Why Warren Buffett is Right About These Two Mid-Cap Stocks

Editors' pick: Originally published Jan. 7.

There are times when investors need to look beyond income and consider dividend-free shares that promise outsized growth, to ensure a balanced portfolio. When iconic investor Warren Buffett picks up stocks like the two highlighted below, you know it's probably wise to follow in his footsteps.

Let's talk about two mid-caps and decipher how they found a place in the legendary investor's portfolio.

USG Chart USG data by YCharts

USG (USG)

USG is a manufacturer of wallboards and other products for interior walls and ceilings. To that extent, the over 110-year-old business is dependent on the volatile residential and non-residential construction environment.

Trading at less than 9 times earnings, USG is clearly a value buy. Consider its peers, Deltic Timber (nearly times earnings, mostly because of faster growth), Masco (15.4 times) and Louisiana-Pacific (19.1 times), which all trade at higher valuations.

Analysts have suggested for USG a more than 44% rise in earnings a share (EPS) for the December 2015 fiscal year. Additionally, they project a 25.20% EPS growth per year for the next five years (double the pace of industry).

Berkshire Hathaway (BRK.A) is USG's biggest shareholder. It was Warren Buffett who helped USG and a clutch of other firms with financing in 2008-2009. USG survived the recession, at a time when the U.S. economy was on in a downward spiral and "housing" was an unmentionable word.

The economic situation today is markedly better. Overall U.S. construction spending should witness solid growth across 2016 (in particular for the private residential and commercial construction markets), and USG is well placed to leverage the positive ascent.

As you adjust your portfolio to improving economic conditions, it pays to follow the investment lead of Warren Buffett and his Berkshire Hathaway. According to a company presentation, USG now occupies the number one market position in the wallboard, surfaces and substrate products space in North America. USG's ceilings business ranks number two in a consolidated industry and its distribution arm at the top for the U.S. specialty distribution sector.

USG's strong market position in all of its core businesses, robust brand recognition, large manufacturing network and sizable gypsum reserves have reinforced its formidable standing in its operating markets.

USG has improved its leverage, fortified its liquidity scenarios and boosted free cash flow generation. For the 12 months ending Sept. 2015, free cash flow was $130 million (compared to $41 million during 2014) and against figures in the negative for 2010, 2011, 2012 and 2013.

Analysts covering the stock have a 12-month median target of $28, a nice 15.6% rise from current levels.

VRSN Chart VRSN data by YCharts

VeriSign (VRSN)

It is said that Buffett broke his cardinal rule in 2012-2013 to pick up this tech stock.

Tech stocks have never been a favorite of Buffett, who prefers financial services, railroad and other industries he understands.

On the face of things, VeriSign perfectly fits into Buffett's moat theory. The company acts as a registry for the .net and .com URL extensions, which together account for more than half of all top level domains in the world.

Additionally, VeriSign could raise .net prices by 10% per year. Simply put, the company enjoys a stranglehold over its market. And so, even if you're paying 26.1 times the forward earnings (for what is a monopoly of sorts), it doesn't come off as a bad deal.

Just hours ago, Citigroup announced a "sell" on the stock, to book profits after a 53% rise in 2015. We think the stock has plenty of juice left.

For a tech company that operates in a near-monopolistic environment, VeriSign trades cheaply. Its three-year average profit growth of 35.5% and operating margins of 56.6% make it an excellent investment option.

With internet usage, e-commerce and data uptakes rising significantly in emerging markets, VeriSign is effectively positioned to capture this exciting landscape. Furthermore, for 27 quarters, the company has grown revenues on every occasion.

In terms of earnings, analysts estimate VeriSign to post an EPS growth of 12.50% for the Dec. 2015 fiscal year. For 2016, EPS growth is expected to accelerate to 13.10% backed by a healthy 7.40% growth in revenues. Equally appreciable is the company's growing free cash flows (from $135 million in 2010 to $595 million in the last twelve months).

For the next five years VeriSign is committed to sharpen its focus on operating its core businesses. We think that's a pretty smart game plan.

In the context of the economic conditions described above, which stocks should you buy or sell? We suggest you take your cue from Buffett, arguably the greatest investor of all time. To learn what Buffett is buying and selling in 2016, download a copy of our free report.

 

 

 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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