3 Companies That Warren Buffett Should Buy Next

Warren Buffett has been nothing short of a master dealmaker for the better part of five decades now. Through a disciplined approach that stresses the understanding of a company's fundamental business model, as well as buying and holding businesses, not stocks, over a very long period of time, Buffett has played Wall Street like a violin.

Dating back to 1970, Buffett's holding company, Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) , has not once in 43 years had its five-year average gain in book value per share underperform the average five-year performance of the S&P 500. I can't even begin to describe how phenomenal that is, given the multiple recessions we've endured as a country.

It might just be safe to say that Warren Buffett knows a thing or two about investing and buying undervalued companies. Some of his latest purchases include railroad BNSF, which gives Berkshire exposure to consumer-goods and petroleum shipping, Heinz (through a partnered buyout with 3G Capital), which adds a strong consumer-condiments brand to Buffett's portfolio, and NV Energy, a Las Vegas energy provider that Buffett's energy subsidiary MidAmerican will probably use to expand its alternative-energy platform.

But as we've come to learn from Warren Buffett, he's always on the lookout for undervalued businesses. While the large scope of these previous deals may slow down acquisition activity in the near term, there are always companies on Buffett's radar. Here are three companies that I think would be a perfect fit for Berkshire Hathaway and that I think should be on Warren Buffett's radar.

Clorox (NYSE: CLX  )
Clorox has quite a few "Buffetisms" in its favor right off the bat. First, it has an easy-to-understand business model. We're not talking about drug development or bank derivatives here; Clorox is strictly a consumer-goods company that offers an array of cleaning and household products, as well as a lifestyle segment that mainly sells dressings and sauces.

Secondly, many of Clorox's products are set to remain in high demand regardless of economic activity. Bleach, for instance, tends to be an inelastic demand item that'll be purchased by consumers even if we're in a recession. Products like Fresh Step and Scoop Away cat litter, as well as Glad trash bags, also show little pricing pressure if the economy weakens. In short, much of Clorox's product line can be put on autopilot and it would still sell.

Finally, it's as simple as this: Clorox just makes money. Over the past decade, its worst year saw it rake in $342 million in free cash flow. Even including that year, Clorox has been able to generate $5.45 billion in free cash flow since 2003, which is half of its current market value.

Given that it has excellent brand recognition and a product portfolio that could be put on autopilot, I think it'd be an excellent choice for Warren Buffett's Berkshire Hathaway.

Total System Services (NYSE: TSS  )
Buffett may have been a bit gun-shy with technology and finance stocks of late, but he could combine the best of both worlds by purchasing Total System Services, a software developer and payment processor for the credit card industry.

Total System Services, also known as TSS, has a business model that certainly encompasses more business aspects than Clorox's does, but it's still very much a transparent "what you see is what you get" type of company. Total System has software that's responsible for every aspect of the credit card evolution process, including opening, servicing, and processing payments. It also offers electronic check and fraud prevention and detection services.

Source: Andres Rueda, Fotopedia.

Why might Buffett be interested in TSS? I think a big part of the answer lies in the fact that much of the world's transactions are still being done in cash -- 85%, according to MasterCard CFO Martina Hund-Mejean. That leaves literally decades' worth of opportunity for TSS to pick up payment processing and other credit service contracts.

Another factor that would sway heavily in TSS's favor is that it's been steadily increasing book value and boosting its dividend over the past decade. With TSS's annual payout having quintupled since 2003, it could signal to a potential purchaser like Buffett just how sustainable the business model can be.

With nothing short of a depression set to weigh down TSS's business model, it could make the perfect addition to Berkshire Hathaway.

NextEra Energy (NYSE: NEE  )
Admittedly, this is by far the most outrageous of the three because of the hefty $34 billion market value already attached to NextEra Energy and its $28 billion in debt -- but if anyone can do it, Buffett can!

I highly doubt you'll see Berkshire Hathaway making any plays for an energy company so soon after taking the reins of NV Energy, but there isn't an electric utility that speaks to sustainability more than NextEra.

Source: Andreas Klinke Johannsen, Flickr.

Chosen as one of my selections to the Basic Needs Portfolio, NextEra Energy is the leader in alternative-energy capacity in the United States. It recently surpassed 10,000 MW of wind-generating capacity and has been regularly contracting with U.S.-based First Solar to expand its solar-generating capacity. President Obama has made no secret that he plans to focus the U.S. on cleaner-burning alternative energies to reduce our reliance on foreign oil. No electric utility is better prepared for this transition than NextEra.

NextEra also hits on all the key fundamental components Buffett would like to see, including a doubling in book value from $19 a share to $38 over the past decade, as well as 18 consecutive years of dividend increases. Being the most socially responsible of all electric utilities could really make NextEra stand out from the crowd when Buffett goes shopping in the future.

Do you have a company you think would be better suit for Buffett to buy? Tell me in the comments section below.

The price of becoming the world's greatest investor is that Warren Buffett can no longer make many of types of investments that made him rich in the first place. Find out about one such opportunity in "The Stock Buffett Wishes He Could Buy." The free report details a sector of the economy Buffett's heavily invested in right now and exactly why he can't buy one attractive company in that sector. Click here to keep reading. 


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  • Report this Comment On July 07, 2013, at 2:28 PM, bigballsivegotem wrote:

    how about 3 companies he shouldnt buy and someone else should because i think hes greedy enough and really doesnt deserve more money. but that darned media, damn who owns it again?

  • Report this Comment On July 07, 2013, at 2:41 PM, Lilly2014 wrote:

    Isn't he retired yet?

  • Report this Comment On July 07, 2013, at 4:33 PM, doco177 wrote:

    Look no further than the top o’ the 1%, the Oracle of Omaha. Peter Schweizer of Reason reckoned in an exposè published last year on Warren Buffett that this folksy fellow “needed the TARP bailout more than most.”

    Let’s run through the numbers. Berkshire Hathaway firms in total received $95 billion in TARP money. Berkshire, you’ll recall, held stock in Wells Fargo, Bank of America, Goldman Sachs and American Express. Not only did these companies receive TARP funds… they also dipped into the FDIC’s treasury to back their debt. Total bailout: $130 billion. TARP-enabled companies accounted for 30% of the Oracle’s publicly disclosed stock portfolio.

    He’s definitely one of the top beneficiaries of the big bank bailout. And to sharpen the sting, he even got a better deal to help ailing Goldman Sachs than our own government. Buffett got a 10% preferred dividend while the Feds got all of 5%. He cleaned up with $500 million a year in dividends. Without the bailout, you can bet many of his stock holdings would have gone near-zero instead.

  • Report this Comment On July 09, 2013, at 5:29 PM, AnsgarJohn wrote:

    I would be suprised if NEE was bought by Berkshire Hathaway. Here is the Validea Buffett analysis:

    Detailed Analysis Guru Score: 35% Find Other Stocks that Pass This Guru

    STAGE 1: "Is this a Buffett type company?"

    A bedrock principle for Buffett is that his type of company has a "durable competitive advantage" as compared to being a "price competitive" or "commodity" type of business. Companies with a "durable competitive advantage" are more likely to be found in these sub-industries: Brand Name Fast Food Restaurants, Brand Name Beverages, Brand Name Foods, Brand Name Toiletries and Household Products, Brand Name Clothing, Brand Name Prescription Drugs, Advertising, Advertising Agencies, TV, Newspapers, Magazines, Direct Mail, Repetitive Services for Businesses, Low Cost Producers of Insurance, furniture, or Low Cost Retailers. While you should be easily able to explain where the company's pricing power comes from (i.e. a strong regional brand image, a business tollgate, its main products are #1 or # 2 in its field and has been on the market for years and hasn't changed at all, a consumer or business ends up buying the same product many times in a year, etc. or having the lowest production cost among its competition), there are certain figures that one can look at that can qualify the company as having a durable competitive advantage.

    LOOK FOR EARNINGS PREDICTABILITY: [PASS]

    Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Annual earnings per share from earliest to most recent were 2.51, 2.48, 2.34, 3.23, 3.28, 4.07, 3.97, 4.74, 4.59, 4.56. Buffett would consider NEE's earnings predictable, although earnings have declined 5 time(s) in the past seven years, with the most recent decline 1 years ago. The dips have totaled 13.1%. NEE's long term historical EPS growth rate is 4.8%, based on the average of the 3, 4 and 5 year historical eps growth rates.

    LOOK AT THE ABILITY TO PAY OFF DEBT [FAIL]

    Buffett likes companies that are conservatively financed. Nonetheless, he has invested in companies with large financing divisions and in firms with rather high levels of debt. NEE has a debt of 22,866.0 million and earnings of 1,547.6 million, which are insufficient to pay off the debt in less than five years.

    LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY: [PASS]

    Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage. US corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for NEE, over the last ten years, is 12.7%. Although he prefers ROE to be 15% or higher, this level is acceptable to Buffett. It is not enough that the average be at least 15%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last 3 years must also exceed 15%. The ROE for the last 10 years, from earliest to latest, is 13.3%, 12.2%, 10.8%, 13.2%, 12.4%, 14.3%, 12.7%, 13.8%, 12.8%, 12.0%, and the average ROE over the last 3 years is 12.9%, thus passing this criterion.

    LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON TOTAL CAPITAL: [FAIL]

    Because some companies can be financed with debt that is many times their equity, they can show a consistently high ROE, yet still be in unattractive price competitive businesses. To screen this out, for non-financial companies Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. In addition, the average ROTC over the last 3 years must also exceed 12%. Return On Total Capital is defined as the net earnings of the business divided by the total capital in the business, both equity and debt. The average ROTC for NEE, over the last ten years, is 5.9%, and the average ROTC over the past 3 years is 5.5%. This level is unacceptable to Buffett.

    LOOK AT CAPITAL EXPENDITURES: [FAIL]

    Buffett likes companies that do not have major capital expenditures. That is, he looks for companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive. NEE's free cash flow per share of $-4.49 is negative, indicating that the company is spending more money than it is taking in. This is not a favorable sign, and so the company fails this criterion.

    LOOK AT MANAGEMENT'S USE OF RETAINED EARNINGS: [FAIL]

    Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years of $18.55 and compares it to the gain in EPS over the same period of $2.05. NEE's management has earned shareholders a 11.1% return on the earnings they kept. This is unacceptable to Buffett, as management is not profitably allocating retained earnings. Essentially, investors would be better off if the company paid all earnings out to shareholders and let them invest the earnings on their own.

    HAS THE COMPANY BEEN BUYING BACK SHARES: [NEUTRAL]

    Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value. NEE's shares outstanding have not fallen in either the current year or the last 3 or 5 years and so it fails this criterion. This is a bonus criterion and will not adversely affect the ability of a stock to pass the strategy as a whole if it is failed.

    The preceding concludes Buffett's qualitative analysis. If and when he gets positive responses to all the above criteria, he would then proceed with a price analysis. The price analysis will determine whether or not the stock should be bought. The following is how he would evaluate NEE quantitatively.

    STAGE 2: "Should I buy at this price?" Although a firm may be a Buffett type company, he won't invest in it unless he can get a favorable price that allows him a great long term return.

    CALCULATE THE INITIAL RATE OF RETURN: [No Pass/Fail]

    Buffett compares his type of stocks to bonds, and likes to see what a company's initial rate of return is. To calculate the initial rate of return, take the trailing 12-month EPS of $3.65 and divide it by the current market price of $80.66. An investor, purchasing NEE, could expect to receive a 4.53% initial rate of return. Furthermore, he or she could expect the rate to increase 4.8% per year, based on the average of the 3, 4 and 5 year historical eps growth rates, as this is how fast earnings are growing.

    COMPARE THE INITIAL RATE OF RETURN WITH THE LONG-TERM TREASURY YIELD: [PASS]

    Buffett favors companies in which the initial rate of return is around the long-term treasury yield. Nonetheless, he has invested in companies with low initial rates of return, as long as the yield is expected to expand rapidly. Currently, the long-term treasury yield is about 2.20%. Compare this with NEE's initial yield of 4.53%, which will expand at an annual rate of 4.8%, based on the average of the 3, 4 and 5 year historical eps growth rates. The company is the better choice, as the initial rate of return is close to or above the long term bond yield and is expanding.

    CALCULATE THE FUTURE EPS: [No Pass/Fail]

    NEE currently has a book value of $38.23. It is safe to say that if NEE can preserve its average rate of return on equity of 12.7% and continues to retain 49.42% of its earnings, it will be able to sustain an earnings growth rate of 6.3% and it will have a book value of $70.39 in ten years. If it can still earn 12.7% on equity in ten years, then expected EPS will be $8.97.

    CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

    Now take the expected future EPS of $8.97 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (22.1) (5 year average P/E in this case), which is 13.0 and you get NEE's projected future stock price of $116.65.

    CALCULATE THE EXPECTED RATE OF RETURN BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

    Now add in the total expected dividend pool to be paid over the next ten years, which is $24.10. This gives you a total dollar amount of $140.75. These numbers indicate that one could expect to make a 5.7% average annual return on NEE's stock at the present time. The return is unacceptable to Buffett.

    CALCULATE THE EXPECTED FUTURE STOCK PRICE BASED ON AVERAGE EPS GROWTH: [No Pass/Fail]

    If you take the EPS growth of 4.8%, based on the average of the 3, 4 and 5 year historical eps growth rates, you can project EPS in ten years to be $5.83. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (22.1) (5 year average P/E in this case), which is 13.0. This equals the future stock price of $75.82. Add in the total expected dividend pool of $24.10 to get a total dollar amount of $99.91.

    CALCULATE THE EXPECTED RETURN USING THE AVERAGE EPS GROWTH METHOD: [No Pass/Fail]

    Now you can figure out your expected return based on a current price of $80.66 and the future expected stock price, including the dividend pool, of $99.91. If you were to invest in NEE at this time, you could expect a 2.16% average annual return on your money. Buffett likes to see a 15% return, and would even go down to 12%.

    LOOK AT THE RANGE OF EXPECTED RATE OF RETURN: [FAIL]

    Based on the two different methods, you could expect an annual compounding rate of return somewhere between 2.2% and 5.7%. To pinpoint the average return a little better, we have taken an average of the two different methods. Investors could expect an average return of 3.9% on NEE stock for the next ten years, based on the current fundamentals. Buffett accepts a 12% return, although 15% is preferable. This return is unacceptable to Buffett, thus failing the criterion.

  • Report this Comment On July 16, 2013, at 4:53 PM, susan400 wrote:

    with due respect, You don't know Buffett.

    h would never buy a 32b mkt cap with 28B in debt, ever.

    CLx maybe but niot at these valuations.

  • Report this Comment On July 25, 2013, at 3:34 AM, xuhaofei110 wrote:

    @bigballsivegotem

    really? "he's greedy enough" first off, i agree with a couple of people before me that Buffett would not even consider buying these companies, but to say that's one of the most philanthropic pioneers in the 20th century is greedy? Perhaps your dictionary's a different edition than mine because Buffett doesn't match that description. Just because he puts his money behind strong management and safe, long-term values and ends up earning a profit doesn't mean he's greedy. It means he's smart with his money.

  • Report this Comment On July 27, 2013, at 8:08 AM, ValueSpreadsheet wrote:

    TSS looks like a wonderful company indeed! Value Spreadsheet gives it a solid score of 80 (out of 100).

    Consistently high ROE

    Low debt/equity

    Stable and nice net margin (+-13%)

    Healthy FCF levels

    High Altman Z score

    Solid current ratio

    But while the fundamentals of TSS are amazing, the company does not offer a big enough Margin of Safety. Value Spreadsheet estimates the intrinsic value of TSS to be around $30, which means there is currently less than 15% upside potential.

    Still, TSS is definitely a stock to keep an eye on!

    Nick

    http://www.valuespreadsheet.com

  • Report this Comment On August 02, 2013, at 3:41 PM, whyaduck1128 wrote:

    I see CLX as a lucrative acquisition target (in fact, it's so up his alley that I wonder why he hasn't pursued it already), but the other two don't fit what I see as the usual Buffett company. I don't see the "moat" he likes, the distinctive "something" that makes the company and its products unique.

    Then again, not being a clapping-seal Buffett devotee, perhaps I don't have as much insight as many into the mind of the master.

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