years as the price had cratered down to $10 a share from its current $48.

American Express is currently selling at a P/E of about 12.5 and though it is not as low as the price Buffett had paid, it is not much higher for a business that is in great shape. American Express has averaged a return on equity in excess of 20% over the past 10 years and despite government attempts at curtailing credit card fees no serious competition is threatening its market share. The American Express customer is of the wealthier stripe and thus has not seen the kind of defaults of the much more challenged borrowers of credit.

With Wells Fargo selling around a P/E of 10 it is hard to argue this bank is not selling at a very attractive price also. Buffett has regularly commented that the bank will “earn its way out of its problems.” It surely has not missed a beat as it has not logged a net loss during the recession. But the bank is joined at the hip with the housing market so it will continue to struggle as long as mortgagors are treading rising waters.

Both Wells Fargo and American Express are exceptional companies which are leaders in their respective markets. Interestingly, both Wells and American Express, which rank as No. 2 and No. 3 in Buffett’s largest holdings, are two seeds from the same pod. The founders of Wells Fargo, Henry Wells and William Fargo, formed American Express first before venturing west to found Wells Fargo.

Buffett has said he prefers buying great companies at fair prices rather than fair companies at great prices. Both American Express and Wells Fargo certainly meet the standard of a “great” companies; the prices are hardly unfair either.

Disclosure: Long WFC

Josh Zachariah

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 2.8/5 (10 votes)

Comments

tkervin
Tkervin - 2 years ago
The other side of the coin is that we may be headed back into recession. Hussman and others are fairly certain that this is the case. Europe may not easily resolve their many difficulties and frankly we may not either. The unusually high corporate earnings will mean revert. (See MMM). We have had a nice run back to nearly 12k and frankly I think we are about ready to roll over. Personally I have been increasing my bond and cash positions.

I believe we go lower, perhaps much lower. Now would not be the most opportune time to begin any new long positions. You will find better bargains down the road.
playmaker23
Playmaker23 - 2 years ago
I agree with Tkervin, maybe one month ago low pick was a great time to add long positions but right now it is becmoing more risky for a big correction in the next 6/9 months.In that situation you have to be very very long to recover it.

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