Warren Buffett is famously averse to giving stock advice - in fact, he starts his opening message on the Berkshire Hathaway website by saying, "You probably know that I don't make stock recommendations."
Right now, however, he'll have to choose some stocks, because Berkshire Hathaway (BRK.A, BRK.B) has too much cash on hand. According to public financial records, the investing giant has over $110 billion in available cash - far in excess of Buffett's frequently stated target of $20 to $30 billion in cash reserves for a rainy day.
In his annual shareholder letter, Buffett discusses two major points of importance for investors: his preference for purchasing full ownership or controlling shares in major companies, and the poor prospects for such purchases right now. To quote, "In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects."
Being merely human, Buffett goes on to say that he wants it both ways: "That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities. We continue, nevertheless, to hope for an elephant-sized acquisition." Even without taking permanent ownership of a company, Buffett says of opening a large stake, "…that prospect is what causes my heart and Charlie's to beat faster."
How Do We Know What Might Buffett Acquire?
Let's be blunt: Berkshire Hathaway is more likely to buy stock this year than to make another large acquisition. Their last acquisition move was in July 2017, when they took over HomeServices of America. Since then, the conglomerate has focused on buying stock, with $24 billion in net purchases in 2018. This is simply Buffett's observation on corporate overvaluation put into action.
He does, however, add that, "Many stocks have offered far more for our money than we could obtain by purchasing businesses in their entirety." This brings us to Warren Buffett's Rules for Investing and Acquisition:
Rule Number One: Don't Lose Money.
Rule Number Two: Don't Forget Rule Number One.
So, if we want to make predictions on Berkshire's likely moves moving forward this year, let's turn to the Q4 13F and take a closer look at what the company held and compare those holdings to Buffett's known preferences - the types of stocks he says he likes, the types of stocks he buys, and sectors that Berkshire has been recently accumulating.
"What we see in our holdings is an assembly of companies that we partly own and that, on a weighted basis, are earning about 20% on the net tangible equity capital required to run their businesses. These companies, also, earn their profits without employing excessive levels of debt."
Those are Buffett's own words, from his shareholder letter again, describing Berkshire Hathaway's equity holdings. In them, he describes what he looks for in a common stock portfolio. Put into plain English, he likes companies that turn a high profit and don't have debts they can't pay back. Those points are the background to every stock that Buffett buys.
There are two more points, linked together and discernable from his years in the public eye. First, he always looks to invest in a company that has a clear path to increasing value, and second, he always commits to making a very long-term investment. As Buffett has said, "Our ideal holding period is forever."
A Quick Take-Away from the SEC Filings
Berkshire Hathaway's 13F filings for Q4 of last year reveals a curious fact: he sure has bought a lot of big bank stock over the last several years. In fact, at a combined value of over $60 billion, Buffett's bank investments are worth more than his famously large Apple (AAPL) holdings. And when you add in his stakes in American Express and Moody's Corporation, his total holdings in the financial industry starts edging up to $80 billion.
Several factors have influenced this move toward the banking industry: Banks underperformed the overall markets last years, making their prices in Q4 comparative bargains; the Republican tax bill helped boost big banks' bottom lines during the course of the year; and, the Fed's policy of raising rates will likely be reflected in banks' rates, as well, further influencing profits.
Clearly, Buffett sees opportunity and profit to be had in the banking industry.
A Word about Insurance
While the bulk of public attention goes to Berkshire's equity portfolio, the conglomerate's largest holdings are actually insurance companies, owned outright. Remember the GEICO gecko? He's a Berkshire Hathaway subsidiary. Back to Buffett's letter: "Our property/casualty ("P/C") insurance business … has been the engine propelling Berkshire's growth since 1967…
"One reason we were attracted to the P/C business was the industry's business model: P/C insurers receive premiums upfront and pay claims later."
Today, Berkshire Hathaway's insurance holdings provide the company with over $122 billion in cash available for investment. This money - called 'float,' and ultimately derived from insurance customer premiums - is earmarked for claims payment, but until claims are made, the insurer can use the float for its own corporate benefit. Berkshire uses it for investment purposes.
As Buffett has explained, his company can get paid for holding on to other people's money. It's no wonder he loves the insurance industry.
And now we can talk about some stocks that may be eligible candidates for an "elephant-sized acquisition."
Pulling out the Crystal Ball: An Attempt to Read the Mind of Warren Buffett
OR, Five Companies in which Warren Buffett May Expand his Holdings
The filing records show five companies that are of interest to this analysis. One, JPMorgan Chase, is a world-class big bank, while the other four companies have market caps in the $10B to $50B range. Two are banks, and two are insurance companies. Berkshire increased its holdings in one of each, while keeping the others steady. It holds a less than 1% position in each of them.
We'll examine each of these stocks, where it stands in the markets, and what the four- and five-star analysts from TipRanks' database have to say about them.
M&T Bank Corporation
This is a medium-sized bank holding company, with a market cap of $23 billion. M&T Bank Corp (MTB) operates bank branches in eight states and the District of Columbia, all located in the Mid-Atlantic and Northeast regions of the US. Berkshire Hathaway has a 0.42% stake in the company, which it held steady in the last quarter. That stake is worth $770 million as of December 31.
Like the other mid-size companies on this list, MTB has a mixed set of reviews from the analysts. The most recent, from Barclays Jason Goldberg, gives the stock a 'Buy' rating with a price target of $207, suggesting a 20% upside potential - all good news. However, Baird analyst David George at the same time downgraded his rating to 'Hold,' saying, "the risk/reward is less compelling following the stock's recent rally ." His price target of $175 suggests a 1.4% upside.
Overall, MTB shares get a 'Moderate Buy' rating on the analyst consensus, based on 4 'Buy' and 5 'Hold' reviews. The stock trades for $172, and the average price target of $183 suggests a 6% upside potential.
Buffett's interest in this stock can be explained by M&T's recent quarterly earnings. The company reported a 68% net income gain from the year-ago quarter, and the $3.79 EPS was significantly higher than the forecast $3.51. In addition, M&T is a reliable dividend stock, with a history of adjusting the yield to keep the payout high. The current annual payout is $4, making the yield 2.32%.
PNC Financial Services Group
While not a household name, PNC Financial (PNC) is the eighth largest bank company in the US, more than double the size of M&T, with more than triple the number of local branches. While PNC shares are down over the last year, they have gained $18 since Christmas and are up 55% on a three-year time frame. Those last points could explain why Berkshire recently expanded its stake in PNC, from 0.38% to 0.53%. While still a small holding, that is an increase of 39%.
PNC's two most recent analyst reviews show another set of mixed messages. Both are 'Hold.' From Deutsche Bank, Matt O'Connor downgraded the stock from 'Buy,' while Oppenheimer's Chris Kotowski maintained his Hold rating.
Kotowski said, "The earnings call featured all the normal hand wringing questions about deposit betas and "slow loan growth," but in our view what we think a lot of analysts don't realize is that this is a bottom line-, not top line-oriented management. The point is not just to make loans, but to make money, and that is what the company does."
The analyst consensus on PNC shares, based 2 'Buy' ratings and 8 'Holds,' is a 'Hold.' The stock does have an 8.99% upside potential however, based on a share price of $126 and an average price target of $138.
That upside is important, since making money is what Buffett wants all of his investments to do. PNC does deliver on that score. While its last quarterly earnings showed an EPS just below the estimate, the bottom line gained 20% from the prior quarter. In addition, PNC is another high-performing dividend stock, with a 10-year record of dividend growth, a 3% yield, and a $0.95 per share quarterly payout.
Torchmark (TMK) is the smaller of the two insurance companies we'll look at. It operates through six subsidiary companies in Texas, Oklahoma, and New York. The company reported strong gains of 26% in net operating income for the fourth quarter of 2018. Life insurance premiums, the source of the 'float' that Buffett likes, increased 3% to $600 million.
So, Torchmark looks like a profitable insurance company, but like the two banks above, it has mixed reviews from the market analysts. Early this year, Jay Gelb of Barclays, reiterated his 'Sell' rating, and lowered his price target to $68. That same week, though, JPMorgan's Jimmy Bhullar upgraded TMK shares to a 'Buy,' and put the price target at $88 for a 6% upside.
In his comments, Bhullar wrote: "the market is drastically overestimating TMK's susceptibility to deteriorating credit trends," and he added that "the recent pullback generates a buying opportunity."
On consensus, TMK shares are a 'Hold,' based on 1 'Sell' and 1 'Buy.' The stock shows a downside of 5%, with a $78 average price target and a share price of $82.
But here is an interesting point: The pullback Bhullar noted was the general market decline, that bottomed out on Christmas Eve. On that day, TMK hit a low of $70; it has since climbed back to $82 and is now mostly level over 12 months. On the three-year time horizon, TMK is up 60%. Those gains are sure to have attracted Buffett's attention, but so could Torchmark's six-year history of dividend growth. The current dividend, while a modest 64 cents and 0.77% yield, is considered reliable.
Travelers Companies, Inc.
Travelers (TRV) is a $35 billion insurance company, specializing in property and casualty, just as Buffett likes. His interest in the company makes sense, as it would fit well with exiting holdings in the insurance industry. Berkshire nearly doubled its holding in Travelers during Q4 2018.
As with the companies above, however, the market's analysts are fairly split. TRV has received 2 'Hold' ratings and 2 'Buy' ratings in the last two months, and the 'Holds' are the more recent. On January 23, Credit Suisse analyst Michael Zaremski reiterated his 'Hold,' and set a price target of $141 for a 6% upside.
A week earlier, January 15, Compass Point analyst Bijan Moazami had initiated a 'Buy' rating, fixing the target at $155. Moazami said, "Travelers maintains a very competitive expense ratio allowing its positive reserve development to stabilize earnings." His price target suggests an upside potential of 16% for this stock.
The consensus rating on Travelers is a 'Hold,' based on 2 'Buy' ratings, 2 'Sells,' and 3 'Holds.' TRV shares are trading for $133 now, so the $137 average price target offers only a modest 3% upside potential.
Travelers reported an increase of 23% in net income last year, while the stock is up 18% since Christmas and up 27% over the last 3 years. The dividend is a robust 2.32% yield, giving a $3.08 annual payout, and has shown steady growth since 2004. Despite the 'Hold' rating, Buffett's interest in this stock should be clear.
JPMorgan Chase & Co.
The largest company on this list, JPMorgan (JPM) is already a substantial part of Berkshire's bank holdings. Buffett's company has almost $5 billion invested in JPM, since Q3 of 2018. While large in absolute numbers, this represents only a 1.5% stake in the bank; due to SEC regulations, Buffett likes to keep non-controlling stakes in companies below 10%, so there is substantial room for growth in this investment.
Again, the market's analysts are more divided than the legendary investor. The most recent rating, from BMO Capital's James Fotheringham, is a 'Hold,' with the price target lowered to $116. Defending his rating, he cites the bank's "lowered expectations for net interest income as well as performance of its corporate & investment bank and wealth management segments." It's important to note, however, that Fotheringham's price target still suggests an 11% upside potential for JPM shares.
Morgan Stanley analyst Betsy Graseck set a 'Buy' rating on JPM at the same time, with a target of $124. She says, "The bank is looking to use its scale and "best in class ROE" to price competitively to take share in every business line," and likes that business approach. Her price target gives the stock a solid 18% upside.
JPM's overall rating is a 'Moderate Buy,' based on 5 'Buys,' 6 'Holds,' and 1 'Sell.' The shares are currently priced at $104, and the average price target gives a 12% upside.
It's important to note here that, of these five companies, JPM is far too large for even Warren Buffett to attempt to buy outright. However, as pointed out above, he may attempt to purchase an enlarged stake in this company, perhaps up to 9%. Such a purchase would total over $30 billion. That would certainly count as an "elephant-sized acquisition."
"I will never risk getting caught short of cash."
That quote, a firm promise that Buffett has held to for over fifty years, brings us to our last point: The combined market cap of just the four smaller of these companies is $124.2 billion, higher than the total cash Berkshire has on hand, and much higher than the $80 to $90 billion of that cash available for use. Should Warren Buffett show an interest in buying these companies outright, even he can't have it all.
Author: Michael Marcus
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.