It is widely known that Warren Buffett has made a fortune buying quality companies at discounts to their intrinsic value and holding for long periods of time. But this week, his company Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) boosted its stake in kidney dialysis company DaVita (NYSE:DVA) to over 10%, as the company climbed to its all-time peak stock price. The buy was not an anomaly for Buffett, but representative of several instances in his investing history in which company quality trumped price for the investor who has said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” While Buffett has clearly succeeded overall with his strategies, in at least one instance in his past, buying a good company at a high price has proved disastrous.
Few value investors would consider DaVita a cheap stock. It has a P/E of 18.99, P/B of 3.9, its highest level in more than a year, and its stock price has escalated almost 65% in the last five years. Buffett, or one of his new portfolio managers Ted Weschler or Todd Combs, first bought shares at an average of $71 in the fourth quarter of 2011, and paid an average of $84 and $86 for additional shares in the next two quarters, respectively. The stock is up 29% from his average purchase price per share.
On Sept. 28, Berkshire added 282,403 more DaVita shares at $103.83 per share, a record high share price, pushing it above the 10% ownership threshold.
But DaVita meets several of Buffett’s criteria signifying a high-quality company:
- Proven and predictable revenue and earnings growth
- Sustainable price power and gross margin (moat)
- Capable management
DaVita has achieved an annual EBITDA per share growth rate of 17.8% over the last ten years, and 18.6% revenue per share growth in the same period. Its gross margin has risen from 30.7% in 2008 to 33% in 2011, and has remained near its level a decade ago, 34.3%.
DaVita is the second-largest kidney dialysis company in the U.S., behind Fresenius Medical Care AG & Co. (NYSE:FMS), and has approximately one-third of the dialysis market share. DaVita operates 1,884 outpatient dialysis centers in the U.S., serving approximately 149,000 patients as of June 30, 2012, according to its website.
Fresenius, by contrast, operates 3,124 dialysis clinics globally and treats 256,456 patients worldwide. DaVita has room to grow to catch up with it internationally. Fresenius treats 164,058 patients in the U.S., close to DaVita’s domestic number, with 1,077 international clinics. At an earlier stage in its international expansion, DaVita treats approximately 1,000 patients outside the U.S. at 19 dialysis centers.
Fresenius has 13.1% EBITDA per share growth and 12.1% revenue per share growth annually on average for the last 10 years. It has a slightly higher margin, 35.3%, expanded from 30.4% a decade ago, and a P/E ratio of 20.2 and P/B ratio of 2.5. Its share price is also close to a 10-year high.
DaVita also offers high-quality care. In an annual patient satisfaction survey, 96% of respondents said they would recommend DaVita for dialysis services, and its clinical outcomes are the best or among the best in virtually every category, with 10 consecutive years of improvement, according to its web site, evidencing capable management.
Buffett’s biggest mistake with buying high occurred in early 2008, when he doubled down on ConocoPhillips (NYSE:COP) in 2008, at historical high prices, just before its approximately 50% freefall in the remainder of the year. The stock has still not reached Buffett’s buy prices that year, and he sustained billions in losses.
Despite fitting Buffett’s idea of a high-quality company in some ways – strong net income and revenue growth and a 28.4% gross margin – ConocoPhillips suffered the effects of a record spike and then collapse of crude prices in 2008.
Buffett explained to investors in his 2009 annual letter:
I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.
Buffett bought at peak prices in two other prominent instances. First, he initiated an IBM (NYSE:IBM) stake in the first quarter of 2011 at an average price of $159 a share, an all-time-high quarter, and continued to build the position as the price steadily increased to even greater heights in 2012, making it his third largest position. As of the end of the second quarter, he owns 5.83% of IBM’s shares outstanding, at a cost of approximately $10.7 billion.
When asked about his purchase at all-time highs on CNBC, Buffett lauded the company’s economic moat, shareholder reverence, management, record of strategy execution and vision for the future, calling it “a wonderful company.”
He also acknowledged buying railroad Burlington Northern Santa Fe LLC (BNSF), Berkshire’s largest-ever acquisition, at all-time highs in 2009 and 2010.
"Berkshire's $34 billion investment in BNSF is a huge bet on that company, CEO Matt Rose and his team, and the railroad industry," Buffett said in a statement. "Most important of all, however, it's an all-in wager on the economic future of the United States. I love these bets.”
The large DaVita holding increase may be Buffett allowing his portfolio managers Weschler and Combs to invest greater amounts of Berkshire’s float. Because Buffett famously makes mostly massive investments that will move the needle at Berkshire, smaller purchases made in the last several quarters, such as DaVita, were likely made by the new managers.
Ted Weschler held a long-term position in DaVita at his management firm, Peninsula Capita, before joining Berkshire in 2011, roughly the same time Berkshire began buying shares. If the new DaVita purchase comes from Weschler, it raises the question of whether Weschler will be more concerned with price or business quality after Buffett retires and he and his two associates alone run the portfolio.
Since Berkshire disclosed its 10% ownership of DaVita, the price has increased almost 4%.
See Warren Buffett’s portfolio here. Also check out the Undervalued Stocks, Top Growth Companies and High Yield stocks of Warren Buffett.