Warren Buffett has created tremendous wealth for Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) shareholders over the last 50 years. The multinational conglomerate's owner and CEO is widely followed not just because of Berkshire's impressive gains, but how he earned them.
Some of Buffett's best investments over the years were made in companies with strong consumer brands that were run by shareholder-friendly management teams and earned high returns on capital. It's this simple approach backed up by Buffett's massive personal wealth that has so many investors looking to learn from the Oracle of Omaha.
Three stocks that Berkshire doesn't own but would fit the basic criteria Buffett looks for in a potential investment are Walt Disney (NYSE:DIS), Activision Blizzard (NASDAQ:ATVI), and PayPal Holdings (NASDAQ:PYPL).
1. Walt Disney: Unique assets and outstanding management
This is an easy one because Buffett has a history with Disney stock going back to his years managing Buffett Partnership. In 1966, a 36-year-old Buffett met Walt Disney, liked the visionary's plans for Disneyland, saw a bargain in the stock, and bought a 5% stake. That investment of a few million dollars would be worth billions today had not Buffett sold the shares in 1967 to lock in a 55% gain.
In 1996, Buffett found himself once again involved with Disney stock, when one of Berkshire's largest holdings at the time, Capital Cities/ABC, merged with Disney.
At the end of 1996, Berkshire owned 24.6 million shares of Disney with a market value of $1.7 billion. Earlier that year in his letter to shareholders, Buffett wrote, "We're happy to be once again a large owner of a business with both unique assets and outstanding management."
However, over the next few years, Buffett would end up completely selling all of Berkshire's Disney stock. If he had held that stake, those shares would be worth $10.5 billion and would currently be one of Berkshire's largest stock holdings.
Leaving the reasons Buffett may have had for selling Disney aside, it's clear the House of Mouse still has the "unique assets and outstanding management" Buffett described more than 20 years ago. Under CEO Bob Iger, who took over in 2005, Disney is arguably a stronger consumer brand today that in its entire history.
One of the traits Buffett likes in a CEO is good capital allocation skills. Iger has certainly passed that test. Since the end of 2005, Disney stock has tripled the return of the broader market. That outperformance can be credited to the enormous value Iger created by acquiring Pixar (2006), Marvel Entertainment (2009), and Lucasfilm (2012).
Under Iger, Disney became the first Hollywood studio to earn $7 billion at the box office in a single year, thanks to the additions of valuable properties like Marvel and Star Wars.
What's more, Disney typically generates a profit margin and returns on invested capital that are even higher than Berkshire's. The timelessness of Disney's franchises, profitability, and good stewardship from management should appeal to Buffett.
2. Activision Blizzard: Making decisions to strengthen a competitive position
Top video-game maker Activision Blizzard is another company with attributes Buffett would be interested in. Buffett could buy Activision outright if he wanted to, given that Berkshire is sitting on $124 billion of cash and short-term investments, which dwarfs Activision's market cap of $46 billion.
Why would Buffett want to? For the same reasons he has been interested in Disney and for a similar reason that he cited for buying a large stake in Apple. One of the main reasons why Buffett purchased a large stake in Apple, as he told CNBC, was his observation of how people can't seem to live without their iPhone.
Likewise, Activision Blizzard's popular video game franchises, including World of Warcraft, Overwatch, Call of Duty, and Hearthstone have the same hold on the millions of people who play these games on a monthly basis. Kids were playing video games in the 1980s, and those kids have grown up to be parents and many of them are still playing games. The video game industry is valued at $152 billion and keeps growing every year.
Activision Blizzard CEO Bobby Kotick has steered the company to stellar returns over the last 20 years. But he took the company to another level when he negotiated the merger with Blizzard Entertainment in 2008. Since that merger, Activision has consistently generated strong cash flows every year. That allowed the company to initiate its first dividend in 2010, and the payout has increased every year since.
Activision earns a high operating margin of nearly 30%, which is indicative of the low capital intensity of its business; something that Buffett would obviously be attracted to.
One of the reasons for Kotick's success in building such a consistently profitable gaming business is that he has called Buffett a mentor and has been a Berkshire shareholder. It's clear that Buffett's emphasis on capital allocation, making decisions that strengthen a company's competitive position over time, has rubbed off on Activision's management.
3. PayPal Holdings: A sticky service growing incredibly fast
If Buffett likes Apple, he should love PayPal. Why? Because PayPal has a growing base of about 300 million users who are increasingly using their accounts for daily financial transactions, whether it's shopping online, in-store, or sending money to friends and family.
Buffett made a simple observation about Apple's business that could have led anyone to the same conclusion about the iPhone maker's prospects. Buffett could find plenty more investment ideas if he went one step further and browsed what apps young people have installed on their iPhone. If the Oracle did that, he might find PayPal's Venmo app.
Venmo is one of the most widely used peer-to-peer payment apps. It's a small slice of PayPal's total payment volume, but the app is growing incredibly fast.
Venmo is a microcosm of what is driving PayPal's growth. More and more people are using their phones to move money around. It's the future of shopping, banking, stock trading, and commerce in general, and PayPal is at the center of this tectonic shift happening around the world.
Buffett's top 10 holdings favor mostly traditional bank stocks, likely because of their low valuations, so it's unclear if he would ever invest in a more tech-oriented financial service like PayPal. But there is no question that PayPal has the same stickiness with its service that attracted Buffett to Apple.