Warren Buffett comes as close to a legendary man on Wall Street as anyone alive. His powers of observation and his accomplishments as an investor are beyond repute.
For example, I read that in 2002, he told one of his Berkshire Hathaway companies, General Re, to untangle itself from a couple of thousand contracts it had involving such complex financial instruments as securitized mortgages. This was about five years before the credit crisis we are going through hit everyone's radar screen and these financial instruments became Wall Street's equivalent of Superman's kryptonite.
In a Fortune magazine article in 1999, he said he expected the stock market to produce a return, after discounting for inflation, of about 4% a year over the coming years. This was when the market had been producing double-digit returns for years -- and before the Internet bubble went "poof." The current decade is largely proving him right. The man can see the future.
That foresight is why I like looking at my Buffett-based strategy, which I based on Buffett's approach to investing. Buffett is well known for his preference for consumer-products companies (Coca-Cola
(KO)
, Gillette, and recently his role in the hookup of Mars and Wrigley
(WWY)
), so I have run a screen looking for strong consumer-oriented companies favored by the strategy.
If you have been reading this column for any length of time, you know I do not make predictions. I am not predicting that Buffett has any interest in investing in these companies (well, one he is known to own). But these are all solid companies that get the nod from my Buffett-based strategy.
One such company is PepsiCo
(PEP)
, maker of Pepsi sodas, Tropicana orange juice, Frito-Lay chips and Quaker Oats cereals. The strategy demands that the company be in a dominant position in its markets, and that is certainly true of PepsiCo, which is ranked No. 1 or No. 2 in sodas and chips. Earnings have been adequately predictable, going up in eight of the past 10 years. The past 10 years have seen an average growth rate in earnings of 13.6%, and analysts' earnings estimates for the next 10 years average 10.9% growth a year. Both of these are perfectly acceptable numbers.
The company has manageable debt. Earnings were $5.7 billion, while debt is $4.9 billion, meaning debt can paid off with less than a year's worth of earnings. Return on equity over the last 10 years has been a very strong 30.3%, and has never dipped below 26.9% during this period (the strategy sets a minimum of 10%).
Return on capital has also been strong -- 23.9% averaged annually for the past decade -- and never dropped below 18.5% (9% is the minimum required for ROC).
PepsiCo also has positive cash flow per share, another plus. Another good mark is that management has earned shareholders a return of 16.1% on earnings retained.
All of this financial analysis says the company is performing well. At this point, the strategy shifts to analyzing the stock's price, and looks for an expected average annual return to the investor of about 15% or more over the next 10 years, given today's price level. PepsiCo shareholders, according to our analysis, can expect a return of 15.4%, which indicates the stock is a good buy at this time.
Hansen Natural
(HANS)
is another consumer products company liked by the Buffett strategy. This company's best-known product is Monster Energy, the second-largest energy drink, which is the fastest-growing segment of the beverage industry.
Hansen's earnings have been reasonably predictable, the company has no long term debt (that is impressive), return on equity is consistent and high (25.4% on average over the past 10 years), while return on capital is also very strong (24.2% during the past decade). Cash flow is positive and management has earned shareholders a high-energy 40.2% return on the earnings retained. In terms of what shareholders can expect to earn annually given the stock's current price, the analysis produces an effervescent 21%.
The last company I want to mention is HOG. Whoops, that's its stock symbol, though its products are known to aficionados by that moniker. I am of course referring to the iconic motorcycle maker, Harley-Davidson
(HOG)
. Its product line needs no introduction.
Some things about Harley that blasts loudly in its favor according to the Buffett strategy: earnings per share have dipped only once in the past 10 years, long-term debt ($980 million) is not much more than recent annual earnings ($896 million), return on equity is a strong 27.5% and consistent, while return on total capital is 21.6%, also cause for riding a few hairpin turns at top speed.
As with PepsiCo and Hansen, Harley enjoys a positive cash flow per share, and management has earned shareholders a very respectable 16.0% on retained earnings. Investors can expect a return of 15.7% a year over the next 10 years given the stock's current price.
These three companies are high performers with consistent track records and well-priced stocks. I am not predicting Buffett himself would want to buy any of these (he owns Harley and is a long-time investor in Coca-Cola and therefore probably not likely to buy PepsiCo), but I would say that for long-term, solid investments, these are good bets for virtually any investor when purchased at current prices.
A note: I'll be a featured speaker at the Las Vegas Money Show today (at 2:15 p.m. and 6:00 p.m. PDT) and Wednesday (at 11:30 am PDT) this week at Mandalay Bay. I'll be talking about how to profit from Guru Analysis of Buffett, Lynch and Graham, and I hope you will stop by and say hello.
At the time of publication, Reese's clients were long PepsiCo and Harley-Davidson, although holdings can change at any time.
John P. Reese is founder and CEO of Validea.com, an investment research firm, and Validea Capital Management, an asset management firm serving affluent investors and companies. He is also co-author of the best-selling book, The Market Gurus: Stock Investing Strategies You Can Use From Wall Street's Best. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback. Click here to send him an email.
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