Buffett Recommends Buying these Stocks
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When someone like Warren Buffett recommends buying shares in a certain company investors should listen. It's not convenient to blindly replicate Buffett's ideas -- after all, one of Buffett's investing principles is that investors should do their own research and always invest in the companies and sectors they understand well enough.
As a starting point for further research, however, Buffett's ideas may be an invaluable resource. Even when investors disagree with Buffett and his latest investment moves, there is a lot to be learned from his thought process and strategic decision making.
Buffett has made some notorious moves in the last year, and he has ventured into areas that he had never visited before. Two very important decisions in that sense were those about buying back Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) stock and also buying an almost 5.5% share of IBM (NYSE: IBM).
Buffett had never bought back any shares of Berkshire or ventured into the world of technology companies before, so it's worth analyzing the rationale for those two decisions. We can read in Berkshire latest investors' letter:
Last September, we announced that Berkshire would repurchase its shares at a price of up to 110% of book value. We were in the market for only a few days – buying $67 million of stock – before the price advanced beyond our limit. Nonetheless, the general importance of share repurchases suggests I should focus for a bit on the subject.
Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.
The explanation is quite clear: at a price to book value below 1.1 Buffett considers that Berkshire is materially undervalued, and that situation merits a share buyback. Shares of Berkshire have risen since the news about the buyback surprised investors in September of last year, but it's currently trading below 1.2 in terms of the price to book value ratio, so it's not too far away from those levels.
The ratio of 1.1 can be the limit for deciding if Berkshire will continue buying back its own stock or not, but it certainly doesn't mean that the shares are overvalued above that level. Also, keep in mind that Berkshire has increased its book value by almost 20% annually since 1965; even if growth rates are much slower in the future, the company's book value should not take very long to catch up to Berkshire's higher price, bringing its price to book value ratio to lower levels unless we also see higher increases for the stock.
Berkshire is a very solid company that has big chances of providing investors with better than average returns over the long term. Buffett knows the company better than anybody, and considering the quality of its assets it sounds like quite a reasonable idea that Berkshire could be worth clearly more than 10% above its book value.
As for IBM, Buffett values both its operational improvements in the last years and the company's smart financial management.
As all business observers know, CEOs Lou Gerstner and Sam Palmisano did a superb job in moving IBM from near-bankruptcy twenty years ago to its prominence today. Their operational accomplishments were truly extraordinary. But their financial management was equally brilliant, particularly in recent years as the company’s financial flexibility improved. Indeed, I can think of no major company that has had better financial management, a skill that has materially increased the gains enjoyed by IBM shareholders. The company has used debt wisely, made value-adding acquisitions almost exclusively for cash and aggressively repurchased its own stock.
Buffett understands that Berkshire benefits in two ways with its position in IBM: the first and most important factor is IBM's ability to adapt to changing market conditions and customers' needs in order to increase earnings and cash flows, but a second and important consideration is the company's ability to return cash to its shareholders via stocks buybacks.
In the end, the success of our IBM investment will be determined primarily by its future earnings. But an important secondary factor will be how many shares the company purchases with the substantial sums it is likely to devote to this activity.
IBM has made many smart decisions in the last years: its transformation from a hardware manufacturer to a services and software company has been a huge boost to margins and cash flows. The company has also been expanding into high growth regions and trends like cloud computing and other technological innovations bode well for this blue chip in the middle term. Add to all these factors an intelligent financial management and it looks like Buffett started with his right foot when deciding to invest in the technology sector.
There are always good reasons to listen to Buffett, and in his last letter to Berkshire Hathaway shareholders the Oracle of Omaha has provided investors with two very interesting investment ideas. It wouldn't be wise to ignore them.
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