In August, Warren Buffett’s company, Berkshire Hathaway Inc. (NYSE:BRK-A), agreed to buy Precision Castparts Corp. (NYSE:PCP) for a total cash value of $32.0 billion. There are still plenty of analysts out there furiously questioning why Warren Buffett wasted a ton of cash on PCP stock.
Despite how often the naysayers doubt Warren Buffett, the “Oracle of Omaha” never fails to impress. His fund recently made $4.4 billion in profit after H. J. Heinz Co. and Kraft Foods Group Inc. merged to form The Kraft Heinz Company (NASDAQ:KHC). Now Warren Buffett is turning his sights on Precision Castparts and the bears still haven’t learned to trust him.
I understand that $32.0 billion is not a tiny amount, even by Warren Buffett’s standards. But don’t let the big price tag fool you.
There’s a reason Warren Buffett is widely acknowledged as the greatest investor of all time; he sees value where the rest of us see nothing at all. The advent of KHC stock should be proof enough of that.
Warren Buffett saw some overlap between Kraft and Heinz, so he brought them together using the help of a few private equity firms. He offered holders of Kraft stock $16.50 per share plus a 49% stake in KHC stock. (Source: “Warren Buffett Will Celebrate July 4th With A New Stock: The Kraft Heinz Company”, Forbes, July 2, 2015.)
It was a universally popular deal that made a lot of money for everyone involved. The acquisition of Precision Castparts is likewise brilliant, because it finds untapped value in a business that produces a tangible product.
What’s Next for Warren Buffett on Precision Castparts?
When considering the bet on Precision Castparts, you have to think about how Warren Buffet approaches investment. If you read the mainstream financial press, you’d likely think about the latest technology stocks or what’s happening in the economy.
Warren Buffett is more old-fashioned. He genuinely considers a company’s business model (crazy, I know!). Buffett likes to know what a company makes, how much it costs them to make it, how they get it to consumers, and how much they make from selling it.
If you can’t understand the firm’s business model, don’t invest in it. That’s Warren Buffett’s motto and it’s held him in good stead for decades beyond count. PCP stock falls directly into the mold of a classic Warren Buffett investment.
Precision Castparts is essentially a cutting-edge engineering firm that produces components for the aerospace and energy sectors. The firm earned $10.0 billion in revenue during a time when the entire industry was getting hammered by low energy prices. How did they do it?
PCP stock took a huge bump after Warren Buffett picked up the company. Buffett understands that Precision Castparts signs long-term deals with their clients, keeping them somewhat insulated from short-term fluctuations in the market.
KHC Stock Proves Buffett is a Genius
I’m sure Warren Buffett has noticed that Precision Castparts pivots towards the aerospace industry. More than 70% of the company’s orders come from aerospace firms, including The Boeing Company and Airbus Group SE.
“I’ve admired PCC’s operation for a long time,” Buffett said in the statement. “It is the supplier of choice for the world’s aerospace industry, one of the largest sources of American exports.” (Source: “Buffett to Acquire Precision Castparts in $37.2 Billion Deal”, Bloomberg, August 10, 2015.)
Think about it: PCP stock was trading at a discount because of the oil price slump, and yet Precision Castparts has an ironclad hold on their business. Warren Buffett doubled the profits of Berkshire Hathaway by creating KHC stock, and now he’s moving on to PCP stock.
Investors should trust him. Warren Buffett doesn’t always pick the hottest stocks, but that’s precisely what makes him a great money maker. If history is any judge, Precision Castparts will pay off big time for Berkshire Hathaway, much like KHC stock did this past summer.