Equity analysts at Wells Fargo (WFC, Financial) recently published a research note looking at the potential stocks Warren Buffett (Trades, Portfolio) might be interested in in the current market. They selected these equities based on criteria they believe Buffett always looks for in companies before investing. For example:
- Five-year average return on equity or return on invested capital greater than 15%.
- Debt-equity less than or equal to 80% of the industry average.
- A five-year average pre-tax profit margin of 20% higher than the industry average.
- Attractive valuation: The current price-earning ratio vs. the 10-year historical average.
- Attractive valuation: Price-book value below historical multiples.
- Attractive valuation: Price-cash flow ratio attractive versus the rest of the industry.
What is interesting about the list of companies they ended up with is that while they might be Buffett stocks from a quantitative point of view, almost none would realistically fit into his portfolio.
For example, the analysts recommend Altria (MO, Financial) as a stock that the Oracle of Omaha might be interested in today. As the largest cigarette manufacturer in the U.S. and the owner of the Marlboro brand (inside the U.S.), Buffett is never going to have an interest in this business due to the negative health impacts of tobacco.
When once asked if he would be interested in owning part of RJR Nabisco, Buffett replied, "I'm wealthy enough where I don't need to own a tobacco company and deal with the consequences of public ownership."
So Altria is off the list.
Other companies the team at Wells Fargo suggested are Bed Bath & Beyond (BBBY), Urban Outfitters (URBN, Financial) and Michael Kors (KORS, Financial). Once again, while all these companies might have fantastic economics and attractive valuations, the one thing they all also have in common is that Buffett never has and probably never will be interested in the retailing and fashion industries. (This is not strictly true, since there are some exceptions such as Nebraska Furniture Mart, which Buffett bought off the infamous Mrs. B., and Fruit of the Loom. However, but these are isolated cases. On the whole, Buffett has stayed away from retailing and fashion.)
Wells Fargo also selected Franklin Resources (BEN, Financial), an asset manager that specializes in emerging markets. While this might fit in with his existing financials portfolio, Franklin is an active investment manager. Buffett has said on many occasions that the vast majority of active investment managers do not justify the fees they charge, so it is unlikely that he would go back on these statements and get into the industry himself.
He could buy the firm if it switched to being a focused passive manager but if Buffett wanted to get into this business, it is much more likely he would seek to buy a company with a more established reputation in the passive investment management business such as Vanguard.
Another recommendation is Regeneron Pharmaceuticals (REGN, Financial). Once again, this is close, but no cigar (or should I say no cigar butt) pick. Buffett has never dabbled in the pharmaceutical biotech industry and while his recent 180 into the airline industry and tech sector teaches us that we should never say never when it comes to him, I think it is safe to say that biotech stocks are too far out of his circle of competence for them to ever be a target for Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial).
The only real idea in the Wells report is EQT Midstream Partners (EQM, Financial). We know that Buffett recently has been devoting a large chunk of capital from Berkshire Hathaway away from capital-light industries such as insurance towards more capital-intensive industries such as utilities and railroads.
If he wanted to get into the pipeline industry, EQT could be an excellent way to do it, and the business might fit well into one of Berkshire's existing business divisions -- that is if he can get a reasonable price for the company.
Disclosure: The author owns shares in Berkshire Hathaway.
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