Warren Buffett has a problem. One-hundred and twelve billion of them to be exact. That’s the amount of cash that Berkshire Hathaway (NYSE:BRK.A,NYSE:BRK.B) has on its balance sheet at the end of 2018. And odds are, Buffett’s cash hoard has only grown over the last three months as his vast empire continues to pay some hefty dividends.
The problem for Warren Buffett and Berkshire is that amount of cash starts to be a real drag on its profitability and returns. So, for the last year or so, Buffett has been searching for a firm to buy. And given BRK’s size, it needs to be a big one to move the needle. Unfortunately, the Oracle of Omaha hasn’t found just the right one yet.
But there could be plenty of choices.
Analysts have started to look at what Buffett could buy to add to the Berkshire Hathaway arsenal. In total, about 141 different firms could meet the Warren Buffett standard for cash flows, profitability and value. Here are the best possible Warren Buffett stocks that regular retail investors may want to snag up as well.
Cincinnati Financial Corporation (CINF)
It’s no secret that Warren Buffett loves insurance stocks and BRK is chockfull of them. That’s because Buffett loves their float. An insurance company’s float is basically all the premiums it’s collected, but hasn’t paid out just yet. This money can be invested in a wide range of things — with some caveats on amounts. Most insurance companies use bonds and other fixed-income instruments, but not all. Berkshire’s subsidiaries use their float to bet on stocks.
And so does insurer Cincinnati Financial Corporation (NASDAQ:CINF).
CINF is property and causality insurer that has been very successful in using its float to boost its returns over the years. Additionally, the company has some very conservative underwriting standards which have helped limit losses. Combining this plus its local agent-specific businesses model — which partners with existing insurance agencies to promote its businesses — and Cincinnati Financial has been a long-term winner.
In fact, with its last dividend hike, CINF has managed to raise its dividend for 59 years straight.
That sort of steadfastness could be exactly what Buffett is looking for. Moreover, CINF could be an easy fit into Berkshire’s other insurance assets. With a market cap of around $15 billion, the stock would be an easy one for Buffett to swallow as well.
If there is one thing Buffett likes, its simple to explain businesses that churn out hefty cash flows year in and year out. That’s basically what Fastenal (NASADQ:FAST) has been doing for the last 50 years.
FAST produces and sells a variety of hardware and supplies that other industrial firms or businesses need to keep running. This includes everything from boring nuts and bolts to more exotic fare like tools and pumps. It’s basically an industrial supplier to the industrials. That’s a good place to be.
Over the years, Fastenal has cemented itself as one of the top players in this niche. The key for the firm comes down to its relationships with other industrials and manufacturers. FAST’s system makes it easy for procurement managers to order. The firm operates more than 2,220 branches and a hefty online website. But the real win is that FAST has been able to get inside manufacturers themselves. This comes from Fastenal’s storage bin replenishment and vending machine programs. Here, FAST is able to directly integrate into a manufacturer’s ordering/supply chain and allows for ease of repeat customers. Simply, FAST is able to integrate itself into a customers’ workflow. Last year, the firm processed more than 41 million orders and pulled in more than $5 billion in revenues. More importantly, it has allowed FAST to grow at a very hefty clip in terms of margins and profits.
With a wide moat, great growth and $20 billion market-cap, Buffett could and should swallow up Fastenal.
Buffett is clearly a fan of homeownership as several of Berkshire Hathaway’s subsidiaries focus on products for construction and decorating. This includes carpet-producer Shaw Flooring. Under this banner, paint-producer Sherwin-Williams (NYSE:SHW) could get the nod from Buffett.
With its 2017 purchase of Valspar, SHW became the global leader in paints and coatings. This includes a hefty amount of paints and stains for personal/home use. But the real reason why Buffett could give SHW a nod is its industrial businesses. Sherwin-Williams produces a ton of different coatings and paints for a variety of industries — including lucrative aerospace and automotive/transportation finishes. These sort of performance coatings have been a bright spot in its business — with sales jumping 5% in the last quarter. Profits here jumped by over 60% as Valspar was able to significantly contribute. That’s the sort of growth that Buffett would love to see inside Berkshire.
And Buffett could find plenty to love in its dividend as well.
Thanks to big growth in several of these performance coatings segments, Sherwin-Williams recently was able to raise its dividend by an eye-popping 31%. Meanwhile, the stocks payout ratio is measly 23%. That leaves plenty of room for future payout increases.
In the end, SHW is the kind of specialty industrial business that throws off serious cash flows. Exactly what characterizes most Warren Buffett stocks.
Southwest Airlines (LUV)
The long joke among investors is that investing in an airline was the surest way to lose to money. For the longest time, no Warren Buffett stocks were airlines. But that was then and this is now. And now Berkshire counts holdings in the four major airlines, but Southwest (NYSE:LUV) could ultimately be the one that gets bought out.
Things have changed a lot for the industry. Thanks to deregulation and the wave of mergers, the number of airlines has shrunk in the U.S. That has provided the remaining ones with larger operating footprints and better profit profiles. Additionally, dropping oil prices have reduced one of the biggest costs for the sector. That’s what initially drew Buffett into the sector in the first place.
Why Southwest will get the love is that it the airline checks a lot of boxes for Buffett.
For one thing, the corporate culture at LUV is top notch and is still run by early insiders and founders. Secondly, it’s moat as a carrier is deeply entrenched and many low-cost competitors have difficulty competing. Finally, the top-notch carrier may be cheap.
LUV cut its guidance twice in the last two months thanks to woes over canceled flights. Southwest flies almost exclusively 737 planes — though not exclusively 737 Max planes. With that, shares have dropped and now trade for just 10 times free cash flows. That’s a very juicy figure and could get Buffett to just buy out the stock.
Moody’s Corporation (MCO)
Businesses that produce plenty of cash flows because they have no overhead are something Buffett likes as well. So, when you combine with this with an irreplaceable moat, you know Buffett is 100% onboard. This could help explain his attraction to Moody’s Corporation (NYSE:MCO).
Moody’s — along with rival S&P Global (NYSE:SPGI) — provides credit ratings, research, and risk analysis services. And as one of the three main ratings agencies, investors, banks and other customers rely on MCO to make their investment decisions. This includes BRK. In fact, a company can’t issue a bond without a ratings agency giving it it’s blessing.
The best part is that Moody’s only real overhead is salary. That leads to plenty of cash generation and mega-sized margins for its products. This year, Moody’s estimates that it will generate more than $1.6 billion in free cash flows. Meanwhile, the firm has been more than happy to share those cash flows with investors. Over the last five years, MCO has managed to grow its dividend by an average of 12%. Currently, the stock yields 1.03%.
These factors are some of the reasons why Buffett and Berkshire own a hefty slog of Moody’s shares.
Add in its growth potential from side analytic business and the need for robust credit research and there’s a good chance that Buffett could finally take the firm private.
Disclosure: At the time of writing, Aaron Levitt did not hold a position in any of the stocks mentioned.
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