With Berkshire Hathaway's (NYSE:BRK.A) annual report in hand and the recent deal for Lubrizol (NYSE:LZ) still in the news, there is once again a fair bit of interest in speculating on what sorts of companies Warren Buffett would (or does) like. Though specific predictions of Mr. Buffett's moves are more often wrong, there are a handful of non-bank financial services stocks that investors may want to consider with an eye towards their franchise value and difficult-to-replace market niches. (For more, see Emulate Buffett For Fun And Profit - Mostly Profit.)
Making Payroll Services Pay
Automatic Data Processing (NYSE:ADP) and Paychex (Nasdaq:PAYX) do more than just handle payroll (for large and smaller companies, respectively), but that is their signature business lines. There is a lot here that an investor seeking to emulate Warren Buffett should find attractive. (For more, see Buffett Picks To Coattail.).
This is a recurrent fee-collecting business; people get paid on a regular schedule and these companies can collect a small fee every time they do. It is also a bet on the recovery and prosperity of the country; more jobs means more payroll and more demand for payroll services (and Buffett is a noted optimist on the long-term prospects of the U.S. economy). Last and certainly not least, each company produces a "float" of money, money paid to the companies for payroll but not yet disbursed to employees, that can be profitably invested.
Title Insurance: A New Play on a Familiar Theme
Most Buffett-watchers are aware of the significant role that insurance operations have had in building Berkshire Hathaway into what it is today. Although the company has not been quite so active in acquiring insurance companies in recent years, title insurance could be an attractive opportunity.
Title insurance basically shields home owners and lenders from the risk that a piece of property does not have a clean and proper title; said differently, title insurance serves as a backup to insure that the title is accurate and the owner has access to the property (and that the lender has a valid claim in the cause of default). (For more, see 10 Hurdles To Closing On A New Home.)
Unlike property and casualty (P&C) insurance or reinsurance, where claims are routine and expected, title insurance companies typically only pay out a small portion of their premiums as claims. Or at least that was how the business used to operate, before the greed, sloppiness, and dishonesty of the housing bubble created problems throughout the system.
Like many businesses tied into housing and mortgage lending, title insurance is a business that is getting better but still ailing. Leading title insurance companies like Fidelity National (NYSE:FNF), Old Republic (NYSE:ORI) and First American (NYSE:FAF) all trade below book value today (accounting book, not tangible book), while typically trading at about a 20% premium to book value in more normal times.
Tutorial: Intro To Insurance
Information Is Power
Warren Buffett famously likes businesses that have built a monopoly or near-monopoly through the quality and significance of their products and services. In terms of financial information services, Factset (NYSE:FDS) and Bloomberg come to mind as premier providers of expensive subscription-based services. It is hard to call Factset cheap on its fundamentals (and Bloomberg is a private business), but it produces ample recurrent cashflow and its customers tend to be quite sticky. What's more, Factset is still actually quite small and has many potential avenues for organic growth and expansion.
Apart from the title insurers, none of these stocks may pop out as "Buffett-cheap." That said, commentators about Buffett's investment strategy often grossly over-simplify and misunderstand his approach to value and valuation (as seen by the howling and second-guessing of his Burlington Northern buy a while ago). To put a finer point on it, Mr. Buffett has never shown himself to be willing to be tied down to notions like P/E or EV/EBITDA when approaching the value of a business; the quality of the assets also matter and businesses that offer near-monopolies or low cost of capital are often worth more than simple ratios suggest.
Investors should not buy any of these stocks on the idea that Berkshire Hathaway will acquire them. Consider buying them instead for their own inherent qualities - qualities that Buffett has said he admires and that often produce years of value for patient investors. (For more, see 4 Lesser-Known Companies Buffett Owns and Buffett Brings Lubrizol Into The Fold).