According to The Atlantic, here is a list of the ‘Top Ten American Firms’ based on estimated total profits for 2011:
1. Exxon Mobil (XOM)- estimated 2011 profit of $32.3 billion
2. Microsoft (MSFT)- estimated 2011 profit of $21.0 billion
3. Chevron (CVX)- estimated 2011 profit of $15.3 billion
4. JP Morgan Chase (JPM) - estimated 2011 profit of $19.1 billion
5. Pfizer (PFE)- estimated 2011 profit of $18.3 billion
6. Apple (AAPL)- estimated 2011 profit of $18.2 billion
7. Bank of America (BAC)- estimated 2011 profit of $16.3 billion
8. International Business Machines (IBM)- estimated 2011 profit of $15.7 billion
9. Wells Fargo & Co. (WFC)- estimated 2011 profit of $15.6 billion
10. Wal-Mart Stores (WMT)-estimated 2011 profit of $15.3 billion
One of my favorite quotes from Berkshire Hathaway (BRK.A, BRK.B) CEO Warren Buffett’s stable of wise commentary is, “I look for companies that drown me in cash.” At some point, most investors are going to feel an impulse to get rich overnight, even if that means taking significant risk. After all, who wouldn’t want to own a stock that doubles or triples in value? But of course, it’s not that simple. As a general rule of thumb, companies that appear poised to double or triple their stock price need to do something significantly different from the status quo—they need to launch a new product, expand into new markets, reverse bad trends, reach profitability, etc. Sure, there are companies that are legitimately undervalued relative to continuing earnings power, but generally speaking, most investors looking to make a quick buck are betting that the company will deviate from the trajectory of the status quo and do something to increase earnings to reward investors.
But this requires taking on an unnecessary risk in investing. Why wouldn’t you just look to companies that are gushing out very large profits, and load up on shares when they appear undervalued, provided you believe the company possesses an economic moat strong enough to ensure similar profits for years to come? I don’t know how most investors reach their ‘starting point’ for researching investments, but for me, I like to bring up lists of the most profitable firms in the country and then weed the superior investment opportunities from the mediocre ones based on that initial profitability criterion.
It’s easy to look at successful investments and then write articles about how well investors would have done had they bought in at a given time frame. Heck, I even did that here, when I talked about how a $25,000 investment in Johnson & Johnson (JNJ) stock could turn into $1 million.
But lists like this that capture a particular moment in time without the rose-colored glasses of selective hindsight allow you to evaluate a set of companies, warts and all. And to be sure, each of these companies has their fair share of blemishes. Bank of America has been a disaster this year, losing over 60% of its value, losing $8 billion in the second quarter, and flirting with the possibility of extreme share dilution or even insolvency. Exxon and Chevron rely on a high price of oil to make their record-smashing profits, whereas Microsoft, IBM, and Apple have to constantly fight the tides of technological obsolescence and disruption to ensure their large profits. Likewise, Wal-Mart doesn’t have any strength in the way of a brand name (that is to say, no one values a consumer good because it was bought at Wal-Mart), but rather, derives the entirety of its economic strength from the belief of most customers that they can go to Wal-Mart to find the lowest prices. That is to say, there is nothing particularly attractive about the Wal-Mart name that draws people to it, only its function in society—if John’s Supercenter Inc. were able to sell goods for half the price that Wal-Mart does, shareholders of Wal-Mart would suffer severely.
Unfortunately, due to short-attention spans and the appeal of a ten-second sound bite, most Warren Buffett quotes are condensed to one sentence. If I could expand Buffett’s ‘drown in cash’ observation to a paragraph, I would say that investors should look for companies that have made a lot of money in the past, are making a lot of money in the present, are maintaining or enhancing their economic moats that made such profits possible, and appear poised to continue to make these profits in the future. That’s a high hurdle to meet—I would guess most investors would only find about ten companies out of the top fifty most profitable American firms that meet these stringent requirements. But I think such demanding selectivity is necessary for making superior investments.
For instance, I’d be willing to guess that over the next ten or so years, oil will still be the dominant form of energy used in the world. Today, I paid about $3.40 per gallon to fill up my car. My best guess is that, due to the combination of a weaker dollar (due to US deficits), increased demand (as populations grow and developing economies further industrialize), and maybe even a global economic recovery, I will be paying more per gallon in 2017-2020 than I do now. So I think I will do well over the medium to long-term if I load up on shares of Exxon-Mobil when they’re trading around 8-9x earnings per share, or the $68-$73 range. Even if prices stagnate or fall a bit, Exxon Mobil can survive a difficult environment just fine, and it absolutely excels when the price of oil increases. So I think buying shares of Exxon in the upper sixties price range would be a solid application of Buffett’s advice to buy companies that drown their investors in cash.
You might disagree. You could think Apple (AAPL) fits Buffett’s profile much better. Or heck, you could think Wells Fargo (WFC) is the perfect example of this type of Buffett stock, since he owns over 8% of the bank and has been gobbling up shares of the California-based lending giant for most of this year. But regardless, this is where the judgment and independent thinking of the individual investor must begin. I think Buffett’s ‘drown in cash’ approach provides us with a good framework for researching investment opportunities. If you can find firms with great track records of profitability that you believe still maintain the economic moats that got them there, then you shouldn’t come out a loser if you buy-in when the company in question is fairly valued or cheaper.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.