Two companies recently joined, or rejoined, an elite group: They successfully passed through the Buffett-Munger Screener. That makes them two of just 31 stocks in this exclusive “club”.
A club that can be characterized with the frequently-quoted words of Warren Buffett (Trades, Portfolio): “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Charter Communications Inc. (CHTR, Financial) and Clearfield Inc. (CLFD, Financial) are, at the same time, connected and quite different. What they have in common are management teams that get them on the Buffett-Munger list. They are also quality companies available at reasonable prices.
As we’ll see, they differ in their use of debt, and their capitalizations are poles apart. Neither company pays a dividend.
About Charter Communications
Based in Stamford, Connecticut, this $103 billion telecom company reaches more than 54 million customers, 32 million of them in 41 states, through its Spectrum brand. Those customers include residential and business subscribers, who buy internet, TV, mobile and voice services.
Its recently published fourth-quarter and full 2021 investor presentation summed up its results over the past year:
In the presentation, it also reported seeing “Converged Connectivity Revenue Opportunity.” Specifically, that refers to two opportunities:
- It believes it has a low share of household spending on wireline and connectivity services compared to future capabilities of a fully deployed network and offerings.
- It has an opportunity to increase its market share by saving its customers money.
The Buffett-Munger screener uses four criteria: predictability, debt, competitive advantages and valuation.
Charter has earned a 4 out of 5 rating for predictability, meaning it should outperform lesser-rated companies over the next 10 years. A case for steady growth might be made for Ebitda, but is probably impossible for earnings per share:
Competitive advantage is the second screener criteria, and it appears Charter has several, including sheer size, the ability to bundle, its diverse product and service lines and its geographic diversity. However, its return on invested capital of 6.30% is relatively low.
Third, companies that make it through the screener use little or modest debt. Charter has grown its debt significantly—and its total assets:
At the end of December 2021, its debt reached $531 million.
There is just one criterion for valuation in the screener: the PEG or PEGP ratio. Investors calculate it by dividing the price-to-equity ratio by the five-year Ebitda growth rate. In Charter’s case, the price-earnings ratio is 24.04 while the five-year Ebitda growth rate is 18.70%, resulting in a PEG ratio of 1.29. That’s slightly above the fair valuation level of 1.
As this 10-year price chart shows, its fair valuation is mainly due to a slump that has continued since the end of August 2021:
There were several reasons for the slump, including a downgrade from an analyst concerned about competitive threats as well as investors concerned about Comcast’s (CMCSA) entry into smart-TV and plans to become a live-streaming gateway.
Clearfield
The company describes itself this way in its 10-K for fiscal 2021 (which ended on Sept. 30):
“Clearfield is focused on providing fiber management, fiber protection, and fiber delivery products that accelerate the turn-up of gigabit speed bandwidth to residential homes, businesses, and network infrastructure in the wireline and wireless access network. We offer a broad portfolio of fiber products that allow service providers to build fiber networks faster, meet service delivery demands, and align build costs with take rates.”
It is a micro-cap, near the opposite end of the capitalization range from Charter, at $781 million. Its primary source of revenue is community broadband, as shown in this slide from its first-quarter 2021 investor presentation:
Like Charter, Clearfield generates predictable growth, earning a 4 out of 5 rating from GuruFocus. Yet when we look at a chart of Ebitda and earnings per share over the past decade, the growth doesn’t appear very smooth:
Nevertheless, it does meet the criteria of the Buffett-Munger screener.
Turning to competitive advantages, Clearfield focuses on one: faster install times for its customers:
According to the 10-K, its products allow customers to connect twice as many homes using fewer resources and in less time. In turn, its customers can begin collecting revenue from their customers sooner.
Clearfield has no debt, so it breezes through the third criterion for Buffett-Munger.
The fourth and financial criterion is murkier. It has a PEG ratio of 1.79, well above the fair value mark of 1. That’s based on a price-earnings ratio of 29.85 and a five-year average Ebitda growth rate of 16.70%.
A liberal interpretation of fair value might be set at 1.79. And it may become overvalued if the share price begins to recover from the tech slump that brought it down in early January:
Conclusion
Two companies in the communications sector, with very different outlooks.
Charter Communications meets all the criteria to be a Buffett-Munger company, but that requires a loose interpretation for predictability, competitive advantages and debt. It does have a fair valuation, but that’s only because the share price has been in a slump for five months.
Clearfield appears to be a better choice since it has found a niche in the fiber optics industry, where it enjoys at least one competitive advantage. It also has no debt, but we might question its predictability and valuations.
Still Clearfield might be worth a look for value investors with a long-term perspective because it is debt-free. Growth investors might want to look at Clearfield, too, because of its strong Ebitda growth. However, based on the Buffett-Munger criteria, I would find it hard to make a case for Charter to either value or growth investors.
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