Warren Buffett's Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) has too much cash: As of the end of the third quarter the company's cash pile had ascended to more than $35.3 billion. The Oracle of Omaha likes to keep the company's cash balance above $20 billion, but too much cash can be drag on earnings and profitability for Berkshire Hathaway investors.
It's not like Buffett is in any hurry to put that money to work, but taking a look at some alternatives that could fit his investment criteria sounds like a good way to identify high-quality ideas worth considering for your own portfolio.
Patience and discipline
To begin with, let's consider what this means for Berkshire Hathaway. Too much cash sounds like a nice problem to have, and it certainly provides safety and flexibility for the company.
On the other hand, Buffett considers $20 billion to be more than enough from that point of view, and the current balance, well above that amount, is generating lackluster returns for the company at historically low interest rates.
If the market continues on its bull run and Buffett can't find good enough investment alternatives, cash will likely continue increasing and this will probably become a considerable drag on the company's return on capital.
This does not mean that Buffett will put that money to work only because Berkshire has too much cash; the Oracle of Omaha will wait as long as he has to for compelling investment opportunities meriting a long-term position.
For Berkshire shareholders, this probably means subpar returns if the market continues rising steeply and Berkshire is left behind with too much cash in its portfolio. However, that's the price of discipline: You sometimes need to forgo short-term profits in exchange for a consistent and long-term proven approach to investing.
Nobody knows when or by how much the market will retrace, but it will happen sooner or later, and Berkshire Hathaway's cash will become enormously valuable when the time comes. In the meantime, let's take a look at a couple of high-quality names worth a place on Warren Buffett's shopping list.
A sweet deal
Hershey (NYSE:HSY) is the leading player in the U.S. chocolate market, with a tasty market share above 43%. The company owns a product portfolio consisting of more than 80 brands including Hershey's, Reese's, Kit Kat, Twizzlers, and Ice Breakers, among others.
Buffett loves consumer names with strong brand presence in stable industries with predictable long-term demand, and Hershey fits that description quite well.
Hershey has a rock-solid trajectory of cash flow generation, the company translates more than 12% of revenue into free cash flow, and that money is then actively distributed to investors via dividends and share buybacks. Management is committed to distributing 50% of the company's earnings as dividends, and those payments have increased at a 6.5% annually over the last five years. Dividend yield is around 2% at current prices.
You don't want to stuff yourself with chocolate too quickly, though, as it can lead to serious indigestion. Hershey is trading at a P/E ratio above 31, which is materially higher than the company's five-year average P/E ratio of around 22.5.
A great company trading at a steep valuation can make a sweet candidate to add to your shopping list for a market pullback.
Colgate-Palmolive (NYSE:CL) is well-known for its oral care business, which generates nearly 44% of the company's revenue thanks to a global market share of more than 45% in toothpaste and more than 33% in the manual toothbrush business on a worldwide scale. But this global powerhouse also offers sizable exposure to other businesses like personal care, home care, and pet care, which represent 22%, 21%, and 13% of sales, respectively.
Colgate sells its products in 223 countries and makes more than 80% of its revenue outside the U.S., which provides geographic diversification and growth opportunities in emerging markets to investors.
The company has above-average profitability with an after-tax return on capital of 31.4% versus 17.7% for its peer group, and has produced many smiles for shareholders over the decades with an amazing trajectory of growing dividends. Colgate has paid uninterrupted dividends since 1895, and it has raised those dividends for 50 years in a row.
Colgate trades at a P/E ratio of 25.3 versus an industry average of 21.4 and has a five-year average P/E ratio of 18.3. The dividend yield of 2.1% is also signaling an optimistic valuation in comparison with a yield of 2.8% for the average stock in the industry and 2.3% for Colgate over the last five years.
Colgate deserves a premium due to its competitive strengths and superior profitability, but waiting for a cheaper valuation may provide a better entry point in this global leader.
When a high-quality business is trading at an expensive valuation, it can be considered a good candidate for a future purchase. When the price becomes more convenient. Hershey and Colgate seem to be good enough for Warren Buffett's shopping list, so maybe they also deserve a place on your own list of companies to buy when the opportunity arises.