Was Warren Buffett a True Value Investor When He Bought Precision Castparts?

Was Warren Buffett a True Value Investor
       When He Bought Precision Castparts?
                                      August 13, 2015
                                    by Chuck Carnevale
                                     of F.A.S.T. Graphs
When I first got interested in investing in common stocks some 50 years ago, I thought it would be
wise to research and then study the investing behaviors and philosophies of the recognized investor
greats. My efforts first led me to Ben Graham, and from there to many other famous value investors
such as Philip Fisher, Walter Schloss, William J. Ruane, Irving Kahn, Peter Lynch, and of course the
venerable and perhaps most famous of all, Warren Buffett.

Although each of these investing greats had their own unique style and approach, they were all
investors that focused on value. Consequently, I patterned my own investment philosophies and beliefs
on sound valuation. Admittedly, assessing sound valuation is not a perfect science. However, there are
certain fundamental principles that do apply and have passed the test of time. One of those principles
is to be only willing to invest when fundamentals, primarily earnings, can be purchased at a price that
makes economic sense.

Does Warren’s Purchase of Precision Castparts Make Economic Sense?

Yesterday, Seeking Alpha reported on Warren Buffett’s purchase of Precision Castparts Corp (PCP)
under the following headline: “Buffett pays high price for Precision Castparts.”

There were several links in the report, but this one suggested that Warren was paying a P/E ratio of
18×1 year’s forward earnings:

“It's the biggest deal of Warren Buffett's career: BRK is paying $235/share for PCP, a 21.2% premium
over Friday's closing price and 18x projected profit over a 12-month period.”

Since I’ve been a long-term follower of Warren Buffett, I thought it would be interesting to evaluate
Warren’s purchase through the lens of the F.A.S.T. Graphs™ fundamentals analyzer software tool. My
first graph produces a look at the company’s earnings and dividends only (yes, PCP does pay a
miniscule dividend). What we discover is a reasonably consistent record of operating earnings growth
averaging 15.6% since 2003. Although there is minor cyclicality along the way, Precision Castparts has
been a very profitable enterprise. Note that although earnings fell in 2009, the company remained
highly profitable even during the Great Recession.

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With my second graph I bring in monthly closing stock prices (the black line) and a calculation of the
historical normal P/E ratio (the dark blue line). It’s interesting to note that since 2003 Precision
Castparts’ stock price has been awarded a normal P/E ratio of 18.2, which is the multiple of the dark
blue line across the entire graph.

What I found interesting is that coming off of excessive valuation in 2013, Precision Castparts’ stock
price fell precipitously throughout all of 2014 and prior to Warren’s purchase throughout 2015. At the
beginning of 2015 the stock price went right on through the historical normal P/E ratio of 18, and just
prior to being purchased by Warren Buffett was trading at a theoretical fair value blended P/E ratio of
15.4.

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However, what I found most interesting is that the price that Warren Buffett is paying brings the stock
price into alignment with its historical normal P/E ratio. Personally, I do consider that a moderately
steep price to pay. On the other hand, perhaps it’s not too high considering he’s buying the entire
company.

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When I examined the associated performance report with the above graph, it provided additional
perspective on why Warren Buffett might have been interested. This high-quality aerospace and
defense company has dramatically outperformed the average company as measured by the S&P 500
since 2003. However, Warren Buffett’s purchase did provide a nice boost to the historical returns of
long-term shareholders.

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At its closing price on August 7, 2010 Precision Castparts was trading at a blended fair value P/E ratio
of 15.4. Once again, this is below the historical normal P/E ratio of 20.3 since fiscal year 2011.

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Consequently, an argument could be made that Warren Buffett is paying a slight discount to the
company’s historical normal P/E ratio over the past 5 or 6 years. I’m not suggesting that he’s buying
the company cheap, I’m simply pointing out that relative to historical norms, it doesn’t appear that he is
overpaying either.

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Next I thought it would be interesting to do a quick examination of Precision Castparts’ historical gross
(gpm) and net profit margins (npm). I chose the period 1999 to present in order to offer a perspective
on whether margins were improving or declining. Interestingly, Precision Castparts’ gross and net profit
margins have been on the upswing over the past 6 or 7 years.

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Warren Buffett often talks about the book value of Berkshire Hathaway in his reports. Therefore, I
thought it might be interesting to look at Precision Castparts’ book value (common equity per share-
ceps). As of the end of fiscal year March 2015, Precision Castparts’ book value was $76.64.
Consequently, Warren Buffett is paying approximately 3 times book, which I don’t consider a steep
price for such a strong profit growth company.

Precision Castparts has also seen strong growth in assets per share (atps) since fiscal year March
2009. As of the end of fiscal year March 2015, Precision Castparts had assets of $136.24 per share.

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Finally, I took a look at Precision Castparts’ revenues since fiscal year-end March 2009. Once again, I
discovered strong double-digit average growth of revenues.

Summary and Conclusions

Warren Buffett has indicated that he will utilize about $23 billion of Berkshire Hathaway’s cash and
borrow $10 billion to fund the approximately 97% of Precision Castparts that he did not already own.
Although I do not feel that he necessarily stole the company, considering that he is purchasing the
entire enterprise the deal seems to make sense, and is just what I would expect from Warren Buffett.
Therefore, to answer the question posed in the article title, it appears that Warren Buffett has been
true to his value investing principles. Regardless of how the reader may feel, I hope this presentation
provided some additional insights into the mind and investing strategy of the venerable Warren Buffett.

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Disclosure: No position at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and
should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies discussed may not continue and the
companies may not achieve the earnings growth as predicted. The information in this document is
believed to be accurate, but under no circumstances should a person act upon the information
contained within. We do not recommend that anyone act upon any investment information without first
consulting an investment advisor as to the suitability of such investments for his specific situation.

© F.A.S.T. Graphs

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