Finding myself in a bit of rut with my portfolio, I turned to the old master Warren Buffett for inspiration.
He championed an approach that has since been canonised as ‘value investing’. This is an almost scientific strategy, using financial data to determine undervalued shares. It is logically underpinned by the idea that these shares will eventually have their true value recognised by the markets, potentially making those who discovered them early rich.
Buffett didn’t act blindly on faith in numbers, however. He was careful to select only ‘good businesses’. These characteristics include cash generation, high capital returns, stability of profit but also a winning mentality among its staff.
Taking these principles that made Warren Buffett incomprehensibly rich, I have selected two shares that meet his winning criteria.
Don’t just take it from me, investment guru Ronald Baron includes both in his market-beating hedge fund portfolio!
Top of the class
Arch Capital Group (NASDAQ:ACGL) is a specialist insurance company that has become a market leader in a series of regions, primarily through its mortgage arm.
The stock has rallied by 26% this year, outperforming the insurance industry by 4%. Its return on equity was 13.2% in the last 12 month. It also boasts a mammoth $17.17bn market cap.
When considering Buffett’s ideas, it ticks all the boxes of a ‘good business’: steady cash generation, efficient use of investment and a winning culture that drives a seemingly inexorable rise.
What’s more is that it is still undervalued. Zacks Investment Research believe that its earnings per share could increase by up to 40% next year. Its profits-to-earnings ratio, that tool beloved by Buffett, shows that it is undervalued amongst the insurance cohort it is outperforming.
New business opportunities, the prospect of interest rate rises and growth in established jurisdictions suggest that its giddy ascent will continue. As such, I’m a happy shareholder of this stock.
My second Buffett pick is Hyatt Hotels Corporation (NYSE:H). This luxury hotelier has had a golden year as foreign travel has rebounded as the pandemic loosened its grip on our lives. With hotels in every corner of the globe, it has raked it in as leisure travel recommenced.
Its shares have risen by 14% this year, and 10% of their total value has come from growth this year. Holders of these shares have rubbed their hands with glee as net income per share has risen by $1.46. Like Arch Capital, it also outperforms its cohort on this metric. These are indicators of a winning culture as well as favourable return of investment. Subsequently, it certainly meets the classification of a ‘good business’ under the Warren Buffett definition.
Its fortunes are also set to rise even further as a surge in ‘revenge tourism’ combines with new hotel openings and acquisitions. Consequently, Zacks Consensus Estimate shows that earnings per share could almost double next year based on how undervalued it is by the market.
All things considered, the stock is on my watchlist as a potential buy in the near future.
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Tom Hennessy has a position in Arch Capital Group. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2022