Could Warren Buffett and Berkshire Hathaway Target These Elephants Next?

Berkshire Hathaway’s (BRKA) buyout of the H.J. Heinz Company (HNZ) on Thursday was big news.  Warren Buffet is, of course, well known for his shrewd investments and distaste for quick turnaround.  If anyone is looking for an idea as to how he goes about applying this as an investment strategy, one need look no further than Berkshire’s annual reports in which six simple criteria for acquisitions have been reiterated year after year, barely modified, since at least 1995.  They are the following, taken directly from 2012’s annual report:

(1) Large purchases (at least $75 million* of pre-tax earnings unless the business will fit into one of our existing units),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can’t supply it),
(5) Simple businesses (if there’s lots of technology, we won’t understand it),
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).

*this is the only element of the criteria that has been changed over the years, when the figure of $75 million was tripled from $25 million in 2011

The following are some suggestions on how to plug the above criteria in to a stock screener:

1. For Market Cap, anything in the range of $75 million, all the way up to $27 billion, which is about what Berkshire has left to spend after the Heinz deal, considering Buffet’s stated desire to make another big acquisition.

2. To assess “Demonstrated consistent earning power”, you would probably want to select from the fundamentals, keeping in mind Berkshire’s avoidance of projections and turnaround: “EPS growth past 5 years” and/or “EPS growth this year”.  The amount of growth will likely depend on the specifics of respective sector and industry categories, but presumably you would be looking for a “positive” figure.

3. For “earning good returns on equity while employing little or no debt”, you may want to have a look at the Debt-to-Equity and Long Term Debt-to-Equity ratios.  Once again the specific ratio for which you end up screening would have to take into account average figures in a particular industry or sector.

4. It can be difficult to know specifics about a given company’s management, and in any case there is no screen that includes this as a criterion.

5. Based on Berkshire’s current holdings, preclude tech companies (especially newer ones), and look more to sectors more prominent in the Berkshire portfolio like materials, financials, consumer-oriented businesses, and industrial goods.

6. The offering price is a variable that cannot typically be known based on hypothetical situations.  That said; keep in mind during this exercise that Thursday’s buyout of Heinz was completed at a premium of 20 percent, a fairly generous figure for Berkshire standards that likely has much to do with the size, and perceived value and strength of the company. So you can adjust the market cap accordingly for a potential acquisition price.

Using the screener at finviz.com, this is one example of how you might do this:

With market cap set at over $2 billion, EPS growth for this year and the past 5 years at positive, debt/equity and long term debt/equity ratios at under 0.5, and an analyst recommendation of Buy or better, the result is shows about 150 companies that fall within the Berkshire’s budget.  Among these there are a few that, given further subjective variables such as Buffet’s preference for long-established household names, and based on his current holdings, seem like they could be possible candidates for Berkshire:

–Michael Kors Holdings Ltd. (KORS) – With a market cap of $12.32 billion, the apparel store has been doing very well recently with little indication of slowing down, as it has tapped in to growing consumer demand for higher-end but elegant rather than ostentatious clothing and accessories.  EPS growth is at 161.65 percent for this year and 121.86 percent for the past 5, with a debt/equity ratio of 0.01 and a LT debt/equity ratio of 0.

–Costco Wholesale Corp. (COST) – With a market cap of $44.44 billion, the company is too large for Berkshire alone to purchase the entire thing, but that would not stop them from doing so in tandem with another entity such as 3G (who went in about 50/50 on the Heinz deal), or from purchasing some significant amount of shares.  Furthermore, Costco fits criterion number four, as they have a sterling reputation for the way they manage their business.  EPS for the past 5 years is at 10.43 percent, for this year at 17.87 percent, while both their debt/equity and long-term debt/equity ratios are both at 0.11.

–AFLAC Inc. (AFL) – The accident and health insurance provider has a market cap of $22.9 billion, EPS growth for the past 5 years of 13.05 percent and for this year of a whopping 47.99 percent, and debt/equity and long-term debt/equity ratios of 0.27, the company seems like it could be a logical addition to Berkshire’s list of holdings, alongside their other insurance companies such as GEICO and U.S. Liability Insurance Group.  AFLAC would have the added benefit of expanding Berkshire’s presence to include health insurance.

–Henry Schein Inc. (HSIC) – The medical equipment wholesaler has a market cap of $7.78 billion, EPS growth for the past five years of 14.66 percent and for this year of 13.64 percent, and a debt/equity ratio of 0.24, while the long-term debt/equity ratio is at 0.17.  Not only is this a popular stock at the moment, but it would bring a major player in healthcare into the Berkshire portfolio much the same as AFLAC.

–Parker Hannifin Corporation (PH) – The industrial equipment and components company has a market cap easily within Berkshire’s reach at $14.37 billion, with an EPS growth for this year at 16.98 percent and for the last five at 9.75 percent, while its debt/equity ratio is 0.38 with a long-term debt/equity of 0.28.  Such an acquisition would also expand Berkshire’s major holdings into a new area, and one that would be very complimentary to its strong existing presence in materials and construction.

Of course no screen will ever be able to encompass all of the variables that might be relevant to making reasonable assessments about what Berkshire, or any company for that matter, will do in the future.  Each preset screen is different, and there are many variables that are subjective or intangible, or otherwise not measurable by a given company’s numbers alone.

The following companies have also been mentioned for one reason or another in the media as a result speculation, though they did not show up in the results of the screen. Despite that, they could still be included in a list of plausible Berkshire acquisitions based on other criteria: DirecTV (DTV) and M&T Bank Corp (MTB), and DaVita Inc. (DVA), in which Berkshire is already a significant stakeholder in these names.

Keep in mind, this is more of an exercise in assessing companies and stocks from different perspectives, and should have more value in that context than as a means of making literal predictions about what Berkshire will decide to buy next.  That said, this is by no means a comprehensive list, so if there are any companies, screen criteria, or other variables that were missed, please feel free to comment below and share your thoughts.