Best companies

With stock prices declining it looks like we may soon have the chance to buy some very good companies at reasonable prices. No more, “I think BRKB, AAPL and GOOGL are excellent companies, but the stock prices are too high.” What companies would people on this board love to own at reasonable prices? FWIW, I’ve nibbled on AAPL and GOOGL recently, but I’d love to buy more.

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I put 15% of my portfolio in baba. 0.3% in JPM, 1% In atvi

Watch list: fds, tsco, ASML, para, dva, amzn, but none I had enough conviction to pull trigger

Rather than suggesting specific names, a few suggestions for strong clues:

  • Their main business hasn’t changed a whole lot in the last 10 years.
    This is often (not always) a good checklist clue that it might not change much in the next 10.
    That’s a good thing: surprises are more often bad than good.

  • Obviously, not too much leverage.
    Preferably debt < 5 years of net earnings.
    A few extraordinary firms can handle up to 10, like Hershey, but not many.

  • High ROE for a long time, and not falling on trend.
    This is a clue (not proof) that they have a moat: if someone could raise the capital to go into
    direct competition with them and undercut them, they would. But they haven’t.

  • Not a long time loser sector.
    There are some great exceptions, but unless you have good reason to believe a given firm is an exception, expect the usual outcome.
    Apparel, retail, airlines (ha!), toys.

  • Not in a business with no control over their own prices, or where buyers buy almost entirely on price.
    Commodities, banks, insurance. Airlines again.

  • Above all: selling a product or service for which their clients, rightly or wrongly, perceive no close substitute.
    Clients of ASML perceive no close substitute for the products, and they’re probably right.
    Clients of Coke perceive Pepsi not to be a close substitute for a Coke–they’re arguably wrong about that, but it doesn’t matter.

  • Here’s an industry I like: medical equipment.
    This particular subset is pulled from one my favourite quant screens. That industry, but also seeking stuff like high growth, no dividends, and lots of cash on hand.
    QDEL IART MASI ICUI GMED NEOG AVNS TNDM NUVA NVRO
    The speculation is that an equally weighted portfolio of these stocks might beat the market, till their financials change materially.
    Maybe.

Jim

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I believe asset managers are very cheap; BLK, TROW, BAM are all worthy of investment, with BLK probably the safest, and BAM has the catalyst in asset manager spin-off later this year. TROW is the cheapest and riskiest with AUMs declining for the last several quarters, but has a great track record of relentless earnings and dividend growth.

In health care I like both CVS and MCK. Both don’t have pipeline risks as they are distributors/retailers. MCK is the largest of an oligopoly of 3. CVS is paying off debt from Aetna acquisition and should start increasing dividends and buybacks in 2023 and currently trades at single digit PE.

In semiconductor design/fabrication both QCOM and Intel are trading below 11 fwd PE. QCOM is a no-brainer with its 5G IP. Intel is a bit trickier as they are planning 100 billion in capital spending to catch up with Asian manufacturers and ARM-based designs, so you have to have faith in their success.

Others on my watchlist are UPS, RH, KMX, TD, OXY warrants. Unfortunately I have more ideas than cash.

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Based on Jim’s criteria on what types of companies to consider in an earlier post in this thread, my best picks are:

Asset Manager Black Rock
Drug Distributor McKesson
Semiconductor Qualcomm
Package Delivery UPS

I’ll chip in with my “broken record” recent favourites
Carmax (KMX) at $88.30
LKQ at $48.00

And they both seem to be nice long term keepers.
I think one might get solid double digits in both for the next ~five years based on current pricing.
Opinions differ, of course, or they wouldn’t be reasonably priced right now.

The biggest obvious “gotcha” seems to be that neither is as cheap as it appears at first because earnings are temporarily elevated at both.
But if the worst thing you can say about a firm is that they’re making too much money lately, that’s not so bad.

Jim

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High ROE for a long time, and not falling on trend.

I would substitute ROE with Free cash flow. Actual cash generation is far more important.

In health care I like both CVS… CVS is paying off debt from Aetna acquisition and should start increasing dividends and buybacks in 2023 and currently trades at single digit PE.

CVS will have strong free cash flow of $10 B. We need to see whether they are going to catch WMT or TGT bug, but if they don’t this is a good price. Also, CVS has been talking about M&A for sometime and they are not able to close because of the valuation. This is an area of concern. When you are on the market for a long-time and unable to get any deals, the management is cornering themselves to do a deal and that is when you make mistakes. Not everyone is WEB, to approach these things with ruthless detachment. For most management’s they cannot just keep saying we are looking at M&A for many quarter and not deliver on it.

I would substitute ROE with Free cash flow. Actual cash generation is far more important.

Free cash flow is nice, and free cash flow yield is good for company valuation, but neither can help you identify good candidates likely to have moats they way ROE can.
Unless you’re speaking of using free cash flow to shareholders’ equity ratio, not a metric I’ve used.
It looks pretty good though. (not the same as conventional FCFE which isn’t a ratio)

ROE has its quirks, of course. You have to have already eliminated those with too much leverage,
and you have to remember that ROE is pretty meaninglessly high for firms with super depressed book value.
Usually because either they did massive buybacks for many many years, or they have such steady
earnings that lenders will let them pay out all their equity as dividends like IBM or Moody’s.
That’s not really that big a problem, though. They tend to be good companies.
Those with positive earnings and negative equity–infinite/meaningless ROE in effect–are statistically very good investments.

Jim

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you have to remember that ROE is pretty meaninglessly high for firms with super depressed book value.

Would it make sense to attenuate ROE according to the relationship between return and book value?

I get my data from VL; their go-to value metric is Free Cash Flow as opposed to ROE. I wonder if there’s a way to reconcile FCF with ROE.

Might that be accomplished by beneficially trimming return according to the relationship between book value and sales, for example? Or perhaps simply according to the history of book value in relation to that of one or another metric. As you’ve pointed out, some very successful companies that required major investment at the outset have essentially amortized those substantial initial inputs to a point where book value is no longer a meaningful metric. If I recall correctly, you’ve mentioned Hershey’s and Coke, among others. Both catering to human enjoyment, I might add. Perhaps that’s the avenue of my recollection.

There may also be companies now contending for attention that initially required little in the way of initial capital. Perhaps there’s a way to accommodate them within any such formulation.

Tom