Buffett should use Colgate
Posted
Aug 27 2009, 09:44 AM
by
John Reese
Rating:
Berkshire Hathaway recently filed its latest holdings statement with the SEC, and one major position Warren Buffett is keeping steady is consumer goods giant Procter & Gamble (PG).
Berkshire owned close to 100 million shares of P&G at the end of the second quarter, according to the filing, making it one of Buffett's biggest positions. In fact, the only companies that Berkshire (BRK.B) has greater stock stakes in, dollar-wise, are well-known Buffett favorites Coca-Cola (KO), Wells Fargo (WFC), and Burlington Northern Santa Fe (BNI).
P&G certainly has some of the qualities Buffett has typically looked for in his investments. For example, both the company and many of its products, including Pampers, Tide, Crest, and Bounty, have strong, recognizable brand names that give P&G an advantage over some peers.
But according to my Buffett-based "Guru Strategy" -- a computer model I've created that mimics the Oracle of Omaha's approach -- one of Procter's biggest rivals is looking significantly more "Buffett-like" than P&G right now. (And it's one whose toothpaste Buffett could probably use, given his well-known penchant for those sugary Cherry Cokes.)
The company: Colgate-Palmolive (CL), which I added to my Buffett-based Top Stocks Wall Street Survivor portfolio earlier this month. (My Validea.com Buffett quant portfolio is up over 38% this year.) Perhaps best known for the two products that bear its names -- Colgate toothpaste and Palmolive dishwashing soap -- C-P also makes a wide array of other oral care, personal care, home goods, and pet care products, many of which have the same strong brand recognition that P&G's products have.
Among its popular brands: Speed Stick deodorant, Softsoap, Irish Spring soap, AJAX, and Murphy Oil soap. The New York City-based firm, whose origins date back to 1806, today sells its products in more than 200 countries and territories, and has taken in almost $15 billion in sales over the past year. Its market cap is about $36 billion.
My Buffett-based model (based on the book "Buffettology," written by Buffett's former daughter-in-law Mary, who worked closely with him) sees a lot to like about Colgate-Palmolive -- in fact, it gives the stock a perfect 100% score, something only eight other stocks in the market can claim.
For starters, the Buffett approach looks for firms with lengthy histories of steadily increasing earnings. C-P has upped its earnings per share in nine of the past ten years, with the lone exception a minor 5% dip five years ago. That's plenty good enough to pass this first test.
Buffett is a very conservative investor, so the model I base on his approach also requires that a company have enough annual earnings that it could, if need be, pay off all its debts within five years. With $3.37 billion in debt and $2.05 billion in annual earnings, Colgate could pay off all its debt in less than two years, which this model considers exceptional.
Strong Management, Durable Advantage
Two qualities Buffett is known to look for in a company are strong management and a "durable competitive advantage" over its peers. And two measures he has used to measure both of those qualities are return on equity and return on total capital.
My Buffett-based model likes companies to have ten-year average ROE and ROTCs of at least 15%. Colgate doesn't just meet those standards -- it blows them away. Its 10-year average ROE is 46.3%, while its 10-year ROTC is 29.4%. Those figures indicate that management is doing a great job with shareholders' money.
Finally, while Buffett is a diehard buy-and-hold investor who shuns market timing, he nonetheless has used two methods to calculate how much he could expect a stock to rise over the next decade, according to Mary Buffett. "In most situations this would be an act of insanity," she writes in Buffettology. "However, as Warren has found, if the company is one of sufficient earning power and earns high rates of return on shareholders’ equity, created by some kind of consumer monopoly, chances are good that accurate long-term projections of earnings can be made.”
One of the two methods focuses on ROE, and the other on EPS. Using the ROE method, my Buffett-based model projects a 21.4% annual return over the next decade for Colgate-Palmolive; using the EPS method, it expects a lesser (though still solid) return of 11.7% per year. Averaging those two together gives us a final expected return of about 16.5% per year for the next ten years, which my Buffett-based model considers exceptional.
Exactly what kind of returns Colgate-Palmolive generates in the coming decade is unclear; I'd bet Buffett himself would admit that there's a lot of room for error in such predictions. What is clear, however, is that Colgate-Palmolive has a solid balance sheet, several extremely well known brand names, and strong management that has been doing an excellent job with shareholders' money for the past decade. So, while it may not be in Berkshire's portfolio right now, CL appears to be just the kind of stock that Buffett snatched up while building his reputation and fortune -- making it worthy of your attention.
Full disclosure: I own CL, PG, KO, and WFC
John Reese is founder and CEO of Validea.com, a premium investment research site, and Validea Capital Management, a separate account advisory firm. He is author of the new investing book, "The Guru Investor: How to Beat the Market Using History's Best Investment Strategies".
