Despite the eye-popping returns, Buffett uses relatively simple criteria to base his investment decisions. He looks for companies with sustainable competitive advantages, and stable, predictable income streams. Here are three companies that meet his criteria and also that Buffett loves.
The staid bank
Wells Fargo & Co (NYSE:WFC) comprises 19.9% of Berkshire Hathaway‘s stock portfolio.
Wells Fargo & Co (NYSE:WFC)‘s sustainable competitive advantage is that it has one of the lowest cost of deposits in the industry, at 0.44% versus JP Morgan’s 0.72% and Bank of America’s 1.19% for 2012. The low cost of deposits allows Wells Fargo & Co (NYSE:WFC) to grow faster and generate superior returns.
The bank’s earnings are more stable and predictable than competitors because Wells Fargo & Co (NYSE:WFC) has tighter risk-management and underwriting standards. The company stayed away from toxic derivatives such as option ARMs, CDOs and SIVs that haunted many investment banks in the financial crisis.
Lastly, Wells Fargo has a bright future ahead of it because it writes almost one out of every three mortgages in the country. With housing recovering, Wells Fargo & Co (NYSE:WFC) should see higher mortgage demand and greater profits. The bank is also well-positioned in high-population-growth areas such as California, which should allow the company to see faster deposit growth than competitors. Shares for Wells Fargo & Co (NYSE:WFC) trade at a reasonable 11 times next year’s earnings, yield 2.7% on its dividend, and have an estimated 5-year annual EPS growth of 7%.
A consumer products company
The Procter & Gamble Company (NYSE:PG) comprises 4.8% of Berkshire Hathaway‘s portfolio.
The Cincinnati, Ohio company is one of the world’s leading consumer product companies with some of the world’s most famous brands, including Crest toothpaste, Tide laundry detergent, and Gillette razors.
The company has a sustainable competitive advantage in that it is very adept at marketing. Over the years, the company has produced over 25 “billion-dollar” brands that all have high brand loyalty and awareness. This lofty brand equity allows The Procter & Gamble Company (NYSE:PG) to charge premium prices and command higher margins than competitors.
The Procter & Gamble Company (NYSE:PG)’s earnings are very stable and predictable because everyone needs to use toothpaste, laundry detergent, and razors. That stability allows The Procter & Gamble Company (NYSE:PG) to be one of the Dividend Aristocrats, companies that have increased their dividend for at least 25 straight years.
Finally, the future of The Procter & Gamble Company (NYSE:PG) looks bright. CEO A.G. Lafley believes that he can trim $10 billion from the company’s bloated overhead cost structure, and run the company more efficiently. He has also made it an initiative to focus more on emerging markets so that Procter & Gamble can increase organic growth from the present 3% to 5%.
Currently, The Procter & Gamble Company (NYSE:PG) trades at 17 times next year’s earnings, yields roughly 3%, and has an estimated 5-year annual EPS growth of 7.88%.
