CDUAF - Buffett And Munger: 'Pick Businesses Not Stocks' - 2 High Yield Meltdown Buys

2023-09-27 08:05:00 ET

Summary

• Warren Buffett and Charlie Munger have said that they focus on picking businesses, not stocks, when making investment decisions.
• We dig into what this means and how investors can apply it to their portfolios today.
• We share two wonderful businesses to buy today at wonderful prices.

Warren Buffett of Berkshire Hathaway ( BRK.A )( BRK.B ) fame once provided a very important insight into how he and his closest business associate - Charlie Munger - have gone about building one of the world's greatest and most successful business empires:

Charlie and I are not stock-pickers; we are business-pickers.

In this article, we are going to delve more into the principle of picking businesses instead of stocks, how that is relevant in today's stock market, and then share two businesses that we think are worth picking even if it seems like their stocks aren't.

Investing Principle: Picking Businesses, Not Stocks

The idea behind picking businesses and not stocks is that when a company performs well over the long term, its stock value should eventually reflect that success. Buffett and Munger apply this principle by actively seeking out companies with promising long-term prospects when making investment decisions.

Too often, investors become so captivated and emotionally influenced by stock charts that they overlook the underlying fundamental performance of the businesses behind the stock tickers.

During times of dramatic market bifurcation, for example, investors often succumb to the emotional temptation to assume that a stock that is going up day after day will continue to do so for no other reason than the fact that its stock chart implies that it has "considerable momentum." Meanwhile, they assume that a stock that is declining day after day will continue to do so for no other reason than the fact that its stock chart implies that it is a "falling knife" with no near-term "support." They therefore sell the falling knife to buy the rocket ship stock.

However, in reality, investors are effectively rushing to a store to sell a piece of merchandise that is on a 30%-50% sale to buy another piece of merchandise that has just had its price hiked by 30-150% recently without even examining the quality or intrinsic value of the actual merchandise. They are therefore reduced to mindless speculators who try to climb on the bandwagon of whatever is hot at the moment with no thought for the long-term wealth creation potential of the underlying assets that they are buying and selling.

In contrast, Buffett and Munger block out the market noise and first assess what a business is worth. They then look at its currently assigned market price and if it is significantly below what they believe the business is worth, they buy it, without regard to whether the stock is falling like a rock or soaring like a rocket.

Why You Should Pick Businesses, Not Stocks In Today's Market

Thus far in 2023, we have seen a massive bifurcation in the performance of stocks. While the A.I. boom has led to a market bonanza for any stock that is related to this emerging disruptive technology, the market has been nearly equally pessimistic on stocks that it views as bond proxies as the "higher for longer" narrative seems to be fully taking root in the markets right now.

A.I. powerhouses like Apple ( AAPL ), Meta ( META ), Amazon ( AMZN ), Tesla ( TSLA ), Microsoft ( MSFT ), Alphabet ( GOOG )( GOOGL ), and Palantir ( PLTR ) have all had very strong years so far:

Meanwhile, the high-yield space has largely suffered from a market meltdown, with numerous REITs ( VNQ ), utilities and yield cos ( XLU ), and high-yield regional banks ( KRE ) suffering a beat-down. Here is a small sampling, with blue chip REITs, like W. P. Carey ( WPC ) and Crown Castle ( CCI ) getting pummeled year-to-date along with dividend growth powerhouse yield cos like NextEra Energy Partners ( NEP ):

How does this relate to the Buffett-Munger principle of picking businesses, not stocks? While many of the leading mega-cap stocks that have had impressive years are undoubtedly wonderful businesses, their valuations mostly now stand at nosebleed levels and therefore render the long-term risk-reward profiles of these businesses less than attractive in our view. In contrast, there are some phenomenal businesses in the high-yield space that are now trading at extremely cheap valuations.

Two High Yield Meltdown Buys

It is at times like this that Buffett-Munger disciples will display the courage to go against the crowd and sell holdings that the market is far too bullish on and then recycle the proceeds into high-quality businesses whose stocks the market has abandoned and left for dead for no other reason than the fact that interest rates are increasingly likely to be higher for longer. In reality, many of these businesses are being misunderstood by Mr. Market because they also offer growth in addition to serving as attractive current income investments.

One example is Realty Income ( O ). The stock has fallen by nearly a third over the past 13 months, despite continuing to grow AFFO per share and its dividend per share at a steady clip.

The reason? Interest rates continue to rise and the market fears that they may remain at that level for a longer period. However, O offers one of the most proven and reliably growing monthly dividend payouts in the entire stock market, has a fortress balance sheet and a battle-tested recession-resistant business model, and currently offers a yield well in excess of where long-term interest rates stand. On top of that, it will likely continue to grow its dividend, cash flow, and overall intrinsic value by a mid-single-digit CAGR for years to come. Clearly, it is far more than a bond proxy, yet the market is beating the stock down relentlessly simply because the risk-free interest rate has moved up.

Obviously, it deserves to sell at a lower level than it did before interest rates rose so rapidly, but the market seems to have entered meltdown mode on this stock and has sold it off irrationally, with many fleeing the stock for no other reason than that the stock chart appears to indicate that its price is in freefall. This is a clear case of investor irrationality, providing investors with the opportunity to buy a wonderful company at a wonderful price.

Another high-quality business that has been mercilessly and irrationally beaten down is ATCO (ACLLF). It is a diversified Canadian infrastructure company whose primary exposure is to Canadian Utilities (CDUAF). Similar to O, its stock price has fallen significantly over the past 13 months despite the company posting a dividend growth streak that exceeds a quarter of a century, the company's balance sheet being in stellar shape, and the company continuing to generate considerable growth in its underlying businesses.

With proven operating excellence (including generating returns on equity that are significantly better than its peers), several exciting growth verticals in its structures and logistics, ports, utilities, and renewable energy businesses, a very strong balance sheet, recession-resistant business model, and a dividend yield that is well north of 5% along with considerable long-term dividend growth potential, ACLLF appears to be a no-brainer buy. Moreover, due almost entirely to "higher for longer" interest rate concerns, ACLLF not only trades at an attractive dividend yield plus growth valuation, but also trades at a steep discount to its utility peers and even trades at a discount to the value of its underlying Canadian Utilities holding, meaning that investors effectively get the structures and logistics and ports businesses for free.

Investor Takeaway

Buffett and Munger have amassed huge personal fortunes and built one of the world's greatest business empires by buying businesses instead of stocks. Given the huge bifurcation going on in markets today, investors would be prudent to keep this important investing principle in mind when making buy and sell decisions in their portfolios. Thanks to irrational selling off of high-quality "bond proxy" businesses, investors now have numerous compelling opportunities to buy wonderful businesses like O and ACLLF at wonderful prices to put themselves on firm footing for long-term wealth compounding and total return outperformance.

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