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The difference between Warren Buffett and the non-billionaire investor is that we have many, many more opportunities to make money than he does. Buffett admits it, too. You most likely heard his quote about being able to achieve a 50% annual return if he had less capital to work with. But the Oracle can't buy a small cap because it wouldn't move the needle in terms of Berkshire Hathaway's returns.
Since we have this God-given blessing of being poorer than Buffett, why do most people focus on what he's buying instead of what he can't buy? Let's take a look at a couple of small, growing companies with P/Es well under their respective industry averages.
In need of a tune-up?
Standard Motor Parts (NYSE: SMP ) manufactures aftermarket replacement parts for a wide variety of vehicles. The company sells to auto shops, as well as do-it-yourself stores such as Auto Zone and Pep Boys, and it shows great year-over-year cash flow growth and trades at a tempting P/E of 5.74.
For a raw materials-intensive business, the company manages debt well -- current assets handily cover total liabilities. Net income from continuing operations grew 160% over last year because of a strong rebound in sales and far lower income-tax expense. The company also recently moved operations to a plant in Mexico -- undoubtedly a cost saver.
But before you call your broker, consider the negatives.
First, insiders are selling. In 2011, the company voted to more than double the amount of shares available to grant as stock options, and many of those shares went to executives. In the past year, the CEO, CFO, and directors have been selling off. It could be just to pay for a third facelift, but I don't like that kind of behavior when it comes at the cost of shareholders.
Second, Standard Motors' latest 10-K cites an inventory management issue. Apparently, return policies were a little lax and customers took advantage. Management claims to have rectified the issue by implementing stricter policies, but this is something to watch.
A 99% Buffett buy? No. The company is cheap and growing, but not cheap enough to justify a so-so management team.
Pass the linguini
Man, Rosetta Stone was useless. Next up on the block is Bravo Brio Restaurant Group (Nasdaq: BBRG ) . The company operates two chains of Italian restaurants -- Bravo! and Brio. Think of these as somewhere in between Olive Garden and Maggiano's.
At a P/E of 5.32, this is some cheap antipasti. Compare with Darden Restaurants (NYSE: DRI ) , owner of Olive Garden, which trades at a P/E of 14.62.
Bravo has enjoyed great cash flow growth for the past few years. It's also seen a sharp increase in net income, largely because of an income tax provision. Bravo looks like a much smaller Darden, except where Olive Garden has an average check of about $16, Bravo averages $22.
Insiders and fund managers are buying. Both the CEO and CFO have made multiple open-market purchases over the past year in the $15-$17 range. Ron Baron of the Baron Capital Group, a $17 billion fund, recently increased his position by more than a million shares at an average cost of $17 per share. The stock has lately been hovering around the $20 mark.
What can it do to make things primo? The company needs to improve its cash position and margins. The company has about $10 million in cash with a good bit of debt on the balance sheet. I would prefer to see that debt paid down, but compared with Darden's much chunkier debt-to-cash ratio, it seems that Bravo is managing comparatively well.
Less of a concern is Bravo's margins. Net income margins are a point or two below the industry average, and gross margins are even lower at about 6% under. Margins are expanding, and I believe the trend will continue as the company streamlines operations. It's in a growth phase right now and needs time to adjust to being a larger company.
A 99% Buffett buy? Yes. The company is incredibly cheap, considering its ability to grow and the strong management team.
Standard Motor Parts is not a bad company, and it certainly warrants its own round of analysis. But looking through the Buffett lens, it just doesn't make the cut when you see management selling out left and right.
Bravo has itself in place to be a real winner if it can get the debt situation under control and beef up its cash. I love that the executives are all industry veterans and have the capacity to bring this company to new levels.
Buffett could read hundreds upon hundreds of 10-Ks a year looking for a small handful of ideas. We looked at two and found a pretty compelling pick. Not bad, not bad.
Stay tuned as we run through this exercise again in the future and keep an eye out for companies on the upward slope but trading at cheaper ratios to their industry peers.