6 Companies That Warren Buffett -- And You -- Should Love

Berkshire Hathaway is flush with cash and the wizard is ready to spend it. Here are the stocks we think best fit his investing philosophies now.

Pity Warren Buffett. Berkshire Hathaway, the sprawling conglomerate he runs, has squirreled away $38 billion in cash. Billions more, in the form of premiums collected by Berkshire's insurance units, including Geico, pour in steadily. And the octogenarian living legend wants to put that cash to work. As Buffett wrote in his recently released annual letter to Berkshire shareholders: "We're prepared. Our elephant gun has been reloaded, and my trigger finger is itchy."

With that high-class problem in mind, we decided to make some stock recommendations for the greatest investor of our time to mull over between now and Berkshire’s Woodstock-like annual meeting, scheduled for April 30.

What Buffett Looks for in a Stock

First, let's review: He likes high-quality, easy-to-understand businesses that provide goods or services that are used in good times and bad. Often these are mundane businesses with modest but predictable growth. They should have solid balance sheets, generate abundant free cash flow (the amount of cash profit left after the capital expenditures needed to maintain the business) and be run by capable, honest executives who are skilled at allocating capital. The stocks should sell at reasonable prices. Technology companies, which make goods with short product cycles and the risk of obsolescence, have never appealed to Buffett, who wants a good idea of what kind of shape a business will be in ten to 20 years from now.

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Buffett pays close attention to a company’s competitive advantages, or lack thereof. He looks for businesses that are shielded from competition by advantages such as a powerful brand, high market share, a low cost structure, and barriers to entry in the industry. Businesses like these tend to earn high, consistent returns on capital and to reward shareholders generously over the long haul.

This strategy is enshrined in Buffett’s concept of economic moats. Here’s how the Oracle of Omaha describes it: “The most important thing to me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.”

With these investment parameters in mind, we came up with six candidates for Buffett to buy. By coincidence, all six companies are more than a century old, suggesting that some savage creatures lurk in their castle moats.

Crown Holdings (symbol CCK)

“I don’t try to jump over 7-foot bars: I look around for 1-foot bars that I can step over.” -- Warren Buffett

Not too much has changed at Crown Holdings, formerly Crown Cork & Seal, since its founder invented the bottle cap for soft drinks. Over the past 119 years, Crown has grown into the global leader in the manufacture of metal cans for food, beverages, and household and personal products. The lack of change is part of the company’s appeal. “It’s an absolutely necessary item that is not going to be eclipsed by some new technology soon,” says Osterweis Fund’s John Osterweis.

Crown, which operates 139 plants in 41 countries, supplies cans to customers such as Coca-Cola, Heinz and Procter & Gamble. The Philadelphia-based company books 72% of its revenues abroad. A growing share of that is in emerging markets, such as China, India and Brazil, where newly affluent consumers are eating more food and drinking more beverages from metal cans of improved quality.

Crown earns an attractive 16% return on capital and generates abundant and rising free cash flow. Sales will approach $9 billion this year. The stock, at $38.87, trades at 14 times estimated 2011 earnings of $2.70 per share (all share prices and related figures are through March 7).

JM Smucker (SJM)

“Only buy something that you’d be perfectly happy to hold if the market shut down for ten years.”

JM Smucker sailed through the Great Recession without skipping a beat. Smucker’s consistency and stability (not to mention its products) should appeal to the famously sweet-toothed Buffett, who already holds shares of Kraft (KFT). The Orrville, Ohio, firm’s portfolio of top brands includes Smucker’s fruit spreads, Jif peanut butter, Crisco cooking oil, Folgers coffee and Pillsbury baking mixes. Founded in 1897, Smucker continues to be managed by descendants of the founder (Tim and Richard Smucker are co-CEOs).

Smucker has a bulletproof balance sheet and achieves a rich operating profit margin (profits from operations divided by revenues) of 23%. The company has boosted its dividend every year since 1995. At $69.51, the stock yields 2.5% and trades at 14 times estimated earnings for the next four quarters of $4.83 per share. Smucker shares look tasty.

Unilever (UN)

“I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.”

Years of mediocre management couldn’t kill off Unilever, a century-old Anglo-Dutch company. Profit margins lagged badly behind those of global competitors Procter & Gamble (PG), a big Berkshire holding, and Nestlé (NSRGY.PK). Paul Polman, formerly a senior executive at both P&G and Nestlé, was hired in January 2009 to whip Unilever into shape. Polman has streamlined the company, squeezing costs and boosting profit margins, and introduced a culture that links compensation with performance.

Now, Unilever is making the most of its global presence and valuable brands, which include Lipton tea, Knorr bouillon, Ben & Jerry’s ice cream, Vaseline, Dove soap and Axe deodorant. Emerging markets account for half of Unilever’s sales and 80% of revenue growth. That helped the company boost product volumes by nearly 6% in 2010, the highest volume growth in 30 years. Unilever earns a lofty 32% return on equity (a measure of profitability). At $30.40, the stock yields 3.2% and trades at 14 times estimated 2011 earnings of $2.10, a price-earnings ratio below that of Nestlé and P&G shares.

With a market capitalization of $86 billion, Unilever is, by far, the largest company on our list. It might even be too big for Buffett, although he might be able to come up with the $100 billion or so it would take to buy the company by borrowing and using Berkshire’s stock as currency. But even if Buffett can’t swallow this consumer giant in its entirety, he might want to add it to Berkshire’s stock portfolio.

Praxair (PX)

“Time is the enemy of the poor business and the friend of the great business. If you have a business that’s earning 20% to 25% on equity, time is your friend.”

Actually, Praxair has a 26% return on equity and sustained its high profitability through the nasty recession. This consistency owes much to the oligopolistic structure of the industrial-gas industry. Four global players -- Praxair, Air Products & Chemicals (APD), France’s Air Liquide (AIQUY.PK) and Germany’s Linde (LNEGY.PK) -- dominate the field, and they tend to avoid competing aggressively on price.

When Praxair builds a facility next to a factory or refinery to supply gases such as hydrogen, nitrogen or carbon dioxide, it pretty much has a captive customer. Contracts are typically long term -- on the order of ten to 20 years. They come with built-in inflation adjustments and require customers to pay for the gases whether or not they take delivery. Customers, which come from the energy, electronics, metals and manufacturing sectors, incur huge costs to switch suppliers.

Praxair generates 60% of its sales abroad and 35% in emerging markets, where brisk expansion is stoking demand for industrial gases. Praxair has hiked its dividend 18 straight years, and the payout has grown at an annualized rate of 19% over the past ten years. At $96.92, the stock yields 2.0% and sells for 18 times forecasted 2011 earnings of $5.39 per share.

Waste Management (WM)

“Never invest in a business you cannot understand.”

It’s not too difficult to understand the basics of Waste Management, the largest solid-waste disposal company in North America. The Houston-based firm collects residential, commercial and industrial garbage and other waste and dumps it in landfills. Not much chance of obsolescence there. In recent years, waste-to-energy projects have also become a major business for Waste.

Michael Keller, co-manager of BBH Core Select Fund, particularly likes the landfill side of Waste’s business. Waste is able to raise prices, he says, because over time landfills have less room for more garbage. And the company’s landfills are particularly valuable in densely populated urban areas, where environmental and zoning restrictions make it difficult for a newcomer to build a new landfill. Plus, it’s hard to transport garbage long distances, and no one wants a dump in his backyard. Moreover, this is not a business that can be outsourced to China or India.

Founded in 1894, this tortoise-like business remained solidly profitable through the recession and isn’t about to be usurped by some new technology. Earnings, which fell slightly during the recession, are inching up. Waste shares, which trade at $37.24, sell for 16 times estimated 2011 earnings of $2.27 per share and yield 3.7%.

Dentsply International (XRAY)

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

You may not be familiar with the name Dentsply International, but you’ve probably used its products under conditions you found less than comfortable (you may have even winced). Dating from 1899, the York, Pa., company is the world’s largest maker of products and tools used by dentists. That includes instruments used for root canals, as well as orthodontic devices, false teeth, dental fillings and anesthetics.

The economics of the business are attractive. Its customers -- 130,000 dental practices -- are fragmented and thus lack bargaining power. Insurance reimbursement is much less of an issue for dental bills than for medical bills. That means purveyors of dental supplies aren’t as vulnerable to cost-cutting pressures.

Meanwhile, demand for dental services tends to remain stable regardless of the economic environment. And the demographics are favorable -- aging populations in the West require more dentistry, and growing middle classes in developing countries are seeking professional dentistry. Dentsply sells in 120 countries and generates 62% of its revenues overseas.

At $37.94, Dentsply trades at 19 times estimated earnings of $2.04 per share, so the stock isn’t especially cheap. But the company is a strong cash generator, and it continues to capture market share. Keller, who holds the stock, says that Dentsply is run by “conservative, focused, Buffett kind of people.”

Contributing Writer, Kiplinger's Personal Finance