Warren Buffett says he is searching for a $20-billion (U.S.) investment for his flagship firm, Berkshire Hathaway Inc. As a public service, we dug through the S&P/TSX 60 in search of the company that most closely fits Mr. Buffett's investment style. We found Shoppers Drug Mart.
Here's our reasoning. A long-time disciple of Benjamin Graham, the father of value investing, Mr. Buffett deviated from his mentor in at least one big way. Instead of focusing on buying balance sheet assets at bargain prices, Mr. Buffett likes to invest in companies with an ability to consistently generate cash flow with a minimum of ups and downs.
Mr. Buffett's distaste for volatility disqualifies most resource and materials companies unless they are trading at deeply discounted stock prices. So the first stage of our analysis was to remove all resource companies that were trading at price-to-earnings multiples above the market average.
The next stage was to measure the consistency of cash flow generation for the remaining 41 companies using standard deviation and 10 years of financial data. We discarded the 21 worst performers by this measure.
Profitability came next. We looked at each of the 20 remaining companies and ranked them on return on equity – not the highest necessarily, but the most consistent.
The final hurdle in the Buffett screen was valuation. We compared each firm's trailing 12-month price-to-earnings ratio with its average price-to-earnings ratio over the past 10 years. We wanted to find a company trading at a significant discount to its historic valuation levels.
Shoppers Drug Mart was the winner. At 14.2 times trailing earnings Shoppers' stock is trading at a 31-per-cent discount to its 10-year average. In terms of the consistency of its cash flow growth and return on equity, it ranked in the best five companies in the S&P/TSX 60 index.
Mr. Buffett likes to find companies with a "moat" around their business in the form of a sustainable competitive advantage. Shoppers Drug Mart's well entrenched brand name seems to qualify. So there you have it – Mr. Buffett, your prescription is ready.