A Good Deal on a Harley for Warren Buffett

• ByTim Melvin, RealMoney.com Contributor
• On 8:45 am EST, Monday January 26, 2009

Over the course of the weekend, I had a lengthy phone call with my good friend the irascible curmudgeon from Chicago. As usual, we talked about everything from Cubs and Orioles baseball to markets. During the conservation, we got on the subject of some of his favorite stocks right now and the fact that they were acting horribly.

Two names in particular were Harley-Davidson and Dow Chemical . The curmudgeonly one offered up the opinion that since Warren Buffett already has enough money committed to Dow, he should just buy the company. Since Berkshire Hathaway already has a $3 billion equity investment already, why not just buy the company outright for $12 billion, the current market cap of the chemical giant?

I allowed that while that made sense, Harley was more of a Warren stock. The brand is an icon, and the moat is enormous. You simply could not recreate Harley-Davidson. You can enter the motorcycle business if you like for a reasonable low cost of entry, but you could never recreate the lifestyle associated with the company.

As I pondered that, I realized that it actually would make a lot of sense for Warren or someone like him to buy this company. Business is terrible right now. Profits were down 58%. Global sales were off more than 13%. U.S. sales fell almost 20%. The 34 cents a share it earned in the quarter was well short of the 57 cents that was expected the always-accurate Wall Street analyst brigade.

This makes sense to me. If I am worried about my job or losing my house, I am not running out to buy a Harley. I do, however, know a lot of people who will give up their house before they give up their Harley. Business is bad, and it will probably be worse in 2009. The financing business is almost 15% of profits in a normal year, and it is virtually frozen by inactive securitization markets. The stock reflects the condition of the business. It is off over 75% in the last year.

This is the perfect company to take private at these levels. The stock is hammered by the weak economy. The market cap is $52.6 billion right now. The enterprise value is $5.5 billion. Tangible book value is a little over $10 a share, and the enterprise-value-to-EBITDA is under 4. While the economy hurts the business right now, over the past five years prior to 2008, the company averaged $1.5 billion of operating profit and net income of almost a $1 billion. An investor willing to wait out the bad times could easily end up with a company kicking out close to a 20% return on investment on an annual basis.

There are a lot stocks like this right now. Business is hurt badly by the current economy. When we recover, pent-up demand for goods and services should take the stocks to levels that are several multiples of the current price. So we should be just buying and buying, correct?

The answer to that is another question. How high is your pain threshold? I believe a stock like Harley could easily rise to four or five times the current stock price over the next five or six years. The problem for investors right now is that it can easily fall by half or more from current levels before the recovery begins. Most people have a hard time withstanding that type of short-term pain.

That's why I keep advising you to move slow and stay small. I bought my initial position in Darling International last year a little above $7 a share. I bought 10% of the amount I might normally consider a decent position. I expect that sometime in the next five years it will be well above $20. Since my initial purchase, the stock has fallen as low as $3.25. I made a couple of additional purchases as it fell, and it is not killing me to keep the stock as if I had bought a full position initially.

My first buy of Hardinge was at twice the current levels. I believe the stock is worth three to four times my price in an economic recovery. By staying small I can mange my pain while I wait and make Mr. Market work for me.

There a lot of stocks like L.S. Starrett and Sunstone Hotel Investors that I believe trade for a fraction of what they are worth in the long run. In the short run, I have to keep in mind that before they double or triple, they could easily fall by 50%.

The economy is horrible, and in my opinion, so far the maneuvering by government and financial market officials are the wrong ones. I do not know when the recovery begins. I am sure it will at some point. Until then, it is critical to manage my pain and enable myself to reap the eventual rewards.

I kind of hope Warren buys Harley. Can't you see Charley Munger and him pulling into the Berkshire meeting on matching Berkshire-themed hogs?

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Please note that due to factors including low market capitalization and/or insufficient public float, we consider DAR, HDNG, SCX and SHO to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Buzz up!