Warren Buffett has been shopping this year. In the years leading up to 2022, the famed value investor had been sitting on a growing stockpile of cash and was more prone to repurchasing shares of his own company, Berkshire Hathaway (BRK.A 1.18%) (BRK.B 1.30%), than buying other stocks at what he viewed as mostly overpriced. This contrarian thinking has served Buffett and company well, and with the bear market hitting the reset on stock valuations this year, the Oracle of Omaha has begun buying businesses again in earnest.
Again, buying stocks in 2022 and 2023 when everyone is worried about a possible recession may seem silly. But if you're eyeing an investment for the long term, buying now before the next bull market begins is the best strategy. To that end, three Fool.com contributors think Costco (COST -0.24%), Prosus (PROSY -1.00%), and ASML Holding (ASML -3.32%) are great buys right now. Here's why.
Costco's calling card: A great return on equity
Anders Bylund (Costco): Buffett loves to invest in companies with a long history of robust returns on equity (ROE). This important metric tells us several things:
- You can't calculate a meaningful ROE without both positive earnings and a positive value for shareholders' equity (also known as the company's book value). In other words, a company with a solid ROE is profitable and has generated significant value for shareholders over time.
- Buffett doesn't see book value as a reliable measure of any company's fair value, but changes to this metric over time should point out whether shareholders should expect higher or lower stock prices in the future. "The percentage change in book value in any given year is likely to be reasonably close to that year's change in intrinsic value," according to the "owner's manual" on Berkshire Hathaway's investor relations site.
- Ideally, you want to see shareholders' equity rising rapidly, alongside equally impressive gains in earnings per share. The resulting ROE chart doesn't have to rise without pause, but it should remain high and stable. An ROE value of at least 20% over several years suggests that you found one of those rare stocks that would catch Buffett's eye.
With this ROE primer in mind, I think it's time to get excited about Costco stock.
The warehouse retail club's book value has increased by 83% over the past five years, including a 16% gain in the four most recent quarters. Earnings are also up by double-digit percentages on a year-over-year basis, doubling in five years. Yet, Costco's stock was swept up in the market's general anxiety over inflation and interest rates in 2022. Share prices are down by 20% this year, in spite of the rising book value. And Costco's return on equity continues to climb a good-looking salmon ladder over time, resting at 29% today:
In my eyes, that adds up to a rare buying opportunity for shares of this well-managed company.
An $89 billion company trading below net asset value
Billy Duberstein (Prosus): Buffett follows the principles of his mentor Benjamin Graham, who preached buying stocks at prices below the value of their net assets. In Europe's tech holding company Prosus, as well as its cross-held company Naspers (NPSNY 0.27%), investors can capitalize on such an opportunity today, which is rare for such a large company.
Prosus holds a portfolio consisting of roughly 80% in China's Tencent (TCEHY 0.10%) stock, with roughly 20% allocated to high-growth e-commerce businesses across online classifieds, food delivery, fintech, and education technology companies, either wholly owned or in partial stakes of larger public companies.
Leaving aside how one thinks these assets will perform, management is currently playing a game of arbitrage, as Prosus' shares trade at a roughly 37% discount to the market value of its listed and unlisted assets. In fact, the stock trades at an 18% discount to the value of its listed Tencent stake alone.
Since June, management has embarked on a strategy of selling a bit of Tencent every day and simultaneously repurchasing Prosus and Naspers shares at a discount. This immediately creates value, so shareholders will be rewarded when and if Tencent recovers, or if the market starts assigning any sort of value to Prosus' other businesses.
That could very well happen in 2023, as China just reopened its economy and rolled back some of the onerous regulations on its technology companies after a two-year campaign. On Wednesday, China's video game regulator gave approval to 44 imported games -- or foreign games to be adapted by Chinese companies for the Chinese market -- as well as 84 domestic titles, including Tencent's new third-person shooter game Synced: Off-Planet.
Tencent's growth had stagnated over the past couple years as authorities clamped down on big tech companies, froze video game approvals, and limited video game playing for children under 18. Now that authorities appear to be relaxing their regulations and seeking to reopen the economy, Tencent's gaming and other businesses should benefit.
In addition, at its recent Capital Markets Day, Prosus management laid out discrete profit margin targets for its other businesses, seeing 35% margins in the classifieds business, 25% in food delivery, more than 10% in fintech, and over 15% in education technology. While these businesses are well below those levels today, management aims to get the other businesses above breakeven profitability in aggregate by the middle of calendar 2024. Investors previously worried Prosus was just throwing money down the drain with these ancillary businesses, so to see management getting serious about their profitability and not growth at all costs is a good sign.
So, the prospect of a Tencent recovery, recognition for the other non-Tencent businesses, and continued repurchases below net asset value all provide a strong case that Prosus is undervalued, while giving investors a large margin of safety.
Buy a wonderful company at a reasonable price
Nicholas Rossolillo (ASML): Buffett buys companies, not stocks. To be sure, to own part of a publicly traded company, you need to buy a stock. However, when viewed through the lens of business ownership, a change in investing mindset occurs. Business ownership is more than a collection of shares with a daily price attached to them that can be quickly discarded. If you are looking for companies that you want to own, rather than stocks you want to buy, you start focusing on quality and business resilience that leads to ultra-long-term ownership.
I believe this is the type of business ASML is -- a quality company that has made itself an indispensable part of the global economy, and one that will likely remain that way for a very long time. ASML makes equipment used in the manufacture of the most advanced chips around, those used in smartphones and data center equipment that handle artificial intelligence and high-performance enterprise applications. In fact, the most advanced of this equipment, known as EUV (extreme ultraviolet) lithography machines, are only made by ASML.
As advanced chips have proliferated over the past decade, ASML has built very sticky relationships with its customers, among them recent Buffett portfolio addition Taiwan Semiconductor Manufacturing. Companies like Taiwan Semi are highly dependent on ASML's current and future chip manufacturing tech development, so ASML has a long path charted to continued growth for the next decade and beyond.
Another part of Buffett's business ownership equation is paying a reasonable (or better) price for the privilege to own it. Based on ASML's estimates through 2030, the company expects it can grow its earnings at a low-teens percentage rate at the low end of its development pipeline, or at an average high-teens to low-20% rate at the high end of its expectations. Besides more sales of its EUV and related equipment, ASML believes it can achieve this via its growing dividend (currently yielding 1.2% a year) and share repurchases.
If ASML can pull that off over the next eight years, the stock is indeed a reasonable price today. Shares trade for 35 times trailing-12-month earnings per share, or 22 times trailing-12-month free cash flow. If you want to invest like Buffett, ASML is a fantastic buy right now before the next bull market eventually begins.
