Warren Buffett's famous investment in Wrigley's gum is a perfect example of his legendary value-based financial philosophy. By buying the maker of an evergreen product that's dead simple to make and in constant demand, the Oracle of Omaha obtained the rights to a steady and highly reliable cash flow for many years to come.
In the healthcare sector, you may find that Steris (STE -0.77%) has many of the same qualities as Wrigley's did. The Dublin, Ireland-headquartered company's specialty is sterilization. If you've been to a healthcare provider recently, it is something that never gets old -- nor does it get more complicated over time. Using Buffett's investment principles, would Steris be a solid bet, and, if so, why?
There's a lot for Buffett to like
Among the essential things Buffett looks for in a company is whether it has an evergreen business that's relatively immune to external shocks. That generally means selling products or services in demand in any season. For example, Wrigley's gum and soft beverage Coca-Cola (KO -0.85%) (another of Buffett's investments) are consumed across seasons and economic cycles. Steris fits that bill. Its customers will always need its products and services no matter what.
Hospitals, healthcare systems, dentists, and biomedical laboratories need to maintain a sterile environment to function. The company's products cover their every need in that department, with its offerings ranging from antiseptic wipes to autoclaves and other sterilization equipment. It also makes infrastructure for sterile areas, like surgical tables, surgical lights, and surgical ventilation systems. Every additional medical procedure requiring sterilization means more money in Steris' pocket.
That's part of the reason why its revenue has grown over 200% over the last decade, reaching trailing annualized sales of nearly $4.3 billion.
Second, a typical Buffett business is not highly capital intensive. Similarly, most of Steris' consumable products are simple to make, and customers need a steady supply at all times. Therefore, 80% of Steris' revenue is recurring, which is a major point in its favor. And its earnings are consistent across long timescales, with its five-year adjusted earnings per share (EPS) compound annual growth rate (CAGR) reaching 13%, another typical characteristic of a Buffett investment.
There's only so much innovation that can go into something like a sterile wipe or a surgical light. The upside is while Steris can keep its research and development (R&D) spending in check, the risk of a competitor looking to spend big on R&D and potentially gnaw away on the company's market share is also vastly diminished. R&D expenses, in fact, clocked only around 2% of its total revenue last year.
Needless to say, the stock is a good performer, handily beating the market over the last five years.
No stock is perfect
As favorable as Steris is, Buffett would likely find issues with a few things.
Its net profit margin of 6.6% is on the thinner side, and it has fallen by 39.5% over the last three years.
Form Buffett's vantage point that could be a dealbreaker. He's well-known to be a stickler for consistency, so that's a yellow flag. On the other hand, higher margins mean that a company can afford to compete with rivals for longer, and they tend to indicate that there's some kind of competitive advantage in play.
And that introduces an even bigger issue.
Steris doesn't have a large economic moat to protect its business. While its specialization in sterilization technologies does mean that its brand is a leader, there isn't anything particularly hard to replicate just about most of its products and services. So if a hospital thinks it can get a cheaper set of laboratory glass washing stations or clinical-grade detergents from a competitor, there's little to stop them from switching to a different vendor.
To get around this, Steris emphasizes complete packages of goods and services which can handle close to 100% of a customer's sterilization needs, and it also tries to lock customers into three- to five-year agreements. While that's better than nothing, it's far from the ideal situation of captive customers that have nowhere else to go.
Finally, management has stated that growing the dividend is a top priority.
Right now, the dividend has a forward yield of 0.75%, but the bigger issue is that it pays a dividend at all.
Buffett usually prefers to see businesses reinvest earnings at existing or higher rates of return. If companies are unable to do so, paying back shareholders in the form of dividends is the better alternative. In short, for Buffett, dividends are a fallback option as they impart a tax burden on investors while simultaneously signaling that a business can't reinvest at attractive rates of return.
With that being said, Steris has also indicated that reinvesting in the company and performing acquisitions are priorities too, so the quarterly payout might not be a dealbreaker for Buffett.
My take on what Buffett's verdict might be
While Buffett doesn't currently have a position in Steris, the business does have many characteristics the legendary investor looks for in his investments.
Its downsides are relatively minor, and mostly pertaining to its plodding pace of growth. That's understandable since the business relies on the number of healthcare procedures to increase each year.
Especially in light of the pandemic, which emphasized the need for sterilization tools, Steris is likely to keep expanding its operations for years to come. But there probably isn't any way for it to increase its revenue dramatically more rapidly than it is currently.
Therefore, it's important to note that if you decide to buy shares of this company, you'll need to have a time horizon that rivals Buffett's before your investment pays off.
If you're ready to buckle up for decades, this stock could turn out to be an ideal investment.