4 Stocks That Buffett Could Buy Now

Includes: BOH, CTL, OI, XRX
by: Frank J. Constantino

Warren Buffett is arguably the greatest investor of all time. He has grown Berkshire Hathaway (NYSE:BRK.A) into a behemoth holding company full of great investments. How does he do it? Buffett has a simple quantitative formula that he uses to calculate a company's worth in minutes. Buffett first selects companies using a qualitative method (management, understanding the business, barriers to entry, etc.); then he employs a quantitative method of his own. This quantitative method is largely unknown, however it may be free cash flow divided by the risk-free rate. WikiWealth.com has determined that this is the mostly likely formula Buffett uses. The people at WikiWealth have built a website that rates stocks based on this formula.

Free cash flow is simply the cash generated from operations and available to investors. The risk-free interest rate is the interest rate that it is assumed can be obtained by investing in financial instruments with no default risk. The risk-free rate used on WikiWealth is the 20 year Treasury yield (or 4.2%, which can be changed).

I have no way of knowing what stocks Buffett is contemplating purchasing. I am not predicting that Buffett will actually buy any of these four stocks. I simply used the quantitative method from WikiWealth to determine a value of what the company is worth. I used my own knowledge of the company's business to determine the ease of understanding and other qualitative factors.

CenturyLink (NYSE:CTL)

Buffett loves cash and telecoms generate a ton of it. CenturyLink boasts $7.46 per share in cash flow and trades at 5.65 times cash flow. It has one of the highest dividend yields in the S&P 500 at 6.88%. Based on the proposed Buffett model, CenturyLink has a fair value of $30.21 billion.

Buffett Formula (FCF/RFR)
FCF 1.269 billion
RFR .042 (4.2%)
Buffett Fair Value 30.210 billion

It's easy to know how CenturyLink makes money. The company is a communications company providing local and long distance phone service, internet access, and broadband. They are currently seeking regulatory approvals to purchase Qwest Communications (NYSE:Q). CenturyLink has had a good run over the last year, up about 22%. I don't expect outsized gains in the future, given the declining business. However, after the purchase of Qwest, CenturyLink will be a telecom powerhouse. They should generate lots of cash for years to come.

Owens Illinois (NYSE:OI)

Owens Illinois manufactures and sells glass containers for beverages in North America, Europe, South America, and the Asia Pacific. Its containers are used for many alcoholic beverages as well as soft drinks around the world. Owens Illinois has a very simple business and because of its scale, very little competition. Using the Buffett model Owens Illinois has a fair value of $21.4 billion.

Buffett Formula (FCF/RFR)
FCF 899 million
RFR .042 (4.2%)
Buffett Fair Value 21.4 billion

Owens Illinois is not cheap. The stock trades at 26 times last year's earnings and pays no dividend. Personally I don't own the stock for this reason. However, with very little competition to drive down margins, Owens Illinois has the ability to generate solid cash flow. The company trades at 9.7 times cash flow. It has $4.28 cash per share on its books. In addition, if earnings estimates are correct, the shares trade at a forward P/E of only 10.

Bank of Hawaii (NYSE:BOH)

Bank of Hawaii was the subject of an article recently published by Motley Fool; The Dividend Stock Warren Buffett Would Buy (If He Were You). The bottom line is Warren Buffett loves banks. His portfolio contains shares of Wells Fargo (NYSE:WFC), US Bank (NYSE:USB) and M&T Bank (NYSE:MTB). The three actually make up about 20% of his portfolio. Bank of Hawaii is down about 4% over the last year. The stock, unlike the big banks, pays a hefty 3.88% dividend. Using the Buffett formula, Bank of Hawaii has a fair value of close to $4 billion.

Buffett Formula (FCF/RFR)
FCF 167 million
RFR .042 (4.2%)
Buffett Fair Value 3.978 billion

The company currently has a market cap of $2.3 billion. It trades at a P/E of 12.5. Bank of Hawaii also has $10.10 per share cash on the books. It's payout ratio is 47%, indicating the dividend is stable. Bank of Hawaii has been a conservative lender, therefore avoiding many of the problems that are still haunting the bigger banks.

Xerox (NYSE:XRX)

I recently wrote that Xerox was one of my favorite stocks for 2011 (Five Stock Picks For The New Year). I feel that Xerox is undervalued and that the stock price does not reflect the transformation in the business that is occurring. Xerox has a forward P/E of 10. It generates 91 cents per share in cash and trades at 12 times cash flow. Using the Buffett formula, I get a fair value of $46.7 billion versus today's enterprise value of $24.6 billion.

Buffett Formula (FCF/RFR)
FCF 1.964 billion
RFR .042 (4.2%)
Buffett Fair Value 46.762 billion
*Note FCF was year ending 2009

For Xerox I used free cash flow from FY2009 due to some errors in the reporting of FCF on the WikiWealth website. The FY2009 numbers I used come from the I-Metrix database.

Although Xerox is probably the most complex company I chose for this article, the business is still pretty easy to understand. Xerox provides document management services for businesses worldwide. The company has a great management team, led by CEO Ursula Burns. Burns is transforming the company from a copier and printer manufacturer into a global services company. Xerox still makes the copiers and printers as well. It is starting to cross-sell between equipment and services, increasing revenue. I think the stock could hit $20 in the next twelve to eighteen months.

It really isn't likely that Buffett will start buying any of these stocks. There are just way too many stocks to choose from and Buffett has interests in many different areas. It is nice to have another formula to help determine fair value for a particular company. Whether Buffett truly uses this particular formula or not, it can add value to you stock research. These four stocks are a starting point for further research. I encourage anyone to look at the WikiWealth website. It is a useful tool. You can use the data they provide or enter your own data from a different source.

Disclosure: I am long CTL, XRX.

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