On Monday, Berkshire Hathaway
A bet on growing economic activity
More than 70% of Lubrizol's revenues are related to the transportation and industrial lubricant business. Over the short term, this presents a risk in that Lubrizol's customers are in cyclical industries. However, given Berkshire's holding period -- forever -- that is of no concern to Buffett; he's willing to bet that industrial activity and transportation needs, and the resulting demand for Lubrizol's products, will be greater in 10 years' time than they are today.
Unless you want to take sides against the long march forward of global trade and industry, that looks like a pretty good bet. The rationale here is similar to the one Buffett invoked to justify the purchase of Burlington Northern: "I basically believe this country will prosper and you'll have more people moving more goods 10 and 20 and 30 years from now. ... It's a bet on the country, basically."
A leading business going cheap
Despite the 28% premium offered over Friday's closing price, the acquisition price tag looks very reasonable. At $135 per share, it represents less than 12 times estimated earnings per share for the next 12 months. Acquirers of entire businesses often look at the enterprise value-to-EBITDA ratio because the enterprise value represents the entire price paid including the assumption of the target's debt (EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of cash flow). The implied EV/EBITDA of Berkshire's offer is a mere 6.7 (on the basis of estimated EBITDA for the next 12 months), which compares very favorably with Lubrizol's peer group average, 7.6.
How does he do it?
Now that Berkshire has announced the acquisition, commentators and analysts -- including me -- are busy explaining after the fact why the acquisition makes complete sense (though sometimes I'm lucky and I get out in front of Buffett). But it's not as if Lubrizol is a micro-cap stock that no one has ever heard of; it's the leader in its industry and a multibillion-dollar company. In that regard, it's remarkable that it took Buffett's bid to highlight the opportunity. Where were the same pundits before Buffett made his bid?
One way to increase your odds of spotting similar opportunities is to begin by identifying "Berkshire-type" companies, irrespective of the price at which their stock is trading. Once you put together a shortlist of these names, you can begin to stake out your quarry by creating a watchlist, the idea being to bide your time until the stock becomes temporarily undervalued. When it comes to great businesses, that doesn't happen often, so you have to be ready to pounce. Buffett follows the same modus operandi: He has followed some businesses for many years, and he is always ready to purchase their stocks if they are offered at the right price. To get you started, I'll point out two Berkshire-type businesses.
Two businesses with great brands and genuine durability
Founded in 1905, Mead Johnson Nutrition
Have you ever worn a Hanes T-shirt or a Champion sweatshirt? If you're an American male, the answer is probably "yes." These brands, part of Hanesbrands'
It's your turn
Neither of these two stocks looks particularly compelling right now, but the only way you'll know when they do is by beginning to follow them. To track them, click on Mead Johnson Nutrition, Hanesbrands, or start a new watchlist and add any company you want. You'll get valuable updates as well as immediate access to a new special report, "6 Stocks to Watch From David and Tom Gardner." Click here to get started.
Fool contributor Alex Dumortier, CFA, has no beneficial interest in any of the stocks mentioned in this article. You can follow him on Twitter. Berkshire Hathaway is a Motley Fool Inside Value recommendation and a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.