An investor could do worse than mimic the philosophy of famed Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) CEO Warren Buffett, arguably one of the most successful investors of all time. Buffett is known for purchasing high-quality companies and holding them for the long term.
With that in mind, we asked three Motley Fool investors to choose companies that they believed might make the cut in a Buffett-inspired portfolio. They offered convincing arguments for Apple Inc. (NASDAQ:AAPL), Bank of New York Mellon (NYSE:BK), and Facebook, Inc. (NASDAQ:FB).
An Apple a day
Danny Vena (Apple): Though his aversion to technology is well documented, one of Warren Buffett's top lieutenants at Berkshire Hathaway initially bought shares of Apple in early 2016. After reviewing the original stock purchase, Buffett said he bought "considerably more" just a short time later. When asked why he increased the stake so quickly, he replied, "Because I like it." By the end of that quarter, the Oracle of Omaha had amassed nearly 10 million Apple shares worth about $1 billion.
Buffett has kept buying Apple stock ever since. According to just-released regulatory filings, Berkshire Hathaway increased its holdings by 23.3% in the final quarter of 2017. As of Dec. 31, its stake had grown to over 165 million shares -- worth nearly $28 billion.
So why does Buffett continue to invest in Apple? He has made several public comments that give us insight into why the company constitutes one of Berkshire's largest holdings.
About the iPhone, Buffett has said, "The degree to which people's lives center around the product is huge." He also stated, "Apple strikes me as having quite a sticky product and an enormously useful product to people that use it."
Buffett has also posited that he believes Apple will be the first company to cross the $1 trillion valuation threshold. When pressed for his reasoning, he replied, "I'd bet on Apple just because they've got a stronger position."
Even though the stock gained 46% in 2017, it still represents a compelling value, trading at just 14 times forward earnings estimates. Apple pays a dividend that currently yields 1.5% and its payout ratio of just 25% leaves plenty of room for future increases.
During its recently completed fiscal 2018 first quarter (which ended on Dec. 30, 2017), Apple reported an all-time record $88.3 billion in revenue, up 13% year over year, which generated diluted earnings per share of $3.89, up 16% over the prior-year quarter and also a record. While iPhones were the biggest growth driver, services and other products showed year-over-year growth of 18% and 36%, respectively.
It just goes to show, if Buffett's buying Apple, maybe you should, too.
A bank in name only
Jordan Wathen (Bank of New York Mellon Corp.): This Buffett holding is more of a services company than a traditional banking institution as it makes very few loans, has no real deposit-gathering operation, and doesn't spend heavily to go find retail customers.
Instead, Bank of New York Mellon is a custodian bank and asset manager that holds and manages assets on behalf of major institutions, funds, and other investors. It essentially cures the common cold of the institutional investment industry, providing the back-end services of settlement and storage of assets, trade clearing, record keeping, and more for clients who entrust it to oversee more than $30 trillion of assets. Fees, not interest income, are responsible for the vast majority of its revenue and profit.
Custody services are largely a commodity, but the custodian banks enjoy some pricing power from the simply reality that switching custodians is a hard way to save money. Furthermore, the custodians enjoy the benefit of being low-cost producers, as asset managers often find it's less expensive (and less of a headache) to outsource basic back-end services than manage the same tasks internally. For obvious reasons, asset managers prefer writing a check to hiring and managing a whole department of workers on their own.
Bank of New York Mellon's boring business of completing other people's paperwork doesn't get much attention from Wall Street. Shares trade at roughly 15 times earnings, reflective of relatively tepid growth prospects. But as a Buffett-style value stock, I see it as a great company to buy and hold, one that can generate respectable single-digit earnings growth that should reward investors with attractive returns over the long haul.
The 21st century newspaper
Jeremy Bowman (Facebook): Buffett is famous for his aversion to tech stocks, but just because he generally avoids the sector doesn't mean his acolytes should. With the internet and smartphones pervading more and more of everyday life, and generating more profits along the way, it's a mistake to avoid the sector. Luckily, investors can find Buffett-esque stocks if they know where to look.
Facebook presents one such option. The dominant social network has an economic moat that is arguably wider than any other publicly traded company as it has more than 2 billion members on its primary network and nearly 1 billion on Instagram. Because of network effects, it seems virtually impossible for Facebook to be unseated, with competitors like Twitter and Snapchat trailing far behind. Its margins are also a sign of its competitive advantages as it finished 2017 with an operating margin of 50%, a level almost unheard of. That's a sign of the immense value Facebook brings to advertisers, which has given it outsize pricing power.
Buffett has long been a fan of newspaper stocks as he believes publications without nearby competition are essentially local monopolies, but Facebook has taken that model and injected it with steroids, using the internet to make itself available around the world and leveraging user data to allow granular targeting for advertisers.
Though the company is still growing fast, the stock is also trading at a fair price, at a P/E of 32. If Buffett were a millennial, I suspect Facebook would be one of his biggest holdings.
Danny Vena owns shares of Apple and Facebook. Jeremy Bowman owns shares of Apple. Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), and Facebook. The Motley Fool has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, short March 2018 $200 calls on Facebook, and long March 2018 $170 puts on Facebook. The Motley Fool has a disclosure policy.